SEC Approves SRO Proposals to Address Extraordinary Volatility in Individual Stocks
and Broader Stock Market
By Paul McCurdy and Evan Barnes
On May 31, 2012, the Securities and Exchange Commission (SEC) approved two proposals
submitted by the national securities exchanges and the Financial Industry Regulatory Authority
(FINRA) designed to address extraordinary volatility in individual stocks as well as the broader
U.S. stock market. One initiative establishes a “limit up-limit down” mechanism to prevent
trades in individual exchange-listed stocks outside of a specified price band. When
implemented, this new mechanism will replace the existing market-wide circuit breakers that the
SEC approved on a pilot basis after the market events of May 6, 2010. The second initiative
updates existing market-wide circuit breakers that when triggered, halt trading in all exchangelisted securities throughout the U.S. markets. The proposals will be operative on a one-year pilot
basis, beginning February 4, 2013.
“Limit Up-Limit Down” Plan for Individual Securities
The “limit up-limit down” mechanism, established jointly by the exchanges and FINRA,
prevents trades in individual listed equity securities outside of a specified price band, set as a
percentage level above and below the average price of the security over the immediately
preceding five-minute period. In essence, the security would enter a “limit state” if its price
moves a certain percentage. For more liquid securities — those in the S&P 500 Index, Russell
1000 Index, and certain exchange-traded products — the level will be 5%, and for other listed
securities the level will be 10%. The percentages will be doubled during the opening and closing
periods and broader price bands will apply to securities priced $3 per share or less.
To accommodate more fundamental price moves, a five-minute trading pause will be triggered if
trading does not occur within the price band for more than 15 seconds.
Under the new plan all trading centers, including exchanges, automated trading venues, and
broker-dealers executing trades internally, must establish policies and procedures to prevent
trades from occurring outside the applicable price bands, comply with trading pauses, and
otherwise comply with the procedures set forth in the plan.
Market-Wide Circuit Breakers
The second initiative updates existing market-wide circuit breakers that when triggered, halt
trading in all exchange-listed securities throughout the U.S. markets. The updated market-wide
circuit breakers lower the percentage-decline threshold for triggering a market-wide trading halt
and shorten the amount of time that trading is halted. Notably, the market-wide circuit breakers
were not triggered during the severe market disruption of May 6, 2010, and since their adoption
in 1988, were triggered only once.
The revised market-wide circuit breaker rules update the existing rules by:
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• Reducing the market decline percentage thresholds needed to trigger a circuit breaker to
7%, 13% and 20% from the prior day’s closing price, rather than declines of 10%, 20%
or 30%.
• Shortening the duration of trading halts that do not close the market for the day to 15
minutes, from 30, 60 or 120 minutes.
• Simplifying the structure of the circuit breakers so that there are only two relevant
trigger time periods - those that occur before 3:25 p.m. and those that occur on or after
3:25 p.m. The two periods replace the current six-period structure.
• Using the broader S&P 500 Index, rather than the Dow Jones Industrial Average, as the
pricing reference to measure a market decline.
•Requiring the trigger thresholds to be recalculated daily rather than quarterly.
“Workable and Effective”
SEC Chairman Mary Schapiro described the initiatives as “the product of a significant effort to
devise a sophisticated, yet workable and effective way to protect our markets from excessive
volatility.” Chairman Schapiro added that, “In today’s complex electronic markets, we need an
automated and appropriately calibrated way to pause or limit trading if prices move too far too
fast. The Commission, along with the exchanges and FINRA, will be closely monitoring the
operation of the new limit up-limit down and market-wide circuit breaker processes during the
pilot period to make sure any rules approved on a permanent basis are as effective as they can
be.”
One-Year Pilot Period
The SEC approved both proposals for a one-year pilot period, during which the exchanges,
FINRA, and the SEC will assess their operation and consider whether any modifications are
appropriate.
Additional Measures
While other initiatives have been undertaken by the SEC in the wake of May 6, 2010 to address
volatility, including, among other things, a rule requiring broker-dealers to have risk controls in
place before providing their customers with access to markets, and new exchange and FINRA
rules to strengthen the minimum quoting standards for market makers and effectively prohibit
“stub quotes” in the U.S. equity markets, the SEC is also considering what additional measures
may be needed, including establishing a consolidated audit trail system to better track orders and
trades in securities across the national market system.
For your convenience, to access the National Market System Plan Approval Order, click here
http://www.sec.gov/rules/sro/nms/2012/34-67091.pdf and to access the Market-Wide Circuit
Breaker Approval Order, click here http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf.
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Paul McCurdy is chair of Kelley Drye & Warren LLP and chair of the firm's Broker-Dealer
practice group. He focuses his practice on representing retail, clearing, direct access and
advisory firms in regulatory, enforcement, compliance, corporate and litigation matters. He can
be reached at (203) 351-8039 and pmccurdy@kelleydrye.com.
Evan Barnes is an associate at Kelley Drye & Warren LLP. He advises broker-dealers and
traders in connection with regulatory, securities enforcement, litigation and transactional matters.
He can be reached at (203) 351-8042 and ebarnes@kelleydrye.com.
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