SEC investigating brokerage firms role in market selloff

The New York Times - WASHINGTON — The enforcement division of the Securities and Exchange Commission is investigating whether market makers and brokerage firms fulfilled their legal obligations to provide liquidity in the markets by buying and selling stock during the sharp market drop of May 6, the chairwoman of the agency said Thursday.

The S.E.C. is also looking into whether market makers and brokers executed investors’ trades correctly.

Mary L. Schapiro, the S.E.C. chairwoman, said the agency was also considering whether to establish market participation mandates for professional traders like high-frequency traders who were not obligated to continue trading during periods of extreme market stress.

The comments came during testimony to the Senate Subcommittee on Securities, Insurance and Investment, which, like a House subcommittee last week, had called the leaders of various market regulators and exchanges to testify on the causes of the May 6 market plunge.

On May 6, stock prices fell by about 6 percent in a matter of minutes before recovering nearly as quickly. Earlier this week, the S.E.C. said that in reaction to the market tumult, circuit breakers would be installed for individual stocks in the Standard & Poor’s 500-stock index on a six-month test basis beginning in June. Those circuit breakers would halt trading for five minutes in stocks that fell or rose by more than 10 percent in a five-minute period.

Ms. Schapiro said the commission would also re-examine its rules concerning circuit breakers for the overall market, which were not tripped on May 6 because the Dow Jones industrial average did not drop by 10 percent. In addition to reviewing whether that percentage level was appropriate, Ms. Schapiro said, the agency would examine whether the trigger should be based on a broader stock index, like the Standard & Poor’s 500.

Gary Gensler, the chairman of the Commodity Futures Trading Commission, said that his agency would also examine its circuit breakers, as well as whether there should be new rules governing the use of computer-driven, or algorithmic, trading.

Mr. Gensler noted that while human traders could react to an unusual event like the one that occurred on May 6, computers simply did what they were instructed to do, repeatedly. That, he added, was part of the problem on May 6.

During the period of highest market stress on May 6, many institutional investors stopped trading, according to a review of the day’s trading activity by the S.E.C. and the C.F.T.C. .

Among those that legally stepped back from the market during that time were several of the firms that employ computer programs to trade millions of shares a second and that are usually the biggest providers of liquidity in the stock market.