New Stock-by-Stock Circuit Breaker Rules

Last week US SEC approved the new stock-by-stock "circuit breaker" rules. The rules, which were proposed by the national securities exchanges and FINRA and published for public comment, come in response to the market disruption of May 6.

SEC anticipates that the exchanges and FINRA will begin implementing the newly-adopted rules as early as Friday, June 11.

Under the rules, trading in a stock would pause across U.S. equity markets for a five-minute period in the event that the stock experiences a 10% change in price over the preceding five minutes. The pause, which would apply to stocks in the S&P 500 Index, would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. Initially, these new rules would be in effect on a pilot basis through December 10, 2010.

The markets will use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience, and to expand the scope to securities beyond the S&P 500 (including ETFs) as soon as practicable.

At Chairman Schapiro's request, the SEC staff also will:

• Consider ways to address the risks of market orders and their potential to contribute to sudden price moves.
• Consider steps to deter or prohibit the use by market makers of "stub" quotes, which are not intended to indicate actual trading interest.
• Study the impact of other trading protocols at the exchanges, including the use of trading pauses and self-help rules.
• Continue to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring speed and consistency across markets.

SEC staff is working with the markets to consider recalibrating market-wide circuit breakers currently on the books — none of which were triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.

Jack's comment: When the market is getting more "emotional", the circuit breaker may be an effective way to let investors cool down, especially if the emotion is triggered by error or manipulative orders.