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August 1, 2010

So Not Fast!

Regulators and Others Question the Need to Trade at Hyper-Fast Speeds

By By John D'antona Jr. and Peter Chapman

Jim Angel called the flash crash.

In an April 30 letter, the Georgetown University professor and market structure expert told the Securities and Exchange Commission that "with so much activity driven by automated computer systems, there is a risk that something will go extremely wrong at high speed." Six days later he was proven correct.

On May 6, around 2:40 p.m. EST, after modest selling pressure throughout the session, the stock markets took a swan

dive and the Dow Jones Industrial Average plummeted 1,000 points. Within 20 minutes, selling abated and the index rebounded 700 points to close the frenetic trading day down only 348 points.

But the carnage included nearly 21,000 canceled trades, with some stocks trading for as little as a penny. Investor outrage ensued. And inquiries from the media, regulators and government officials followed, demanding to know just what had happened in such a short time frame.

Five days after the crash, Angel again wrote the SEC, essentially saying, "I told you so." He repeated his plea that the SEC force the market centers to impose "an automated marketwide trading halt in any instrument that falls 10 percent in a short period of time." Within two weeks of the crash, the SEC did just that, pushing the exchanges to adopt circuit breakers on the stocks in the S&P 500 Index that, if triggered, would halt trading for five minutes.

Speed Limits

I'm delighted by the move," Angel told Traders Magazine. But the academic, who once designed risk models at BARRA, said he's worried about some of the other curbs on trading speed the Commission is contemplating.

Even before May 6, the SEC was already concerned that the activities of short-term traders might be harming long-term investors. In its Concept Release issued in January, the regulator divided the trading world into two camps: short-term and long-term investors. It questioned whether the speedy first group was putting the second group at a disadvantage.

Advocates for short term traders cried "No!" but the events of May 6 didn't help their cause. By June 10, the SEC was making ominous noises about speed limits.

At the annual meeting of the International Organization of Securities Commissioners in Montreal on that date, SEC chairman Mary Schapiro told the gathering that the Commission was investigating whether it would regulate speed. The SEC, Schapiro said, would "explore whether bids and orders should be regulated on speed so there is less incentive to engage in this microsecond arms race that might undermine long-term investors and the market's capital-formation function." Gary Gensler, chairman of the Commodity Futures Trading Commission, seconded Schapiro's comments. "All too often, people confuse volume with liquidity," he said at the same conference in Montreal. "The average holding period may have been a matter of seconds. Is that really liquidity?"

Sen. Ted Kaufman, D-Del., a critic of high-speed traders who first caught the industry's attention in 2009 with his attacks on short selling, supports Schapiro's way of thinking. Kaufman endorsed her comments that the SEC should explore whether to regulate the speed of trading. He said in a June 11 letter to the SEC that markets should not be reduced to a battle of algorithms in which long-term investors are an afterthought and relegated to second-tier status.