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Investors Punished by Never Ending Flash Crashes

In investigating the root cause of inexplicable stock movements like the 14,000% rise in the Iridium-linked security, TheStreet contacted major U.S. stock exchanges, FINRA and the SEC, who initially declined to comment on the record, leaving many basic questions on enforcement unanswered.

After a correspondence, NYSE spokesperson Keara Everdell allowed FINRA's Gira to discuss how the agency goes about work contracted from the exchange.

Two exchange executives, who weren't authorized to speak on the record, and Gira of FINRA expressed confidence that as rules such as Market Access become entrenched and new rules are implemented, erroneous trading is likely to decline sharply.

One exchange executive noted the Market Access rule sets clearer precedent against manipulative or irregular trading, and holds brokers more accountable for a wide range of possible violations.

Another exchange official pointed to soon to be implemented 'limit up-limit down' rules as providing a kill switch that could preemptively stop erroneous executions before they happen.

Gira of FINRA echoed those sentiments and added that because most brokers under FINRA's jurisdiction now face second reviews, future rule violations are more likely to lead to sanctions. He also expressed confidence that a next set of post-crash rules will further arrest erroneous trading and help to stabilize markets.

"The probability of another Flash Crash occurring is much lower than it was before. The market has been shored up because of single stock circuit breakers and should be further supported by the limit up and limit down process that becomes effective next February," says Gira.

Hunsader of Nanex gives exchanges, FINRA and the SEC credit for reducing the number of what he sees as stub quote trades by way of post-crash regulations. Nevertheless, he sees countless violations since the rule's enactment and questions whether some policies such as trade cancellations facilitate rule breaking.

"They shouldn't cancel any of the trades because then there is no incentive to improve," says Hunsader of high and low trade executions that could cause losses large enough to dissuade traders from holding out stub quotes.

While the most abnormal trades are normally cancelled, some irregular trades within erroneous parameters stand and raise the prospect of unwarranted gains and losses. The Iridium-linked security closed Nov. 29 trading 12% higher, after only changing hands a half dozen times in the month. Some ordinary investors were left holding big losses in the wake of the May 2010 crash.

Currently, the SEC is undergoing changing of guard as the likes of chair Mary Shapiro and Markets Director Robert Cook leave the agency. In the interim, Schapiro will be replaced by Elisse Walter, a current SEC commissioner. The SEC, who credits Cook as having been a key figure in the agency's flash crash response and implementation of circuit breaker, erroneous trade and limit-up/limit-down rules, is yet to name his replacement.

The Iridium-linked security's 14,000% surge and many other similar erroneous trading instances signal that regulators have work left to do in responding to the root causes of the flash crash.

Exchanges and industry-appointed regulators like FINRA also need to state in more clear terms how post-crash rules are being enforced, and show better results if erroneous trading continues in the New Year.

-- Written by Antoine Gara in New York

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