[ by Howard Haykin ] The SEC signed off on two rule proposals designed to address extraordinary volatility in individual securities and the broader U.S. stock market.  FINRA filed one rule proposal, while a group of national securities exchanges filed the other rule proposal.

• One Rule Filing establishes a "limit up-limit down" mechanism that prevents trades in individual exchange-listed stocks from occurring outside of a specified price band.  When implemented, this new mechanism will replace the existing single-stock circuit breakers that the Commission approved on a pilot basis after the events of the May 6, 2010 Flash Crash.

• The Second Rule Filing updates existing market-wide circuit breakers that, when triggered, halt trading in all exchange-listed securities throughout the U.S. markets.  The existing market-wide circuit breakers were adopted in October 1988 and were triggered only once - in 1997.  The changes lower the percentage-decline threshold for triggering a market-wide trading halt and shorten the amount of time that trading is halted.

Implementation Date. The exchanges and FINRA will implement these changes by 2/4/13.  On Thursday, the SEC approved both proposals for a 1-year pilot period, during which the exchanges, FINRA, and the Commission will assess their operation and consider whether any modifications are appropriate. “Limit Up-Limit Down” Plan for Individual Securities. The "Limit Up-Limit Down" mechanism, established jointly by the exchanges and FINRA, prevents trades in individual listed equity securities from occurring outside of a specified price band, which would be set at a %-level above and below the average price of the security over the immediately preceding 5-minute period.  For more liquid securities - those in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products - the level will be 5%, and for other listed securities the level will be 10%.  The percentages will be doubled during the opening and closing periods and broader price bands will apply to securities priced $3 per share or less. To accommodate more fundamental price moves, there would be a 5-minute trading pause, similar to the pause triggered by the current circuit breakers, if trading is unable to occur within the price band for more than 15 seconds. Under the new plan all trading centers, including exchanges, automated trading venues, and broker-dealers executing trades internally, must establish policies and procedures to prevent trades from occurring outside the applicable price bands, honor any trading pause, and otherwise comply with the procedures set forth in the plan. Updated Market-Wide Circuit Breakers. The revised market-wide circuit breaker rules update the existing rules by:

• Reducing the market decline percentage thresholds needed to trigger a circuit breaker to 7, 13, and 20% from the prior day’s closing price, rather than declines of 10, 20, or 30%.
• Shortening the duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60, or 120 minutes.
• Simplifying the structure of the circuit breakers so that there are only 2 relevant trigger time periods, those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m. The 2 periods replace the current 6-period structure.
• Using the broader S&P 500 Index, rather than the DJIA (Dow Jones Industrial Average), as the pricing reference to measure a market decline.
• Requiring the trigger thresholds to be recalculated daily rather than quarterly.

The market-wide circuit breakers were not triggered during the severe market disruption of 5/6/10 (so-called "Flash Crash"), which led the exchanges and FINRA, in consultation with SEC staff, to assess whether the circuit breakers needed to be updated in light of today’s market structure. In addition, the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues recommended in February 2011 that the SEC and CFTC review the current operation of the market-wide circuit breakers, and consider appropriate modifications. Additional Measures. In addition to the single-stock circuit breaker pilot program, the SEC has undertaken other initiatives in the wake of 5/6/10, including:

• Approving new exchange and FINRA rules clarifying how and when erroneous trades would be broken.
• Approving new exchange and FINRA rules to strengthen the minimum quoting standards for market makers and effectively prohibit “stub quotes” in the U.S. equity markets.
• Adopting a rule requiring broker-dealers to have risk controls in place before providing their customers with access to the market.
• Adopting a rule establishing a large trader reporting system to enhance the Commission’s ability to identify large market participants and collect information on their trading activity.

The SEC staff also is considering what additional measures may be needed, including establishing a consolidated audit trail system to better track orders and trades in securities across the national market system. For further details, go to:  [SEC PR 12-107, 6/1/12], along with:

• National Market System Plan Approval Order.
• Market-Wide Circuit Breaker Approval Order.