U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office,

http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center,

U.S. Government Printing Office. Phone 202–512–1800, or 866–512–1800 (toll-free). E-mail, gpo@custhelp.com.

62–513 PDF 2010

S. HRG. 111–774 

EXAMINING THE CAUSES AND LESSONS OF THE 

MAY 6TH MARKET PLUNGE 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE CAUSES AND IMPLICATIONS OF THE MAY 6, 2010, 

MARKET PLUNGE AND IDENTIFYING WHAT POLICY CHANGES MAY BE 

NECESSARY TO PREVENT SUCH EVENTS FROM OCCURRING AGAIN 

MAY 20, 2010 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

JUDD GREGG, New Hampshire 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

DAWN RATLIFF, Chief Clerk 

DEVIN HARTLEY, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

JACK REED, Rhode Island, Chairman 

JIM BUNNING, Kentucky, Ranking Republican Member 

TIM JOHNSON, South Dakota 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

MARK R. WARNER, Virginia 

MICHAEL F. BENNET, Colorado 

CHRISTOPHER J. DODD, Connecticut 

JUDD GREGG, New Hampshire 

ROBERT F. BENNETT, Utah 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KARA STEIN, Staff Director of Subcommittee 

RANDY FAUSNACHT, GAO Detailee 

WILLIAM HENDERSON, Republican Staff Director of Subcommittee 

NATHAN STEINWALD, Legislative Assistant 

(II)
C O N T E N T S 

THURSDAY, MAY 20, 2010 

Page 

Opening statement of Senator Warner .................................................................. 1 

Opening statements, comments, or prepared statement of: 

Chairman Reed ................................................................................................. 47 

Senator Bunning ............................................................................................... 2 

WITNESSES 

Mary L. Schapiro, Chairman, Securities and Exchange Commission ................. 3 

Prepared statement .......................................................................................... 47 

Response to written question of: 

Senator Vitter ............................................................................................ 108 

Gary Gensler, Chairman, Commodity Futures Trading Commission ................. 5 

Prepared statement .......................................................................................... 65 

Richard G. Ketchum, Chairman and Chief Executive Officer, Financial Industry Regulatory Authority ..................................................................................... 29 

Prepared statement .......................................................................................... 82 

Larry Leibowitz, Chief Operating Officer, NYSE Euronext ................................. 31 

Prepared statement .......................................................................................... 85 

Eric Noll, Executive Vice President of Transaction Services, The NASDAQ 

OMX, Inc. .............................................................................................................. 34 

Prepared statement .......................................................................................... 89 

Terrence A. Duffy, Executive Chairman, CME Group Inc. .................................. 35 

Prepared statement .......................................................................................... 94 

(III)

(1) 

EXAMINING THE CAUSES AND LESSONS OF 

THE MAY 6TH MARKET PLUNGE 

THURSDAY, MAY 20, 2010 

U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee met at 9:37 a.m. in room SD–538, Dirksen 

Senate Office Building, Senator Jack Reed, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF SENATOR MARK R. WARNER 

Senator WARNER. [Presiding.] Good morning, everyone. Obviously, I am not Chairman Reed. He is on his way back from the 

Pentagon and will be here momentarily, and so as the guy that 

usually sits at the other end of the dais, I get a chance to at least 

open the hearing, and I will relinquish the gavel once Chairman 

Reed gets here. 

I want to thank both Chairman Schapiro and Chairman Gensler 

and our other witnesses today for coming. I think we all saw recently, on May 6th, how challenging the merging of the advance of 

technology, high-frequency trading, and some of the results of perhaps not having totally in place all of the appropriate circuit breaker, stopgaps, and other tools that may be necessary to make sure 

that we do not see a repeat of $1 trillion, 15-minute or 21-minute 

loss that took place on that day. 

Obviously, bringing both this first panel of regulators and then 

our second panel in today is very timely since at the same time on 

the floor of the Senate, we are now, I think, in week 4 of putting 

in place new rules of the road for the 21st century for all of Wall 

Street and our whole financial system. 

Chairman Reed was going to talk—and I am sure he will come 

back and mention this again—about specifically what happened on 

May 6th. I definitely recall, you know, getting panicked calls from 

some of the folks who manage my investments to say, you know, 

we do not know what is happening, and to see this $1 trillion loss. 

I heard the day after that a loss of actually a series of smaller brokers who were really questioning the whole integrity of the system, 

what happens when you have that kind of precipitous loss, precipitous decline in values, then obviously the market responded. But 

an awful lot of small investors who, I think, over the last 2 years 

have had a bit of their confidence robbed by the market falls in 

2007 and 2008. But then to have this action, whether it was tech-
2 

nology-driven, whether it was a result of the overall actions of the 

dramatic increase of high-frequency trading, is something that I 

hope we will be able to get to in this hearing today. 

