Corporate Governance

Market crash caused by a single sale

A mutual fund’s single sale of $4.1 billion in futures contracts triggered a series of events that sent the market into a downward spiral May 6, federal regulators said Friday. 

The computer-automated sale that created the “flash crash” was too large and moved through the market too quickly — in less than 20 minutes — adding pressure during an already turbulent day that was hampered by concerns over the Greek debt crisis, according to a joint staff report released Friday by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

The pressure of the sale, generated by a computer program based on mathematical formulas, shifted from the futures markets to the stock market, creating a rapid drop in individual stock prices and leading investors to pull their money off the market. 

The report and SEC and CFTC staffers said two similar computer programs had been used on sales of equal or larger size in the past 12 months, but both were executed over several hours instead of minutes. 

The report also found the market drop wasn’t caused by a single firm trying to manipulate the market or hedge its position in an aggressive way, easing the uncertainty surrounding the roller-coaster ride of that day. 

The long-awaited report comes nearly fives months after the Dow Jones Industrial Average plunged nearly 1,000 points in less than 30 minutes.

Neither the report nor staffers would name the firm, but news reports identified the mutual fund as Waddell & Reed, based in Kansas. 

On May 6, at about 2:32 p.m., the firm initiated a program to sell 75,000 E-Mini Standard & Poor’s 500 futures contracts using a chosen algorithm, designed to hedge risk from price declines, taking into account volume without regard for price or time. The sale took 20 minutes. 

Staffers wouldn’t comment during a conference call Friday with reporters on why the firm chose that particular computer program in the middle of the afternoon when the market was already down more than 2 percent. Firms regularly choose from computer programs when buying and selling stocks, usually based on the day’s events. 

About 2:42 p.m., the market dropped more than 5 percent in the next five minutes. Prices hit bottom at about 2:47 p.m., down nearly 990 points, or 9.1 percent below the day’s start. The market regained some of its losses, going back up 543 points in less than two minutes, finishing the day down 347.80, or 3.2 percent. 

When staffers spoke with the market participants from that day, a general theme that emerged is that they use automated systems to keep up with the speed of markets and most have automatic pause built into their computer programs if anything dramatic happens, such as prices going up or down. 

“This report identifies what happened and reaffirms the importance of a number of the actions we have taken since that day,” Mary L. Schapiro, the SEC chairwoman, and Gary Gensler, the chairman of the CFTC, said in a statement.

The staff report has been submitted to the SEC-CFTC advisory committee, which has made several changes to market rules in the months since the May crash. 

One change is the addition of a circuit breaker across all stocks in the S&P 500 index that will stop trading for five minutes on individual stocks if prices increase or decrease 10 percent during a five-minute period. 

Other changes could come based on the report, but what and when is uncertain, staffers said. 


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