Staffs of the SEC and CFTC have released the preliminary findings of their investigations into the mysterious May 6 "Flash Crash." Though the precise causes of the acute and sudden disappearance of meaningful prices for many major exchange-listed stocks in the middle of the May 6 trading day still remain a mystery, the SEC and CFTC have put forth this brief to provide context. The agencies' staffs stated in their report that they are pursuing the following working hypothesis and findings:
- possible linkage between the precipitous decline in the prices of stock index products such as index ETFs and the E-mini S&P 500 futures, on the one hand, and simultaneous and subsequent waves of selling in individual securities, on the other, and the extent to which activity in one market may have led the others;
- a generalized severe mismatch in liquidity, as evinced by sharply lower trading prices and possibly exacerbated by the withdrawal of liquidity by electronic market makers and the use of market orders, including automated stop-loss market orders designed to protect gains in recent market advances;
- the extent to which the liquidity mismatch may have been exacerbated by disparate trading conventions among various exchanges, whereby trading was slowed in one venue, while continuing as normal in another;
- the need to examine the use of “stub quotes”, which are designed to technically meet a requirement to provide a “two sided quote” but are at such low or high prices that they are not intended to be executed;
- the use of market orders, stop loss market orders and stop loss limit orders that, when coupled with sharp declines in prices, for both equity and futures markets, might have contributed to market instability and a temporary breakdown in orderly trading; and
- the [effect] on Exchange Traded Funds (ETFs), which suffered a disproportionate number of broken trades relative to other securities.
The SEC and CFTC also reported that they found no evidence of "fat finger" errors, computer hacking, or terrorist activities behind the events of May 6. The agencies' staffs further reported that they continue to investigate a number of key themes:
- Futures and Cash Market Linkages.
- Implications for the Equity Markets.
- Exchange-Traded Funds.
The full text of the SEC and CFTC "Preliminary Findings Regarding the Market Events of May 6, 2010" is available at: http://www.sec.gov/sec-cftc-prelimreport.pdf