There is a series of other comments that Chairman Reed was 

going to make, which I will pass on at this point since I have got 

a series of similar type questions once we get to hear from the witnesses. Let me introduce our first panel of witnesses, and then I 

am going to turn to Ranking Member Bunning and my good friend 

Senator Corker, although I do not know if with only three of us 

here we are going to enforce the Corker rule of opening statements 

or not. Let me go ahead and introduce our two witnesses; then I 

will turn it over to Senator Bunning. 

Our first witness will be Honorable Mary Schapiro. She is the 

Chairman of the Securities and Exchange Commission. Prior to becoming SEC Chair, she was CEO of FINRA, the largest nongovernmental regulator for all securities firms doing business with the 

U.S. public. Chairman Schapiro previously served as Commissioner 

of the SEC from December 1988 to October 1994 and then as 

Chairman of the Commodity Futures Trading Commission from 

1994 until 1996. 

Our second witness is the Honorable Gary Gensler, Chairman of 

the Commodity Futures Trading Commission. He previously served 

at the U.S. Department of Treasury as Under Secretary of Domestic Finance from 1999 to 2000, as an Assistant Secretary of Financial Markets from 1997 to 1999. Prior to joining Treasury, Chairman Gensler worked for 18 years at another firm—at Goldman 

Sachs—and most recently as partner and co-head of finance. 

With those introductions, I will turn to Senator Bunning and 

then Senator Corker, if he chooses. 

STATEMENT OF SENATOR JIM BUNNING 

Senator BUNNING. Thank you, Senator Warner. 

Welcome to the two witnesses we have before us. In many ways, 

this hearing is the follow-up to the hearing we held in this Subcommittee last October on securities and market structure issues. 

Many of the topics we discussed at that hearing are in the spotlight 

again after the May 6th stock market drop. I am glad to see the 

SEC followed through on its commitment to us last fall to start a 

broad examination of market structure issues. 

Technology certainly has changed the way securities and futures 

are traded, and the SEC has made significant rule changes over 

the last decade. But no one in Government has paused and thought 

about how all those changes work together. 

From what we know so far, it appears that 2 weeks ago the markets worked as they were supposed to, according to the rules and 

systems that were in place at the time. A broad examination of all 

the marketplace changes might have revealed the possibility of a 

sudden drop under the conditions that existed 2 weeks ago. And, 

in fact, at least one commentator to the SEC market structure 

study suggested just such an outcome. Of course, that leads to the 

question of what else could happen. 

That is why I think it is critical for the Commission to complete 

the market structure study and not let other matters sidetrack it. 

I appreciate the speed and seriousness both the SEC and the CFTC 
3 

have put into the investigation of the May 6th market drop. Putting in place rules, uniform rules, for pause trading across all exchanges seems like a good first step, and I am glad everyone resisted the temptation to make sweeping changes before first understanding everything that went on. I think it is also important that 

the trading halts will apply for price changes in both directions, not 

just in drops. But I also have some concerns about the reaction and 

what we do not know. 

First, since markets appear to have worked at they were supposed to under the rules in place, I am very concerned that trades 

were canceled on an arbitrary basis. Very concerned. That is unfair, undermines market discipline, and is nothing more than a 

bailout of sellers who would have faced losses from their own decisions to use market orders. 

Second, it is troubling that we do not yet understand the relationship between movers in the futures markets and the stock markets. 

Third, it is also troubling that some traders who claimed to be 

market makers, particularly high-frequency traders, pulled out of 

the market, thus contributing to the drop. 

Finally, I am also bothered that we do not understand why exchange-traded funds suffered worse losses than the securities they 

were supposed to be tracking. 

I hope our witnesses can shed some light on these concerns or 

at least explain what is being done to get to the answers. Thank 

you both for being here, and I await your testimony. 

Senator WARNER. Senator Corker. 

Senator CORKER. I do not have any comments. I look forward to 

the testimony, and thank you for coming. 

Senator WARNER. Again, my thanks to the witnesses, and I think 

we are all very looking forward to your testimony and our questions afterwards. 

Chairman SCHAPIRO. 

STATEMENT OF MARY L. SCHAPIRO, CHAIRMAN, SECURITIES 

AND EXCHANGE COMMISSION 

Ms. SCHAPIRO. Thank you very much. Senator Warner, Ranking 

Member Bunning, and Senator Corker, I appreciate the opportunity to testify today and update you on our ongoing review of and 

response to the market disruption of May 6th. 

During a 20-minute period on that afternoon, the U.S. financial 

markets failed to execute their essential price discovery function, 

experiencing a decline and recovery that was unprecedented in its 

speed and scope. That period of gyrating prices both directly 

harmed investors who traded based on flawed price discovery signals, and it undermined investors’ faith in the integrity and fairness of the markets. Today we continue to work to identify the 

events that triggered the unusual volatility, to better understand 

the various aggravating factors, and to adopt measures that will 

help prevent similar market disruptions. 

