Policy Documents

High Speed Trading Begets High Speed Regulation: SEC Respnse to Flash Crash, Rash

David M. Serritella –
September 29, 2010

On May 6, 2010, the Dow Jones Industrial Average (DJIA) underwent dramatic intraday price swings, at one point dropping over 9% from the previous day‘s closing prices before staging a comeback which minimized the damage to a relatively sane 3.2% decline. Although it quickly rebounded, one stock, which had been trading at forty one dollars a share, remarkably fell all the way to one cent. Before the dust settled on what is now known as the ―Flash Crash,‖ fingers had been pointed many different directions, liberally assigning blame for the market‘s intensely pendulous hurly burly.

While its ensuing investigation has yet to yield a definitive singular cause of the Flash Crash—and, indeed, it may never—the SEC nonetheless responded with new rules unifying and tightening the system of market checks which had previously been separately yet cooperatively controlled by various private actors.  One cannot fault regulators for responding so expediently to the Flash Crash as that day‘s events exposed dangerous fractures in our markets’ foundations.  Unfortunately, the SEC reaction may be as flawed as the system it seeks to protect.

This article examines the new SEC rules against the backdrop of the current market characteristics which likely contributed to the Flash Crash. Part II provides an overview of the Flash Crash. Part III analyzes the special threats posed by the current market practices of automated high speed and high frequency trading and the SEC response to them. Finally, Part IV suggests areas in which the new SEC rules should be refined before becoming permanent.