Courts & Crime

Feds: One trader caused May's 998-point drop in the Dow

NEW YORK — A single trader executing an unusually large and fast sale using a complex computer algorithm triggered the so-called flash crash that sent the Dow Jones stock index plummeting nearly 998 points in matter of minutes on May 6, a new report from two regulators said Friday.

The 104-page report, by the Securities and Exchange Commission and the Commodity Futures Trading Commission, is likely to lead to new restrictions on computer and technology-accelerated trading of stocks. It's also sure to put super fast trading — called high-frequency trading — under the regulatory microscope.

The dizzying drop erased billions of dollars in stock-market wealth in seconds and is largely blamed for an exodus of average people from the market amid a growing perception that the game is rigged in favor of large Wall Street players.

The report identified the trader only as a large investment fund, though McClatchy has learned the culprit was Waddell & Reed Financial, based in the Kansas City suburb of Overland Park, Kan. Last May, Waddell & Reed executives said their own analysis led them to conclude they did not spark the flash crash.

The report was silent on whether criminal charges could result. The firm had no comment Friday on the report, and a phone call placed to its office wasn't answered.

Trading was already volatile on that May day, the regulators said, when the large trader executed a sell order totaling $4.1 billion on what's known as the e-mini futures market, an electronic market that bets on the price of futures contracts. The trader was trying to take advantage of a price difference between the e-mini futures market for the Standard &Poor's 500 and a stock index fund that tracks the S&P 500. (Futures are financial transactions based on a price anticipated at some point in the future, and stock index funds seek to mirror the movements of a stock index.)

In executing the trade, the large trader used a computer algorithm that sold on the basis of volume, not price. That triggered a chain reaction as high-frequency traders rapidly bought and sold in a high-tech version of hot potato. Then, with the market overheated, the computers shut down, leading to a collapse in prices.

Bart Chilton, a member of the CFTC, which regulates the futures market, said the situation could have been even worse, had the trade been executed earlier in the day, when markets in Europe were still open. That might have set off a global financial panic.

"This shows how interconnected markets are," said Chilton, who predicted that his agency and the SEC would take steps to build in safeguards that will prevent such computer driven downturns in the future.

The report dissected a wide range of trading activity before and after the large trade. It said the computerized sell order had been the largest such transaction in 2010 up to the date of the events and that there had been only two sell moves of its size in the 12 months preceding May 6.

One of those two trades also had been executed by the same large trader, but had taken place over a five-hour period. The May 6 trade was programmed to happen in 20 minutes.

Since the flash crash, regulators have imposed more restrictions designed to halt trading on certain stocks for a period 10 minutes when price falls by more than 5 percent. Chilton, of the CFTC commission, argues that even more restrictions are needed on electronic trading.

"We can't assume this cannot happen again," Chilton said.

Others suggested the May 6 crash underscored how a casino atmosphere has overtaken markets that were originally designed to provide businesses with money to finance goods and services in the real economy.

Speaking to the Society of American Business Editors and Writers in New York on Thursday night, Nobel Prize winning economist Joseph Stiglitz, who's on an advisory panel studying the implications of the flash crash, predicted that steps would be taken to curb high-speed electronic trading because there's little evidence it provides a "social value" for both business and the greater society.




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