Over the last 2 weeks, the SEC has moved forward on two separate, but related, fronts. First, along with the Commodity Futures 

Trading Commission, we have been engaged in a comprehensive investigation into the causes of the events of May 6th. On Tuesday, 
4 

we released a staff report detailing the preliminary findings of our 

investigation to the Joint CFTC–SEC Advisory Committee on 

Emerging Regulatory Issues, and this report was also made public. 

Second, we have worked with the exchanges to fashion measures 

that will help protect against a recurrence by imposing a limit on 

the extent to which certain individual stock prices can move before 

trading in that stock is paused. While it will take time to fully analyze the extraordinary amounts of data from a day in which more 

than 19 billion shares of stock were traded and to cross-test different hypotheses, our investigation is focusing on the following 

issues: the possible linkage between the steep decline in the prices 

of stock index products and simultaneous and subsequent waves of 

selling of individual securities; a generalized severe mismatch in liquidity, possibly exacerbated by the withdrawal of liquidity by electronic market makers; the possibility that this liquidity mismatch 

may have been aggravated by disparate trading conventions across 

the exchanges; the impact from the use of ‘‘stub quotes’’; the use 

of market orders and stop loss orders that might have contributed 

to market instability; and the impact on exchange-traded funds, 

which suffered a disproportionate number of broken trades. 

We have discovered no evidence that these events were triggered 

by ‘‘fat finger’’ errors, computer hacking, or terrorist activity, although we cannot yet completely rule out these possibilities. 

At this stage we continue to focus on the events that may have 

triggered the unusual volatility. But regardless of the cause, we believe that the initial volatility was magnified by a variety of factors. So as we work to determine why the first domino fell, we have 

taken an important step toward preventing future disruptions, 

working with the exchanges to develop rules which would impose 

uniform, market-wide standards for pausing trading of securities in 

the S&P 500 index if a securities price moves 10 percent or more 

in a 5-minute period. 

These proposed rules would establish a 5-minute trading pause 

designed to give the markets the opportunity to attract additional 

liquidity in the stock, to establish a reasonable market price, and 

to resume trading in a fair and orderly fashion. The rules have 

been published for comment promptly so that they can be evaluated as soon as practical and quickly adopted. 

Once adopted, the new rules would be in effect on a pilot basis 

through December 10, 2010, during which time the exchanges may 

propose appropriate adjustments to the parameters or operation of 

the circuit breaker. In addition, we understand that the exchanges 

will quickly work on expanding the program to include other securities, including ETFs. 

The SEC staff is also working with the exchanges and will coordinate with the CFTC to consider recalibrating the existing market-wide circuit breakers—none of which were triggered on May 

6th. 

SEC staff is also examining ways to address the risks of stop loss 

and market orders and their potential to intensify sudden price declines, as well as steps to deter or prohibit the use of stub quotes, 

and we will review the impact of other trading protocols, including 

the use of trading pauses by individual exchanges and self-help 
5 

protocols that allow the markets to avoid routing to exchanges that 

are perceived to be responding too slowly. 

Very importantly, and on an expedited basis, we will push the 

exchanges to propose clear, transparent, consistent, and fair rules 

for the breaking of trades that are clearly erroneous. 

Even before May 6th, the Commission had launched initiatives 

to strengthen the U.S. securities markets and to protect investors. 

We have proposed rules that would prohibit flash orders, increase 

the transparency of dark pools of liquidity, prohibit broker-dealers 

from providing unfiltered access to exchanges, and create a large 

trade-reporting system. And earlier this year, as has been mentioned, the SEC issued a concept release on market structure that 

solicited public comments on the impact of different trading strategies, including high-frequency trading, on our markets and investors. These issues will also be the center of a market structure 

roundtable which we will be holding early next month. And next 

week, the Commission will consider a proposal to create a consolidated order-tracking system to allow effective cross-market surveillance of equities trading. 

In conclusion, we are making progress in our ongoing review, and 

we have begun putting in place safeguards that will help prevent 

this type of unusual trading activity from repeating. I look forward 

to working with Congress on these issues in the coming weeks, 

and, of course, I would be pleased to answer any questions. 

Thank you. 

STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY 

FUTURES TRADING COMMISSION 

Mr. GENSLER. Good morning, Chairman Reed, Ranking Member 

Bunning, Senator Corker, Senator Warner. Thank you for inviting 

me here today. I am pleased to testify alongside Chairman 

Schapiro. 

As she mentioned, the CFTC and SEC staff released a joint report Tuesday that presented preliminary findings regarding the 

May 6th market events, and I just wanted to thank the staffs of 

both agencies for working tirelessly and cooperatively to issue this 

detailed report in such short order. I think it was a high level of 

cooperation and public service that got this to you and to the public 

so quickly. 

