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SEC unveils 'flash crash' fixes, but Dow plunge still mysterious

A report on the May 6 stock market 'flash crash' released by regulators Tuesday is thin on answers for why the Dow took a 1,000-point dive.

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Market fragmentation. Markets such as the New York Stock Exchange, the NASDAQ, and over-the-counter markets are entwined but not well integrated, with similar securities trading on different platforms that have different rules. In some cases, trading was slowed in one venue, while continuing as normal in another.

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Evaporation of liquidity. The role of "market maker" financial firms is under review, since they normally keep markets flowing by standing ready to buy or sell when others are doing the opposite. An apparent sudden decline in liquidity may have been deepened "by the withdrawal [of] electronic market makers."

Cascading trades. The crash may have been worsened by automated "stop-loss market orders," in which investors hope to protect themselves by getting out of a security that's falling fast. These and other types of trade orders "might have contributed to market instability," the report said.

The ETF connection. The investigation found that most exchange-traded fund (ETF) declines happened after broader markets had dropped. But ETFs ended up accounting for about 70 percent of the trades that were canceled after the fact by exchanges, because of the severe price swings. The regulators are looking into possible reasons ETFs were so affected, including whether some firms sold ETFs as a way to quickly reduce exposure to the market.

If all these are parts of the puzzle, they still need to be pieced together to explain how some stocks dropped to one penny per share before rebounding. In all, roughly 14 percent of securities suffered greater declines than the broader market on May 6.

"The whipsawing prices resulted in investors selling at losses during the decline and undermined confidence in the markets," the report said.

That explains why, even as the investigation continues, regulators are working on new safety measures:

• Exchanges are expected to implement circuit breakers for individual stocks. A pause in trading would allow market makers to mobilize to meet sudden surges in demand for liquidity.

• Regulators say the exchanges should improve their procedures for breaking (canceling) trades that occur at off-market prices. The policies should become more consistent, transparent, and predictable, they say. On May 6, the cut-off point for many broken trades was that the security had swung 60 percent or more in price. That's cold comfort to someone who lost, say, 50 percent on a trade.

• The regulators also say they are "reviewing the obligations of professional liquidity providers and evaluating the use of various order types (market orders, stop loss orders)."

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