Exchanges to Retool Circuit Breakers

By AARON LUCCHETTI, KARA SCANNELL and DONNA KARDOS YESALAVICH

Major stock exchanges agreed to introduce temporary trading limits on individual stock moves, following on Thursday's volatile trading session, according to people familiar with the matter.

While they didn't settle on details, the leaders of six major exchanges agreed to "a structural framework, to be refined over the next day, for strengthening circuit breakers," the Securities and Exchange Commission said Monday, referring to the market's term for stock halts.

Meanwhile, exchange operators along with leaders from the SEC and Commodity Futures Trading Commission are expected to testify on Capitol Hill on Tuesday at 3 p.m. Eastern time.

The move by the SEC and exchanges to strengthen circuit breakers—including adding the devices for individual stocks—promises to be one of the more significant shifts in trading rules since the agency passed Regulation NMS in 2007 to encourage faster, cheaper electronic trading.

The rule, debated for years, enabled electronic upstarts like BATS Global Markets and Direct Edge to take big chunks of market share from the major incumbents, Nasdaq Stock Market and New York Stock Exchange, by letting them trade even when the NYSE decides to pause.

Thursday's trading showed some unintended consequences of the rule. The NYSE floor slowed trading in more than 1,000 stocks, but the electronic exchanges kept trading with limited buyers at the same furious pace. Some stocks plunged artificially on the electronic markets, falling more than 60% or 90% before snapping back.

Had there been stock-specific circuit breakers across all exchanges that the downfalls could have triggered, many experts say, the velocity of the declines would have been less severe.

"You cannot have one market operating at a different speed than the other markets," says Patrick J. Healy, chief executive of Issuer Advisory Group, an organization that counsels publicly traded companies about their dealings with exchanges.

During Monday's two hour meeting with exchange executives including NYSE Chief Duncan Niederauer and Nadsaq CEO Robert Greifeld, the SEC kicked around several thresholds that could trigger a circuit breaker, but an agreement on the percentage point drop wasn't reached, said a participant in the meeting.

One senior exchange official not at the meeting said a reasonable starting place for temporary halts would be when a stock declined by 10%, though electronic exchange officials who previously disliked circuit breakers as arbitrary measures that could slow trading could push for wider thresholds that would be triggered less often.

SEC officials also pushed exchanges to come up with a more uniform approach to when trades should be canceled for being "erroneous," or too far off the previous market price, the meeting participant said.

Currently, there isn't a uniform approach to dealing with "clearly erroneous" trades. Instead, exchanges have worked, as they did last week, to come up with solutions to errors as they have come up.

Last week the NYSE and Nasdaq agreed to cancel trades that were 60% or more away from a designated price during Thursday's trading, in which the Dow dropped by nearly 1,000 points before making up much of that ground.

By Tuesday, the exchange officials are expected to come back to the SEC with an agreement in principle. It isn't clear how quickly the SEC and exchanges will implement new rules.

The move to add circuit breakers for individual stocks would leave major parts of Regulation NMS intact, especially when markets are functioning normally.

One government official said that, while Reg NMS is likely be part of the SEC's current review of market structure, potential changes are likely to be more "nuanced" than a complete overhaul.

At Tuesday's hearing, before a U.S. House Financial Services subcommittee. SEC Chairman Mary Schapiro is scheduled to testify with CFTC Chairman Gary Gensler.

The House subcommittee will hear from a second panel that includes NYSE Euronext Chief Operating Officer Lawrence Leibowitz, Eric Noll.