This morning I will focus my testimony on the proposal issues in 

the futures marketplace, as Chairman Schapiro has addressed the 

securities markets more broadly. But before I turn to those specific 

events of May 6th, I would like to discuss just the make-up of the 

stock index futures markets. These market stock index futures are 

derivatives contracts that are on central exchanges, and by far the 

most active—about 80 percent of that market—is a contract called 

the E-Mini S&P 500. It is based on 500 of the largest stocks. These 

are traded electronically, as you know, and we have moved toward 

electronic markets where about 88 percent of the futures markets 

today more broadly are done on electronic platforms, as opposed to 

in the old days when people were in the pits in an exchange. 

There is also something called algorithmic trading, which refers 

to the practice of using computer algorithms to direct order entry 

into electronic trading platforms. And in some cases, an investor 
6 

chooses an algorithm by making only a few clicks, a pull-down window, just as on your home computer, provided by the executing 

firms. 

In this new environment, the futures markets do have automatic 

safety features to protect against the errors of order entry and extreme price swings. But I do think that we need to review whether 

further protections are needed in these fast-paced, computer-driven 

markets. And though additional review is necessary, preliminary 

staff findings suggest that a confluence of economic events, signals 

from other markets, and a marked increase in sell orders culminated in the significant decline and dislocations of liquidity in 

this E–Mini contract, this futures contract. 

May 6th began with turbulent skies in the marketplace. Many financial news outlets were reporting the uncertainties emanating 

out of Europe, and volatility in the middle of the day actually 

reached 61 percent higher than the prior day just in terms of a key 

market measure. Market participants also would have observed a 

number of indicators coming out of both the futures and securities 

markets. From the futures markets, they saw a flight to quality— 

to U.S. treasuries, to currency, to gold. And the securities markets, 

after 2:00 p.m., they started to see significant increases in what 

you will hear about later, liquidity replenishment points of the New 

York Stock Exchange where stocks went into go-slow mode, but 

also significant price drops in exchange-traded funds, as was mentioned by Senator Bunning. 

On May 6th, we also saw significant dislocations in liquidity in 

this E–Mini contract, and between 2:30 and 3:00 p.m. though there 

was 10 times more volume—normally, higher volume people think 

of as better liquidity, there is more trading—actually our economists reviewing it have shown that there is evidence that bid-offer 

spreads, the difference between where people will buy and sell, 

widened out and also the order books started to have an overwhelming abundance of sell orders when you look at the details. 

By just before 2:45, a number of large traders began to limit 

their involvement in the marketplace of the E–Mini, and at 2:24:28 

to be precise, the Chicago Mercantile Exchange, one of their risk 

management structures kicked in, a go-slow or a pause called a 

stop logic functionality, and for 5 seconds the market paused. And, 

in fact, then it started to move back up after that pause. 

Now, we have reviewed at the CFTC the trading activity of the 

ten most active accounts on both the long and the short side. We 

are reviewing many others as well. But of those top ten, the predominant ones, nine out of them actually appear to be both on the 

long and the short side. There was one using algorithmic execution 

strategies that was only on the sell side and represented approximately 9 percent of the activity over 21 key minutes, from 2:32 to 

2:51. 

They used a volume restriction which they put into the computer 

system of their executing broker, a volume restriction which in 

other days would have taken that volume and put it out in probably as much as several hours. But on this day, with 10 times higher volume on the critical hour, the volume was placed over 21 minutes. And it may well be that the volume restrictions that on an 

average day would have helped to limit the down draft of the mar-
7 

ket may have been ineffective and actually limited what they had 

hoped to be the market impact. 

The CFTC will continue its analysis, working jointly with the 

SEC on these matters, and I look forward to taking any questions 

that you have today. 

Senator REED. [Presiding.] Thank you. 

I would like to call on Senator Bunning. 

Senator BUNNING. Thank you. This is a question for both of you. 

Thank you for your testimony. Chairman Schapiro, I will start with 

you, but I would like both of you to answer the question. 

As I said in my statement, I am concerned about some of the 

ways trades were canceled. Do you think that was the right decision? And what role did your agencies play in it? 

Ms. SCHAPIRO. Senator, the process for breaking trades is one 

that is done under exchange rules, not by the Government. Exchanges work out a common standard for how far away from the 

last valid price will they break trades. In the case of May 6th, they 

determined that for trades done between 2:40 and 3 o’clock they 

would break trades that were done 60 percent or more away from 

the last valid price at 2:40 or before 2:40. 

That resulted in almost 21,000 trades being broken. About 59 

percent of those were on NASDAQ, about 5 percent on BATS, and 

the others were spread out more broadly. And the exchanges can 

obviously speak to the rationale behind selecting the 60 percent 

number in the next panel, but, frankly, it feels quite arbitrary, as 

I am sure many people think who had trades that were broken that 

they did not want broken or those who had trades not broken at 

50 percent or 40 percent or 30 percent. 

