Investor Bulletin: New Stock-by-Stock Circuit Breakers
Aug. 1, 2011
The Securities and Exchange Commission approved rules on Sept. 10, 2010, to expand the existing circuit breaker program that currently is triggered by large, sudden price moves in an individual stock. The new rules follow changes adopted on June 10, 2010, that impose a uniform market-wide pause in trading in individual stocks whose price moves 10% or more in a five-minute period. The trading pause, which was proposed by U.S. exchanges and the Financial Industry Regulatory Authority (FINRA), initially was limited to stocks in the Standard & Poor’s 500 Index, but has been extended to stocks in the Russell 1000 Index and to certain exchange-traded products.
Why were stock-by-stock circuit breakers put in place?
The SEC staff asked U.S. exchanges and FINRA to propose rules in response to the unusually volatile trading that occurred on May 6, 2010. Although some stocks fell very sharply and quickly that afternoon, the downturn was not broad enough to trigger existing market-wide circuit breakers. Trading in some stocks was halted or slowed on some exchanges but continued on others, sometimes at drastically lower prices. Exchanges and FINRA later cancelled transactions at prices that moved 60% or more from prices just before the market drop, deeming these trades to be erroneous. The Commission is concerned that events such as these can seriously undermine the integrity of U.S. markets and is working to put policies in place to help prevent such events from recurring.
What do the new rules require?
Under the new rules, a U.S. stock exchange that lists a stock is required to issue a trading “pause” in a stock if the stock price moves up or down by 10% or more in a five-minute period. The same pause will be in effect on all other U.S. stock and stock option markets, and the single-stock futures market, resulting in a uniform halt. After five minutes, the exchange that issued the pause may extend it if there are still significant imbalances between orders to buy and sell shares of the affected stock. After a ten-minute pause, other exchanges are free to resume trading in the stock and once that occurs, trading may resume in the over-the-counter markets.
What securities are covered by the new rules?
The new rules first covered stocks in the S&P 500 Index. Starting the week of Sept. 13, the circuit breakers have been extended to stocks that are included in the Russell 1000 Index and to a list of exchange-traded products, including those that track broad-based stock indexes, such as the S&P 500. Some exchange-traded funds also experienced sharp price moves in trading on May 6.
Will the new stock-by-stock circuit breakers apply throughout the trading day? What about after-hours trading?
To avoid potential disruption to market openings and closings (which already have special procedures designed to maintain fair and orderly markets), the individual stock circuit-breakers are in effect from 9:45 a.m. Eastern Time until 3:35 p.m. Eastern Time. They do not apply to after-hours trading. On days when the markets close early, the individual stock circuit breakers are in effect until 25 minutes before the close of the markets, for example, until 1:35 p.m. if the markets are closing at 2:00 p.m.
Are these rules permanent?
The new rules were approved on a trial basis and are set to end on January 31, 2012, unless the industry self-regulatory organizations propose to extend the trial period or request permanent approval of the rules. Extending the trial period or giving permanent approval to the rules could only occur through the filing of proposed rule changes by the exchanges and FINRA.
How do these rules differ from what was in place?
Exchanges have had the ability to halt trading in stocks where there is a large imbalance between buy and sell orders, but those trading halts were not binding on other markets, which remained free to trade the stock. Under the new rules, once a trading pause in a stock is called, it applies to all U.S. stock markets, stock option markets and the single-stock futures market.
The new circuit breaker rules apply to individual stocks, unlike market-wide circuit breakers that were put into effect after market breaks in the 1980s. Market-wide circuit breakers halt trading in all stocks for between 30 minutes to several hours if the Dow Jones Industrial Average falls by 10%, 20% or 30% from preset levels during the course of a trading day. Under existing rules, the New York Stock Exchange sets the circuit breaker levels at the beginning of each calendar quarter based on the average closing level of the Dow Jones Industrial Average in the prior month.
Are other changes being considered?
The exchanges and FINRA may file additional proposed rule changes to expand the circuit breaker approach once more or modify the program in other ways. The SEC staff also has asked exchanges to revisit existing market-wide circuit breakers, which are set at a threshold that is rarely triggered. Other proposed changes may be forthcoming.