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SEC lays down new rules to prevent ‘flash crashes’

Will pause trading of certain stocks

New rules will halt trading of stocks that rise or fall 10 percent or more in a five-minute period. New rules will halt trading of stocks that rise or fall 10 percent or more in a five-minute period. (Richard Drew/Associated Press)
By Marcy Gordon
Associated Press / June 11, 2010

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WASHINGTON — Federal regulators yesterday put in place new rules aimed at preventing a repeat of last month’s harrowing “flash crash’’ in the stock market.

Members of the Securities and Exchange Commission approved the rules, which call for US stock exchanges to briefly halt trading of some stocks that make big swings.

The exchanges will start putting the trading breaks into effect as early as today for six months. The New York Stock Exchange will begin today’s trading session with five stocks: EOG Resources Inc., Genuine Parts Co., Harley Davidson Inc., Ryder System Inc. and Zimmer Holdings Inc. The exchange will gradually add other stocks next week, expecting to reach by Wednesday the full number to be covered.

The plan for the “circuit breakers’’ was worked out by the SEC and major exchanges after the May 6 plunge, which saw the Dow Jones industrials lose nearly 1,000 points in less than half an hour. Regulators don’t know what caused the crash.

Under the new rules, trading of any Standard & Poor’s 500 stock that rises or falls 10 percent or more in a five-minute period will be halted for five minutes.

The idea is for the trading pause to draw attention to an affected stock, establish a reasonable market price, and resume trading “in a fair and orderly fashion,’’ the SEC said.

On May 6, about 30 stocks listed in the S&P 500 index fell at least 10 percent within five minutes. The drop briefly wiped out $1 trillion in market value, as some stocks traded as low as a penny.

The disruption illustrated a sudden, but temporary, breakdown in the market’s price-setting function when a number of stocks and exchange-traded funds were executed at clearly irrational prices, the SEC’s chairman, Mary Schapiro, said in a statement.

“By establishing a set of circuit breakers that uniformly pauses trading in a given security across all venues, these new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices,’’ Schapiro said.

Exchange-traded funds are popular investments that often track a market index such as the S&P 500 and can be traded throughout the day, unlike mutual funds. The funds were affected by the May 6 plunge more than any other category of securities.

The markets will use the six-month pilot period, ending on Dec. 10, to make needed adjustments based on how the new rules work, the SEC said. The scope of the rules could be expanded to securities beyond the S&P 500, including ETFs.