I think going forward we need a process that is much more 

transparent, provides certainty in advance about what trades will 

be broken and which ones will not, and creates fairness for investors. And so I would say that having gotten the circuit breaker rule 

proposals in, my top two priorities now as we continue to drive this 

process forward is to get the exchanges to propose new, clear, consistent, and fair rules for breaking trades within the next 2 weeks, 

and then to expand the pilot program to include stocks beyond the 

S&P 500. 

It is not a process that has left investors feeling at all good about 

our marketplace, and we have got to fix it as soon as we can. 

Mr. GENSLER. Senator, in the futures marketplace, there are exchange rules about breaking trades. They are very clear and tight. 

They have to happen within a very short number of minutes where 

one of the parties comes in. There were no futures trades broken 

on May 6th as it was. But I do share Chairman Schapiro’s views 

in the broader context that rules for such breaking of trades need 

to be clear and consistent, and the public needs to know in advance 

these rules. 

Senator BUNNING. Ms. Schapiro, it is hard for me as someone 

who worked in the market for 31 years to understand how any 

trades can be broken arbitrarily by an exchange, especially those 

rules that you stated. Those are arbitrary rules. And for someone 

who is left out of those arbitrary rules—in other words, did not fit 

in the box—how do you think they feel? 
8 

Ms. SCHAPIRO. I think they probably feel terrible, and I would as 

well if I were in that position. And that is why the rules have got 

to have clarity, and they have got to provide certainty up front so 

people understand that if a trade is executed because of a ‘‘fat finger’’ problem, a technology problem, whatever the reason is, that 

is executed 30 percent or 20 percent away from the market, that 

those trades will be broken without discretion, or they will not be 

broken. But people need to understand that up front. When people 

enter the marketplace, they need to know what the rules are that 

will apply. 

Breaking trades also discourages buyers coming in at a very low 

point and providing liquidity, for example, because their trades 

may be broken as well. So why would they go—— 

Senator BUNNING. In other words, those ones that were done at 

1 cent—are those some of the trades that we are talking about? 

Ms. SCHAPIRO. Absolutely. Several hundred securities that had 

trades executed against stub quotes at a penny or 5 cents are very 

likely to be 60 percent away from their last valid price. 

Senator BUNNING. They were. 

Ms. SCHAPIRO. And they will almost—they will certainly be broken. 

Senator BUNNING. OK. The second question for Chairman 

Schapiro. Have you found that any market makers with obligations 

to stay in the market did not perform on their obligations? And do 

you think the rules for market makers need to be adjusted to reflect the greater role of new types of liquidity providers? 

Ms. SCHAPIRO. We do not have evidence yet of market makers 

who had affirmative obligations withdrawing from the market. It 

is absolutely something that we are looking at, and we have incorporated our Enforcement Division into our ongoing investigation. 

We have close to 100 people at the SEC working on this inquiry. 

I do believe one of the things we absolutely have to look at is the 

fact that many affirmative obligations of market makers have been 

eliminated by the markets over the years. And that is how we end 

up with stub quotes. The obligation to provide a two-sided quote 

used to be required to be reasonably related to the market price, 

no longer is in all cases, and we end up with, you know, a spread 

of 1 cent to $100,000. And that is just unacceptable. 

So one of the things we will be looking at very carefully is the 

creation of affirmative obligations again. 

Senator BUNNING. The only reason I bring that up is that market 

makers make their money on the spread or whatever little chunk 

they take out as being a market maker. At least that is the way 

it was for the 31 years that I dealt with market makers. In fact, 

in some of the over-the-counter stocks that I sat on the over-thecounter desk, we took a quarter of a point out of each trade, and, 

therefore, it was built-in profit for the company that I worked for. 

I do not think a market maker should be able to get out of the 

market they are making the markets in that stock under any circumstances, unless they are belly up. 

Ms. SCHAPIRO. As the markets have evolved, there are other benefits as well of being a market maker. It might be fees and rebates. 

It might be preferential capital or margin treatment and so forth. 
9 

So to the extent there is a benefit from being a market maker, 

my view is there ought to be obligations and responsibilities that 

go along with that. 

Senator BUNNING. I have used up my time. Thank you. 

Senator REED. Thank you, Senator Bunning. 

And I want to thank Senator Warner for initiating the hearing. 

I was at the Pentagon. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. 

I want to continue a little bit along the line of Senator Bunning. 

I also had some concerns about the arbitrariness of what the standards are of breaking trades, but you have got to draw a line somewhere. I think, clearly, both of you have acted quickly in terms of 

circuit breakers, pauses, other tools we can use. 

I have got to tell you, though, I still have some concerns, and I 

am not being critical here, I am just seeking the answer. We are 

a couple weeks after the fact. We still don’t know how this event 

happened in the first place and what were the precipitating causes. 

