On June 1, 2012, the Securities and Exchange Commission (SEC)
announced two new initiatives to address extraordinary volatility
both in individual stocks and the stock market as a whole. The
initiatives were submitted by the Financial Industry Regulatory
Authority (FINRA) after the stock market drastically dropped in a
matter of minutes and the existing rules failed to stop the plunge.
The proposed initiatives include two trigger mechanisms that will
be implemented for a one-year pilot period by February 4, 2013.
This alert describes these initiatives as well as several other
related rule changes. For more detail, a copy of the SEC release is
The first initiative replaces the single-stock circuit breakers
with a "limit up-limit down" mechanism, which prohibits
trading for individual listed equity securities outside of a
designated price band. The price band is set at a percentage above
and below the average price of the stock for the previous
five-minute period. For more liquid securities, such as those in
the S&P 500 Index and the Russell 1000 Index, the price band
will be set at 5 percent. For all other listed securities the price
band will be set at 10 percent, except securities trading at $3 per
share or less which will be subject to an even broader price band.
These percentages will be doubled during the first 15 minutes after
the market opens and the last 25 minutes before the market closes.
To accommodate fundamental price moves, if no trading activity
occurs within the price band for 15 seconds, then a five-minute
trading pause for the individual security is triggered. As a result
of this initiative, trading centers will have to establish policies
that prevent trades outside of the appropriate price band and
comply with the established trading breaks.
Market-Wide Circuit Breakers
The second initiative revises the current market-wide circuit
breaker rules to allow for a trading halt if the market as a whole
declines a certain percentage from the prior day's closing
price. Under the proposed initiative, the percentage decline, or
"trigger threshold," will be calculated daily, as opposed
to quarterly. Additionally, the proposed initiative moves the
trigger thresholds needed to trigger a circuit breaker from 10, 20,
or 30 percent to 7, 13, or 20 percent. The initiative uses the
broader S&P 500 Index, as opposed to the Dow Jones Industrial
Average, to calculate such thresholds.
Whether trading is halted and for how long also depends on when
the percentage decline occurs. Under the proposed initiative, if a
trading halt is triggered that does not close the market for the
day, then the halt will last for 15 minutes, as opposed to a 30,
60, or 120 minute break. The proposed initiative also simplifies
the structure of the circuit breaks so that there are only two
relevant triggered time periods, those that occur before 3:25 p.m.
and those that occur on or after 3:25 p.m.
The SEC also has undertaken several other initiatives in light
of the recent market failures, including adoption of the
New exchange and FINRA rules specifying when and how erroneous
trades would be broken;
New exchange and FINRA rules to strengthen the minimum
quotation standards for market makers and the prohibition of
"stub quotes" in the U.S. markets;
Rules requiring broker-dealers to have risk controls in place
before granting their customers access to the market; and
Rules establishing a large trader reporting system to enhance
the SEC's ability to identify large market participants and to
gather trading activity information.
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