New Trading Pause Proposals to Include More Issuers

June 30, 2010

In an attempt to protect a wider range of issuers from the aberrational pricing experienced by many issuers during the “flash crash” of May 6, 2010, the Securities and Exchange Commission (“SEC”), the exchanges and the Financial Industry Regulatory Authority (“FINRA”) proposed on June 30, 2010 to expand previously adopted circuit breakers by approximately 500 additional stocks by including the Russell 1000 index in the pilot, and also to include over 300 ETFs. The proposed expansion includes ETFs that represent the S&P 500 index, the Russell 1000 index, the Nasdaq 100 index and the Dow Jones Industrial Average. The proposed rules will be subject to a 10-day comment period after publication in the Federal Register. If approved, the rules would be in effect on a pilot basis through December 10, 2010.

In response to the flash crash, the exchanges and FINRA initially adopted circuit breaker rules that would “pause” trading in any component of the S&P 500 Index if its price dropped or rose 10 percent or more in five minutes. This pause gives time for new buy orders to be entered when prices fall sharply, to avoid aberrational trade prices from gaps in liquidity. The pause lasts five minutes and operates from 9:45 a.m. to 3:35 p.m. Eastern Time.

The expanded circuit breaker rules are likely only part of the response to the flash crash. The pilot is likely to be expanded to additional stocks. In addition, the exchanges and FINRA have proposed tightening the rules for breaking erroneous trades. The SEC has announced that it will also review stop-loss market orders, absurdly low stub quotes (which are off-market quotes used by market makers solely to meet their quoting obligations), and the use of self-help rules (which allow a trading center to “trade through” another trading center’s quotes under certain circumstances).

The SEC already has proposed a consolidated audit trail rule and a large trader reporting rule designed to speed collection and analysis of trading information. In addition, the SEC is reviewing comments on its concept release on equity market structure, which raised issues regarding high frequency trading and the role it plays in providing liquidity to the market.

The circuit breaker expansion should help reduce volatility arising from brief gaps in liquidity and protect issuers from aberrational prices in their stocks. The impact of the circuit breakers in times of major market-wide price declines is yet to be determined.

If you have questions regarding this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

Gerard Citera212 450
Robert L.D. Colby202 962
Annette L. Nazareth 202 962 7075
Lanny A. Schwartz212 450
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