I keep coming back to, as an advocate for technology, but technology—here, we may be seeing technology for technology’s sake 

alone, speed for speed’s sake alone, and at some point as we—and 

I have this gut sense that whether it is, and I appreciate what you 

have done, Chairman Schapiro, in terms of flash trading, but this 

whole new area of high frequency trading, dark pools, collocation, 

sponsored access, a lot of the firms are doing this, my sense is, to 

try to get a competitive advantage in the marketplace. 

And how do each of your institutions keep up knowledge-wise 

monitoring these activities? How do you make sure you have got 

the technology expertise? I know we have had some conversations 

where you have to rely on a series of these exchanges to actually 

get data back because you don’t have real-time access to that kind 

of information in the first place. I would love to hear—I appreciate 

what you are doing circuit breaker-wise. I appreciate the need to 

get an ability to break some of the trades when you have got this 

blip or problem in the market. But how do we get ahead of this? 

Have we seen on May 6 what may be the first kind of warning shot 

of what may be the next potential systemic crisis because of technology run amok? 

Ms. SCHAPIRO. Well, let me speak a little bit about how I have 

tried to approach this in the little over a year I have been at the 

Commission, because there are absolutely enormous challenges to 

regulating this highly dispersed and fragmented marketplace we 

have in the equities markets. Depending on how you count, there 

are 50, 60, 70 venues where trading is taking place. Some of them 

are dark. Some of them are less opaque. Orders are handled differently. The protocols and how trading is paused or not paused is 

different across all of them. 

We peeled off a few issues we thought were really critical during 

the fall. Those related to making dark pools more transparent so 

that we would not develop a two-tiered system where retail investors would not have access to the best quotes. We proposed banning 

flash orders. We proposed prohibiting unfiltered access, where 

large customers can go directly into an exchange and not pass 

through the risk management controls of a brokerage firm. We proposed instituting a large trader reporting system so the SEC would 
10 

have access to the activities that are engaged in by large traders. 

Those, we felt, were really critical ‘‘of the moment’’ issues we needed to get started on. 

And then in January, we published this very broad concept release where we asked a lot of questions about what is the impact 

of high frequency trading on retail investors, on the health of our 

markets, on the ability of public companies to raise capital, the 

whole reason our markets exist at the end of the day, and we have 

received over 100 comment letters on that. The comment period 

just closed and we will proceed now to try to pull all of these pieces 

together and figure out how we go forward. 

At the end of the day, our goal has got to be that our markets 

operate fairly and efficiently and effectively for all the constituencies, and I put at the top of that list public investors and public 

companies. And then those who trade for a living, playing an important role. But at the end of the day, our markets have to be 

about investors and the ability to raise capital. So that is how we 

are going forward on these issues. 

Senator WARNER. And before Chairman Gensler answers, and I 

know I have only got a minute left, I guess, Chairman Gensler, in 

your testimony, you described some of the tools some of these institutions use in terms of ‘‘sniping’’ and ‘‘sniffing’’ strategies, where 

you put out a major order and you have got an immediate recision 

component to it to kind of sniff out where the direction of the market is headed. 

If you are a small retail broker or a small-time trader, or if you 

are a company that is seeing your stock potentially manipulated, 

how do we get to that level of confidence when it seems like certain 

institutions are using not greater investigatory knowledge, but 

really just technology, in a sense, to game the market? 

Mr. GENSLER. Well, I think you are absolutely right. The technology has advanced the markets from the humans on the floor of 

the New York Stock Exchange or the floor of the Chicago Mercantile Exchange to these high frequency. The trades are down to 

milliseconds and nanoseconds. There are risk management standards in place in the futures markets, but I do think that we have 

to review them and see whether and where we can do better in this 

regard. 

You also asked about how we stay ahead. We are fortunate in 

the futures market—and this preceded me—that we get the data 

the next day. We get all the data in and we are able to query it, 

access it, and review that data down to the, if need be, the order 

book itself. But in terms of, you mentioned sniping and sniffing, it 

is how a computer puts in a very small order, maybe one future 

contract, and sees whether it is addressed or hit and lifted, and 

then it will put in more and so forth. 

We don’t know yet whether that was a piece of what was happening May 6. We do have enough knowledge that the automated 

execution systems—there is the platform at the futures exchange, 

but then there are platforms that are in the executing brokers, that 

there was at least in this one circumstance, this one sell order, that 

on other days may have taken as many as hours to execute came 

into the market in those critical minutes. We are going to continue 

to look at that and see whether there are appropriate new rules 
11 

with regard to this very real reality. We can’t stop technology, but 

I think that we have to update our regulations to stay abreast of 

this. 

Ms. SCHAPIRO. Senator, could I just add that we can’t unplug the 

machines, but what we can do and are doing with things like circuit breakers is giving the opportunity for the human intervention 

to come back into the market, to apply rational thinking and 

thought, to pause a market and reopen it in an orderly and effective way that serves all investors’ interests. So we have got to get 

that balance right between when the technology, which provides 

benefits, is allowed to run and when it is not allowed to run because it has run amok and we can put the human factor back into 

it. 

