Subject: File Nos. 265-26, SR-BATS-2010-014, SR-EDGA-2010-01, SR-EDGX-2010-01, SR-BX-2010-037, SR-ISE-2010-48, SR-NYSE-2010-39, SR-NYSEAmex-2010-46, SR-NYSEArca-2010-41, SR-Nasdaq-2010-061, SR-CHX-2010-10, SR-NSX-2010-0, SR-CBOE-2010-047, SR-FINRA-2010-025
From: Thomas Hofler Ph.D.

May 13, 2010

First, keep in mind that the majority of securities that dropped more than 90% in the Thursday FlashCrash were ETFs not traded on the NYSE. So the vagaries of the NYSE trading slowdowns were not the cause.

Two, individual stock circuit breakers should have trigger thresholds that are conmensurate with the stock's volatility. A sensible method would split stocks into three catagories: Low beta, medium beta, and high beta. Respective trigger thresholds could be: 5%, 10%, and 30% (or maybe 50%) for these catagories. There is no reason Proctor & Gamble should be treated the same as a small cap bio-tech.

This system would have the added benefit of sending a strong signal to retail investors that some stocks will experience extreme price variability.

Three, I also believe that during breaker-down periods short selling should be halted, and perhaps normal sell order flow should be slowed relative to buy orders. Symmetrically, margin buys should be halted during breaker-up periods, and normal buy order flow slowed.

Clearly, market orders and stop-loss orders played a big role in the flash crash, and perhaps these orders could be treated differently during breaker limited periods. Or at least the SEC could engage in a forceful education campaign on the dangers of market and stop-loss orders.


A separate but related issue is the short selling framework. While I am not a Goldman Sachs hater (I own a small common stock position) I was shocked to read that GS was being fined for large numbers of short sell orders that failed to deliver the shares. Goldman and other brokers are taking full advantage of SEC rules that effectively imply that the government simply doesn't care about naked shorting.

The SEC desperately needs a "zero tolerance" policy in this area. I think that the SEC should actively monitor all brokerages for any fail-to-delivers at the end of every trading day, and not allow the brokerage to engage in any subsequent trading until these are resolved. I would also impose an automatic fine of 10 or 20% of the value of the trade for all short sale fail-to-delivers, with some of the fine shared with the buyer on the trade.

I also believe the best way to curb naked shorting would be to combine the above rules with a rule that demands delivery of all short sales in 1 hour. We live in a computerized world, and it is time to start acting like it.


Thomas Hofler Ph.D.