SEC Approves SRO Proposals to Address Extraordinary Volatility in Individual Stocks and Broader Stock Market
Kelley Drye Client Advisory
On May 31, 2012, the Securities and Exchange Commission (SEC) approved two proposals submitted by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) designed to address extraordinary volatility in individual stocks as well as the broader U.S. stock market. One initiative establishes a “limit up-limit down” mechanism to prevent trades in individual exchange-listed stocks outside of a specified price band. When implemented, this new mechanism will replace the existing market-wide circuit breakers that the SEC approved on a pilot basis after the market events of May 6, 2010. The second initiative updates existing market-wide circuit breakers that when triggered, halt trading in all exchange-listed securities throughout the U.S. markets. The proposals will be operative on a one-year pilot basis, beginning February 4, 2013.
“Limit Up-Limit Down” Plan for Individual SecuritiesThe “limit up-limit down” mechanism, established jointly by the exchanges and FINRA, prevents trades in individual listed equity securities outside of a specified price band, set as a percentage level above and below the average price of the security over the immediately preceding five-minute period. In essence, the security would enter a “limit state” if its price moves a certain percentage. For more liquid securities — those in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products — the level will be 5%, and for other listed securities the level will be 10%. The percentages will be doubled during the opening and closing periods and broader price bands will apply to securities priced $3 per share or less.
To accommodate more fundamental price moves, a five-minute trading pause will be triggered if trading does not occur within the price band for more than 15 seconds.
Under the new plan all trading centers, including exchanges, automated trading venues, and broker-dealers executing trades internally, must establish policies and procedures to prevent trades from occurring outside the applicable price bands, comply with trading pauses, and otherwise comply with the procedures set forth in the plan.
Market-Wide Circuit BreakersThe second initiative updates existing market-wide circuit breakers that when triggered, halt trading in all exchange-listed securities throughout the U.S. markets. The updated market-wide circuit breakers lower the percentage-decline threshold for triggering a market-wide trading halt and shorten the amount of time that trading is halted. Notably, the market-wide circuit breakers were not triggered during the severe market disruption of May 6, 2010, and since their adoption in 1988, were triggered only once.
The revised market-wide circuit breaker rules update the existing rules by:
- Reducing the market decline percentage thresholds needed to trigger a circuit breaker to 7%, 13% and 20% from the prior day’s closing price, rather than declines of 10%, 20% or 30%.
- Shortening the duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60 or 120 minutes.
- Simplifying the structure of the circuit breakers so that there are only two relevant trigger time periods - those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m. The two periods replace the current six-period structure.
- Using the broader S&P 500 Index, rather than the Dow Jones Industrial Average, as the pricing reference to measure a market decline.
- Requiring the trigger thresholds to be recalculated daily rather than quarterly.