The Financial Industry Regulatory Authority and at least two exchange operators are taking steps to counter a growing source of frustration for traders: erroneous stock halts.
Since the new "circuit breaker" rules were put in place in June, trading has been halted in at least half a dozen securities. Only one halt-in Genzyme on July 23-was triggered "appropriately." The rest were triggered by bad trades, or legitimate ones upon which trading halts should not have been based.
The rules, enacted in the wake of the May 6 "flash crash," were designed to slow the progress of a rapidly rising or falling security. The pauses kick in after a trade moves the price of the security by at least 10 percent from its "fair value." They last for five minutes.
The bad halts have annoyed traders. They have complained that trades of a few hundred shares should not be responsible for halting trading in securities that may trade millions of shares per day.
Speaking before the Securities and Exchange Commission on Aug. 11, Kevin Cronin, director of global equity trading at money management firm Invesco, criticized "this nefarious problem." He pointed to "small trades causing circuit-breaker elections and halts in stocks like Cisco and Citigroup that have no business being halted. They’re such small share amounts."
Cronin’s comments were echoed by others. Dave Cushing, director of global equity trading at Wellington Management Co., told the SEC in a letter last month that the firm questions "whether any single trade, particularly a small erroneous one, should be allowed to trigger a trading halt for a security."
Now, FINRA, Nasdaq OMX and NYSE Euronext are taking steps to reduce the likelihood that a single "false positive" print can bring trading to a standstill.
Under proposals by Nasdaq and NYSE, the exchanges would continue to apply the 10 percent threshold but would only halt trading if the print in question is inside the NBBO. If a print falls outside the NBBO, they will not immediately halt trading. Instead, the exchange operators will wait until three trades occur outside the NBBO before halting the stock.
A trade that occurs outside the NBBO "is likely an erroneous execution," Nasdaq and NYSE told the SEC in letters. Most trades occur within the NBBO, sources tell Traders Magazine.
Industry executives reacted cautiously to the plans. Vlad Khandros, in charge of corporate strategy at institutional brokerage Liquidnet, and that firm’s market structure expert, likes the idea, but would not want to see it implemented unilaterally. "It’s great that exchanges are providing their own ideas," he said, "but we’d like a uniform set of rules across the market."
Among the other exchanges, Chris Isaacson, chief operating officer of BATS Exchange, sees the logic in the idea, but has reservations. He notes, for example, that exchanges receive a number of Intermarket Sweep Orders that trade outside the NBBO. They are not "clearly erroneous," but would be ignored under the proposals.
FINRA is also tackling those trades that occur outside the NBBO. Under new FINRA guidelines, qualified contingent trades, print protection trades and error correction trades reported to the trade-reporting facilities operated by FINRA for Nasdaq and NYSE will be automatically blocked from triggering trading halts, regardless of price. These types of trades typically print outside the market’s fair value and will now be classified in the same manner as volume-weighted average price trades, which are also prevented from triggering halts.
FINRA’s move comes in the wake of a trading halt in the shares of Micron Technology. That stock fell 12 percent on Aug. 5, on the strength of a qualified contingent trade, a stock trade that accompanies a trade in a related derivative and typically occurs outside the NBBO.
FINRA is also asking its members to make sure they are coding their trade reports appropriately, so that its systems understand when trades fall outside the scope of the circuit-breaker rule. Brokers reporting the three trade types must start coding their trade reports appropriately by Oct. 18.
"FINRA came up with some functionality that won’t allow these prints to go in with one push of the button," explained Brian Hyndman, Nasdaq OMX senior vice president, U.S. transaction services. "You’ll have to review it a few times."
All four of these trades-the QCT, error correction, print protection and VWAP-are classified as exemptions to the SEC’s Rule 611 trade-through rule. In other words, they are all trades permitted to trade at prices inferior to the best bid or offer.
Despite trader pique, the SEC does not appear overly concerned about the trading halt snafus. SEC chairman Mary Schapiro, speaking at a joint investigative hearing of the SEC and the Commodity Futures Trading Commission on Aug. 11, told panelists that "While we have had a number of triggers, I’d be interested to know if they have caused any harm to the marketplace. It’s not my perception that they have."
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