WASHINGTON -(Dow Jones)- Securities and futures regulators are exploring six different hypotheses and findings surrounding the May 6 "flash crash," but they have not yet pinpointed one single cause, according to a draft summary of the report viewed by Dow Jones.
The findings in the draft summary by staffers at the Securities and Exchange Commission and Commodity Futures Trading Commission are the results so far after combing through trade data to determine what caused the Dow Jones Industrial Average to fall nearly 1,000 points before staging a partial recovery.
While they haven't isolated a single cause, they are looking closely at trading in the E-Mini S&P 500 futures contract, where the patterns are closely linked to the volatile market behavior during the tumult.
The draft summary of the report found that a liquidity drain likely played a role in the dramatic and sudden movements in the price of stock index futures. The report states that regulators are still trying to determine if activity in one market led to activity in others.
The report also suggests that the use of stop-loss market orders, which involve standing sell orders at below-market prices, could have drained liquidity from the system. A fast-falling market could trigger a chain reaction of automatic selling. Regulators are investigating whether that happened on May 6.
Other things that regulators are looking at in their review include the use of stub quotes and the reasons why exchange-traded funds suffered a disproportionate number of broken trades compared with other securities.
Stub quotes generally are far below or above the actual value of a stock and are intended to be placeholders that are never actually implemented. Staffers analyzing the broken trades May 6 found that short sales accounted for approximately 70% of executions against stub quotes between 2:45 p.m. and 2:50 p.m., and approximately 90% of executions against stub quotes between 2:50 p.m. and 2:55 p.m.
This kind of transaction won't be allowed once the SEC's short sale rule goes into effect, the report noted.
The SEC also is on the verge of releasing a proposed rule dictating how and when exchanges should take a time out when stocks start to fall. Sources familiar with the negotiations say the first, a cross-market "circuit breaker" for individual stocks will be implemented, followed by a market-wide rule tied to index levels. It is unclear when regulators and exchanges will implement policies about breaking trades during market volatility.
The exchanges have been working with regulators since the plunge about how to coordinate their responses to unusual trading activity. Lawmakers and market analysts say part of what sent the market into free fall on May 6 was the reaction from other exchanges to NYSE Euronext (NYX) shifting into "slow mode" by shutting down computer trading and relying on humans in response to a few falling stocks.
As for the CFTC, meanwhile, the report states that regulators there are not only examining E-mini Standard & Poor's 500 and Russell 2000 futures trading, but also trading by swap dealers on broad-based security derivatives on May 6.
As part of a future study, both the SEC and CFTC are planning to pursue a joint study examining the linkages between correlated assets in the equities, options and futures markets.
Copyright 2009 Dow Jones Newswires
Stock market’s sell-off still confounds regulatorsREAD: SEC Chair Schapiro’s Statement to Congress on Market ‘Disruption’
