'No smoking gun' in flash crash

By Ben Rooney, staff reporter


NEW YORK (CNNMoney.com) -- Last week's brief-but-historic stock market plunge was triggered by a combination of unusual factors, but its ultimate cause remains a mystery, executives from the nation's leading stock exchanges and market regulators told Congress on Tuesday.

A House Financial Services subcommittee is investigating the causes of the so-called flash crash, in which the Dow Jones industrial average plummeted 1,000 points, representing about $1 trillion in market value, before rebounding in a matter of minutes on the afternoon of May 6.

Mary Schapiro, chairwoman of the Securities and Exchange Commission, said that the SEC cannot point a single, isolated cause for the abrupt market turmoil. But she disclosed a number of new details her agency has uncovered, and addressed some of the more popular theories swirling in the market.

The SEC's preliminary investigation has looked at a sharp drop in the value of a stock future called the E-mini S&P 500, which investors use to bet on the future performance of stocks in the broad stock index.

The E-mini S&P 500 futures price fell more than 5% in a few minutes and then quickly recovered, according to Schapiro.

"It should be no surprise that the broader stock market indexes showed similarly fast and similarly large declines and recoveries," she said, since stock prices follow futures prices.

But the correlation doesn't fully explain what happed on Thursday, she added: "It could have as readily been events or anomalous activities in individual stocks that caused someone to trade first in the futures markets."

Gary Gensler, chairman of the Commodity Futures Trading Commission, said his agency's investigation is focused on one of about 205 participants in the market for S&P E-Mini futures during the timeframe of the selloff. But it's still unclear whether that participant did anything unusual.

The SEC is also looking into "massive intraday price swings" in shares of many Exchange Traded Funds as a possible factor in the crash, Schapiro said. The shares of more than a quarter of all ETFs experienced brief declines of more than 50% in Thursday's tumult.

But the SEC has found no evidence of "fat finger" errors, which occur when a trader mistakenly orders billions of shares instead of millions. Schapiro said it's unlikely that exceptionally large orders in Proctor & Gamble (PG, Fortune 500) shares caused the meltdown.

In addition, she said the SEC has found no signs that the collapse was caused by hackers or terrorists.

Broader problems: A general aversion to take on risky investments and an absence of liquidity in the market exacerbated Thursday's plunge, the regulators said.

Separately, the SEC and CFTC announced a new joint committee that will address emerging regulatory issues.

The committee will review last Thursday's market events and the disparate trading conventions and rules across various markets. Schapiro and Gensler said the committee's preliminary findings will be made available to Congress and the public sometime next week.

The SEC and representatives from the six main stock exchanges, along with the Financial Industry Regulatory Authority, agreed on Monday to a "structural framework" aimed at preventing a repeat of Thursday's crash.

The framework would strengthen procedures for circuit breakers -- the trigger points that halt trading in individual stocks -- and steps for handling erroneous trades. It will be refined Tuesday, Schapiro said.

And starting Monday, her commission now has staffers stationed at all major markets to monitor trading.

Stock exchange chiefs on the hot seat

The subcommittee also heard from Eric Noll, the executive vice president of the Nasdaq OMX group; Larry Leibowitz, chief operating officer of NYSE Euronext; and Terrence Duffy, executive chairman of CME Group.

Those executives told lawmakers that markets were jittery going into Thursday's tailspin -- a factor that could have contributed to the abrupt and panicky selloff. But they both acknowledged that the ultimate cause of Thursday's events remain unclear.

"Nasdaq continues to investigate Thursday's events, but has at present located no 'smoking gun' that single-handedly caused or explains Thursday's events," Noll said in written testimony.

The executives also indicated that a lack of coordination between exchanges, allowing electronic trading to continue after manual trading had been paused, was a factor.

"Although some of the underlying economic and global financial conditions that influenced this selling activity are known, the exact succession of events and what precipitated them remain unclear," Leibowitz said.

Noll testified that the crash was triggered by "a confluence of unusual events," adding that Nasdaq experienced "no system malfunctions or aberrations."

The executives expressed support for many of the reforms the SEC is considering, but warned that regulators should not stifle valuable innovations in the financial markets.

Duffy defended one target of pointed questions: High-frequency trading, which critics say gives some investors an unfair advantage in the market. Amid calls to slap more restrictions on these ultra-fast trading strategies, Duffy backed their use, saying they have "made the marketplace more efficient and competitive for all market participants."  To top of page

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