Senator WARNER. My time has expired, Mr. Chairman, but I just 

would love to revisit, maybe in a second round, do you have the 

technology to stay abreast of the folks on the other side. 

Senator REED. Thank you, Senator Warner. We will have a second round. 

Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman, and thank you for 

your testimony. 

Why is there a circuit breaker on the way up? 

Ms. SCHAPIRO. Interestingly, there were five securities whose 

stocks were executed at $100,000, going up very, very dramatically. 

Apple was one. So the people are disadvantaged when they buy a 

stock at a $100,000 price as much as someone has been disadvantaged when they sell at the penny, and so it is the other side of 

the quote. So our view is, and the market’s view, because these are 

the market’s rules, was that fairness really dictates that the circuit 

breaker work in both directions. 

Mr. GENSLER. And if I might add, in the futures marketplace, the 

very small pauses, these five- or ten-second pauses that are across 

all the futures contracts, are about allowing liquidity to come back 

in. Sometimes in the nanoseconds, there aren’t a sufficient number 

of buy orders or sell orders, so it is about liquidity pauses. In the 

futures market, it is five or 10 seconds. And so it is to make sure 

there are orderly markets. We are not a price-setting agency at the 

CFTC. It is about orderly markets. 

Ms. SCHAPIRO. Nor, of course, is the SEC. 

Senator CORKER. So after 5 minutes, you have this breaker. Is 

there any issue with how trades are—what order they are traded 

in after that? I assume there is a back-up of trades, so how do you 

decide what gets executed after that 5-minute circuit breaker? 

Ms. SCHAPIRO. The primary listing market will be responsible for 

reopening the trading after the 5-minute pause, so during that period, they will be trying to attract liquidity and establish a new 

price for reopening a security. They will do it really just the way 

they do it now when there is a halt, as we have for news pending 

in the markets today. I am sure they can answer that question on 

the next panel in much more detail. 

Senator CORKER. So there is no issue there? 

Ms. SCHAPIRO. I am sure as we put these rules out for comment, 

I am sure there will be many very specific technical implementation issues that we will have to work through during that 10-day 
12 

comment period and then before the markets implement the circuit 

breakers and even while they go through their testing of circuit 

breakers. 

Senator CORKER. You know, the whole issue—I know there have 

been a number of questions regarding breaking trades, so we have 

this situation where we engaged in a lot of technology, where people, the thing they are most concerned about is how close they can 

locate to the exchanges and how quickly, and so that all works to 

the good. And then on the other hand, we break trades when 

things get out of alignment. It just feels incredibly arbitrary and 

doesn’t feel like the kind of—why do we do that? 

Ms. SCHAPIRO. I agree it feels—— 

Senator CORKER. On one hand, we create these tremendous advantages, and then when it doesn’t work well, we figure out a way 

to make it work well. 

Ms. SCHAPIRO. Well, in fact, that is one of the reasons for circuit 

breakers. It is our view, and I believe it is the market’s views, that 

circuit breakers should dramatically decrease the number of trades 

that have to be broken because of a price that is clearly erroneous. 

Where there are better linkages among the exchanges with respect 

to things like circuit breakers or liquidity replenishment points or 

volatility halts and all of these things earlier on, we probably 

wouldn’t have had anywhere near the number of broken trades. 

It is not a good position for us to be in where we are cleaning 

up afterwards, and that is what breaking trades is about. We need 

to have up-front the protection, like circuit breakers, that should 

diminish the number of trades that might ever have to be considered to be broken. I am sure we will never eliminate them entirely. 

There will be people who make mistakes when they enter orders. 

But they should be minimized. 

Senator CORKER. So it is rare that both of you all would be here, 

and I think you both know I respect both of you and enjoy working 

with both of you. But since you are both here and it is just the two 

of you, could you explain any rational reason that both the CFTC 

and the SEC exist? 

Ms. SCHAPIRO. I assume you meant as separate agencies—— 

Senator CORKER. That is correct. 

Ms. SCHAPIRO.——as opposed to existing at all. 

[Laughter.] 

Senator CORKER. No. 

Ms. SCHAPIRO. You know, obviously, Chairman Gensler will want 

to speak to this, as well. I have chaired the CFTC and now the 

SEC. I have had tremendous experience with both agencies. They 

are both populated with incredibly talented and hard working and 

committed people. It is my view that if we were creating a regulatory system afresh, we would not have two separate agencies. 

The market participants largely overlap. The products tremendously overlap, and we know that from the debate in regulatory reform. The issues between our two agencies are coextensive. 

