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May 6 "Flash Crash" Report - the Director's Cut

Gregg Berman, Senior Advisor to the Director of the SEC's Division of Trading and Markets, recently gave an address before the 11th Annual SIFMA Market Structure Conference.  Berman's remarks were focused on the joint SEC and CFTC report on the May 6 "flash crash," and, in his words, "if our report was made into a movie, then my remarks this morning should be taken as the directors-cut DVD, with bonus tracks." Berman's "director's cut" version of the report provides an interesting precis of the suspected triggers of the flash crash:

  • the CFTC had found that a single firm, a large fundamental trader, had sold 75,000 E-Mini contracts between 2:32 and 2:51. But based on an examination of just the price and volume patterns for the E-Mini, it would have been premature to conclude that this trade played a leading role in the main event. After all, half of the contracts had been executed after 2:45 while the E-Mini was on the mend.


  • We also knew that trading on the New York Stock Exchange in a significant number of NYSE-listed stocks was intermittently "halted" around the time of the flash crash by NYSE's use of "Liquidity Replenishment Points" that effectively band stocks to trade only within certain price limits.


  • we knew that exchange traded funds suffered disproportionately during the flash crash. That was notable since most ETFs are listed the NYSE's Arca exchange, and on the afternoon in question, other exchanges reported that they declared self-help on Arca and stopped routing orders to that exchange.

According to Mr. Berman, the SEC and CFTC concluded that these events were related, and served as the starting point of the agencies' investigation.  This investigation followed two lines of inquiry:

The first prong was all about collecting and analyzing market data. We knew that to really understand how and why prices fell so fast we needed to examine underlying order books and trading patterns. The CFTC took the lead on the E-Mini and we at the SEC took the lead on the equity markets.

. . .

The second prong of our investigation involved gathering whatever information we could on the specific actions market participants undertook on May 6, and the reasoning behind those actions.

These lines of inquiry, supported by empirical data, and market participant interviews put into focus a basic question about the current state of equity markets:

Has the structure of our equity markets become so complex, and has trading become so fast, that only the most sophisticated players can effectively monitor and manage their interaction with markets in a robust and holistic fashion? Apparently, for many participants, the answer may be yes.

According to Berman, this issue can be addressed, and many lessons have been learned by the flash crash, chief among them is that

many market participants have their own versions of trading pauses that kick in during extreme events. Unfortunately these pauses don't all occur at the same time or in the same manner. If everyone in a stadium stands up together, then everyone can see the field. And if everyone sits down together, then everyone can still see the field. But if half the people are standing and half the people are sitting you have…a mess. This is what effectively happened on the afternoon of May 6.

Another lesson learned is that a new level of market intelligence is required to stay apace of rapid trading and advances in trading technology.

At the end of May, the SEC released a proposal for the creation of a Consolidated Audit Trail. Allow me to quote from the release "A consolidated audit trail would significantly aid in SRO efforts to detect and deter fraudulent and manipulative acts and practices in the marketplace, and generally to regulate their markets and members. In addition, such an audit trail would benefit the Commission in its market analysis efforts, such as investigating and preparing market reconstructions and understanding causes of unusual market activity." If the events of May 6 don't qualify for unusual market activity, I'm not sure what does. If a consolidated audit trail had been in place prior to May 6, I could have delivered this speech a few months ago.

. . .

I believe that a market structure that can support the requirements of a consolidated audit trail will necessarily be more robust and provide participants with more confidence, even during extreme events. Furthermore, I maintain that the process of implementing such a system will in itself lead to direct and indirect improvements as existing systems are revisited, order types are re-examined, and the industry as a whole confronts some of the issues that make a consolidated audit trail necessary.

Berman's address provides an excellent discussion of the events of May 6, the findings of the SEC and CFTC examination of the flash crash, and lessons regulators and market participants should take away from the event.  Anyone wishing to understand what happened on May 6, 2010 would gain much from reading the entire speech.

The full text of Gregg Berman's address is available at: