'No smoking gun' in flash crash

Last week's brief-but-historic stock market plunge was triggered by a combination of unusual factors, but its ultimate cause remains a mystery, executives from the nation's leading stock exchanges and market regulators told Congress on Tuesday.

A House Financial Services subcommittee is investigating the causes of the so-called flash crash and exploring ways to safeguard markets against technical glitches and erroneous trades.

Among those set to testify at a hearing Tuesday are regulators as well as representatives of NYSE Euronext and the Nasdaq Omx Group.

"Nasdaq continues to investigate Thursday's events, but has at present located no 'smoking gun' that single-handedly caused or explains Thursday's events," Eric Noll, executive vice president of Nasdaq, said in written testimony.

Mary Schapiro, chairwoman of the Securities and Exchange Commission, said that the SEC cannot point a single cause behind the events of May 6. The Dow Jones industrial average plummeted 1,000 points, representing about $1 trillion in market value, between 2:40 p.m. and 3:00 p.m. ET last Thursday.

The market recovered about 650 points of that loss nearly as quickly as it fell. But the free fall raised serious questions about the stability of electronic trading and has prompted talk of new regulations.
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Schapiro said her agency's preliminary investigation has looked at a sharp drop in the value of a particular stock future called the E-mini S&P 500, which investors use to bet on the future performance of stocks in the broad stock index.

The E-mini S&P 500 futures price fell by more than 5% in a few minutes and then quickly recovered, according to Schapiro.

"It should be no surprise that the broader stock market indexes showed similarly fast and similarly large declines and recoveries," Schapiro said, since stock prices follow futures prices.

But the correlation doesn't fully explain what happed on Thursday, she added, saying "It could have as readily been events or anomalous activities in individual stocks that caused someone to trade first in the futures markets."

The SEC is also looking into "massive intraday price swings" in shares of many Exchange Traded Funds as a possible factor in the crash, Schapiro said. The shares of more than a quarter of all ETFs experienced brief declines of more than 50% in Thursday's tumult.

"Ultimately, we may learn that the extraordinary disruption in trading, however it may have been triggered, was the result of a confluence of events which, taken together, exacerbated what already had been a down day and led to an extraordinarily steep price drop and recovery," said Schapiro.
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At the same time, the SEC has found no evidence of "fat finger" errors, which occur when a trader mistakenly orders billions of shares instead of millions, according to Schapiro. But such trades cannot be completely ruled out as a contributing factor.

Schapiro also said it's unlikely that exceptionally large orders in Proctor & Gamble (PG, Fortune 500) shares caused the meltdown. In addition, she said the SEC has found no information to suggest the collapse was caused by hackers or terrorists.

Separately, the Securities and Exchange Commission and Commodity Futures Trading Commission Chairman announced a new joint committee that will address emerging regulatory issues.

The committee will conduct a review of last Thursday's market events and the disparate trading conventions and rules across various markets.

Noll, the Nasdaq executive, and Larry Leibowitz, chief operating officer of NYSE Euronext, told lawmakers that markets were jittery going into Thursday's tailspin -- a factor that could have contributed to the abrupt and panicky selloff.

The two executives also indicated that a lack of coordination between exchanges, allowing electronic trading to continue after manual trading had been paused, was a factor.

"Although some of the underlying economic and global financial conditions that influenced this selling activity are known, the exact succession of events and what precipitated them remain unclear," Leibowitz said.

Noll testified that the crash was triggered by "a confluence of unusual events," adding that Nasdaq experienced "no system malfunctions or aberrations."

The SEC and representatives from the six main stock exchanges, along with the Financial Industry Regulatory Authority, agreed on Monday to a "structural framework" aimed at preventing a repeat of Thursday's crash.

The framework would strengthening circuit breakers, trigger points that stocks need to hit before trading can be halted, and steps for handling erroneous trades. It will be refined Tuesday, according to Schapiro.

In addition, she said commission staffers are now stationed at all major markets to monitor trading as of Monday.