By Jonathan Spicer and Rachelle Younglai
NEW YORK/WASHINGTON |
Fri Oct 1, 2010 11:49pm EDT
NEW YORK/WASHINGTON (Reuters) - A computer-driven sale worth $4.1 billion by a single trader helped trigger the May flash crash, setting off liquidity shocks that ricocheted between U.S. futures and stock markets, regulators concluded in a report.
The report by the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission did not name the trader. Reuters, citing internal documents prepared by exchange operator CME Group Inc, in May identified the trader as money manager Waddell & Reed Financial Inc.
The long-awaited report focused on the relationship between two hugely popular securities -- E-Mini Standard & Poor's 500 futures and S&P 500 "SPDR" exchange-traded funds -- and detailed how high-frequency algorithmic trading can sap liquidity and rock the marketplace.
"The interaction between automated execution programs and algorithmic trading strategies can quickly erode liquidity and result in disorderly markets," the report said.
The "flash crash" sent the Dow Jones industrial average plunging some 700 points in minutes on May 6, exposing flaws in the electronic marketplace dominated by high-speed trading. The Dow was down nearly 1,000 points at its lowest point on that day.
Although the report did not make any recommendations, it lays the foundation for a special commission to propose new rules to avoid a repetition. At least one lawmaker threatened congressional action if regulators did not address the disparity in the markets.
Trading was turbulent that afternoon because of concerns over the European debt crisis. Against that backdrop, a "large fundamental trader" initiated a sell program to sell 75,000 E-Mini contracts as a hedge to an existing equity position, according to the 104-page report.
Citing documents from CME Group, Reuters reported on May 14 that Waddell sold a large order of E-Minis during the market plunge, identifying the firm to which the chairman of the Commodity Futures Trading Commission, Gary Gensler, had alluded in congressional testimony.
The CFTC had resisted naming Waddell in Friday's report because of laws that allow it to withhold such information from the public, sources have said.
SEC and CFTC officials declined to comment on whether they were investigating Waddell for any wrongdoing. Waddell, of Overland Park, Kansas, declined to comment on the report.
THE 'HOT-POTATO' EFFECT
Waddell's selling algorithm had "no regard to price or time," the report said. That, coupled with the "aggressive" reaction by high-frequency traders hedging their positions, led to two separate "liquidity crises" -- one in the E-minis, the other among individual stocks.
Waddell's algo "responded to the increased volume by increasing the rate at which it was feeding the orders into the market, even though orders that it already had sent to the market were arguably not yet fully absorbed by fundamental buyers or cross-market arbitrageurs," the report said.
These arbitrageurs transferred the selling pressure to the stock market, sparking a "hot-potato" effect among high-frequency traders that rapidly passed the same positions back and forth.
The stock market, the report continued, began plunging as trading pauses kicked in at individual firms, as high-frequency traders became net sellers, and as market makers began routing "most, if not all," retail orders to the public markets -- a flood of unusual selling pressure that sucked up more dwindling liquidity.
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