SEC Approves “Limit Up-Limit Down” Plan
and Tighter Circuit Breakers

June 6, 2012

On May 31, 2012, the SEC approved two proposals submitted by the national securities exchanges and FINRA that are designed to dampen volatility in the stock market following the May 6, 2010 flash crash:  the establishment of a “limit up-limit down” plan that would temporarily prevent trading in a particular listed stock in the event of rapid price swings, and the modification of existing market-wide circuit breakers.  Both proposals are scheduled to go into effect on a one-year pilot basis on February 4, 2013.

Limit Up-Limit Down Plan

The new limit up-limit down plan, which is intended to replace the current single-stock circuit breaker pilot, requires exchanges, alternative trading systems, broker-dealers and other trading centers to establish policies and procedures that prevent the execution of trades and the display of offers outside of a specified price band.  Price bands for each security will be set (and reset throughout the trading day) at a percentage above and below the security’s average price over the prior five minutes of trading, but will not be reset if price movements within the period are one percent or less.  The price band for most stocks in the S&P 500 Index and the Russell 1000 Index, as well as certain exchange-traded funds and notes that have been designated in the SEC’s release (collectively, “Tier 1 NMS stocks”), will be 5%.  The price band for most other listed stocks and certain other exchange-traded instruments will be 10%.  Price bands will be doubled during opening and closing periods, and broader price bands will apply at all times for listed stocks and exchange-traded instruments priced at or below $3.00.  If bid or offer quotations are at the far limit of the price band for more than 15 seconds, trading in that security will be subject to a five-minute trading pause.  During its first six-months of operation, the limit up-limit down plan will apply only to Tier 1 NMS stocks.  Thereafter, it will apply to all covered stocks.  

Tightened Market-Wide Circuit Breakers

The market-wide circuit breakers have been updated in a number of ways, including by:

  • decreasing the existing 10%, 20%, and 30% market decline thresholds that trigger market-wide trading halts to 7%, 13%, and 20%, respectively;
  • using the S&P 500 – not the Dow Jones Industrial Average – as the circuit breaker benchmark;
  • recalculating the circuit breaker thresholds on a daily – not quarterly – basis;
  • modifying the time when halts may be triggered; and
  • modifying the length of halts to 15 minutes in the case of drops occurring at or before 3:25 p.m., except for when there is a 20% decline, in which case trading will be halted for the remainder of the day.*

The limit up-limit down plan is intended to be a more finely calibrated replacement to the existing single-stock circuit breaker pilot.  For example, the current single-stock circuit breaker has been triggered a number of times by erroneous trades.  The limit up-limit down plan would not only prevent an erroneous trade from triggering a trade pause, but would keep the erroneous trade from occurring since the plan requires all trading centers to establish policies and procedures to prevent trades outside of the price bands.  The changes to the market-wide circuit breaker system are intended to tighten the system to make it more effective in the high-speed markets of today.  Since their 1988 adoption, the existing market-wide circuit breakers have been triggered only once, in 1997.  The 7% threshold under the revised rule would have been triggered 13 times since 1962, according to the SEC. 

The SEC seeks comments on the operation of the limit up-limit down plan and the new market-wide circuit breakers during the one-year pilot. 

*Our June 30, 2010 newsflash provides information about the single-stock circuit breaker pilot, which as described in the SEC’s May 31, 2012 release, has been implemented in a number of stages.  Our October 4, 2011 newsflash provides information about the changes proposed to the market-wide circuit breakers, all of which the SEC approved.

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

Gerard Citera 212 450 4881
Susan C. Ervin 202 962 7141
Annette L. Nazareth 202 962 7075
Lanny A. Schwartz 212 450 4174
Jeffrey T. Dinwoodie 202 962 7132
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