So I think, were it up to me, and, of course, it isn’t, we would 

have one agency. We don’t, and so Chairman Gensler and I are 

hugely committed to working very closely together, and I think the 

work over the last 2 weeks demonstrates that we are capable of 

doing that. 
13 

Mr. GENSLER. The first part of your question, we exist to protect 

the markets and the public—— 

Senator CORKER. I know—— 

Mr. GENSLER. And the second part of your question—— 

Senator CORKER.——why you all exist separately—— 

Mr. GENSLER. Yes. But the second part of your question really 

dates back to the 1930s, when our predecessor and the SEC and 

when President Roosevelt came to Congress and asked that two 

agencies be set up, one to oversee what was then called the commodities markets, and then the securities markets, our oversight 

was on derivatives contracts, call it futures, and it has been the 

will of Congress for about seven or eight decades now to have two 

agencies. 

I do think that we have worked very well together, not just the 

two of us, but, I mean, the staffs of these two agencies, and we are 

working very well with Congress now to fill the one big gap, the 

over-the-counter derivatives marketplace, to make sure that we 

cover that. 

Our focus at the CFTC has been largely on derivatives contracts 

on exchanges and the SEC, though we cover a lot of the same market participants, is on the issuer public and, of course, the asset 

managers under the Investment Company Act and the accounting 

regimes and so forth. So we have complementary regimes, and it 

has been the will of Congress that that is the way we have been 

for seven or eight decades. 

Senator CORKER. Well, thank you both. I really do think you 

have great staffs and certainly appreciate working with you all. I 

just, as I see you sitting here, realize another issue—we certainly 

have not dealt, in my opinion, with one of the core issues regarding 

this last financial crisis with this bill, and then, again, lack the 

courage as a House and Senate to deal with a very obvious issue, 

and that is that the two agencies are separated. But again, we deal 

with everything in the world in this bill but some of the core issues 

that need to be dealt with. 

But I thank you both for being here and I am sure you all will 

remain separated for many years. 

Senator REED. Thank you, Senator Corker. 

Thank you for your testimony. One of the most potentially disturbing aspects of the testimony is that—and again, I want you to 

clarify it, will give you an opportunity to clarify it—is that you are 

both not quite sure what exactly happened. It was a confluence of 

events, but as I understand the testimony, the precise sequence, 

the precise causative factor among these has not been identified 

yet. Is that a fair statement? Chairman Schapiro and then Chairman Gensler. 

Ms. SCHAPIRO. It is a fair statement. You know, it has been 2 

weeks. Our staffs have been working around the clock. But there 

is an extraordinary amount of data that we have to plow through. 

And we are disadvantaged, quite honestly, on the equities side by 

the fact that we have so many different trading venues. We do not 

have a consolidated audit trail, which is why the Commission will 

be voting on that next week, to create one for the first time. 

But we had to get audit trail data from the options exchanges, 

from the NASDAQ and the New York Stock Exchange. Other mar-
14 

kets, like BATS and ISE and NYSE Arca that don’t even keep full 

audit information, they just have simple books and records requirements. We had 19 billion shares traded that day in 66 million different trades. Seventeen million of them alone were between 2 and 

3. So the enormous amount of data coming from multiple sources 

in different formats, captured in different ways, is creating an 

enormous amount of work for us. 

Our technology, I think as you know, Senator, is not great. It has 

fallen behind over the years, and our capacity to even handle the 

terabytes of data that we are getting slows us to a halt sometimes 

while our systems kind of catch up and allow us to continue our 

work. 

So I will say that I think the staff is doing an extraordinary job. 

We need to get them the technology resources. We are actually 

looking at bringing in a third-party firm to help us crunch the 

numbers. But over the longer run, this agency has got to have the 

capability to process this kind of information quickly and effectively 

so we can reconstruct markets and understand exactly where our 

problems are. 

Senator CORKER. Chairman Gensler? 

Mr. GENSLER. Though there is enormous work yet to be done, I 

might lean into this a little bit more than my staff would want, but 

I think the combination of events, the economic news that was 

coming out of Europe, and by the middle of the day, there was definitely a lot of uncertainty in the market. There was additional uncertainty that was coming from market signals. Sometimes market 

signals are fundamentals, like jobs data, or in this case what was 

going on in Europe. Sometimes the trading data, and we saw a lot 

of trading data in Treasuries, in currency markets that were higher 

uncertainty, and even when the New York Stock Exchange started 

to have some of these securities go into slow mode or the self-help 

modes, all that market data brings you to about 2:30 on that day 

and the market is down two to 3 percent. 

At that point, our review, because we have been able to look in 

the futures markets with CFTC, and for all the reasons Chairman 

Schapiro said, we still have a lot more work to look into the crosslinkages of the securities to futures, but in the futures markets, we 

saw liquidity dislocations where really sell orders were far outstripping buy orders in the critical minutes into the V, the downward 

drift. 

In the midst of that, some liquidity providers that don’t have an 

obligation to be in that marketplace did start to limit their participation in the critical minutes before 2:45. In addition, we did have 

one sizable sell order in the midst of that put in an automated execution system and through an automated execution system, 

through a little pop-down window—we have even sent staff to look 

at the pop-down windows—is able to put in, limit my participation 

to about 9 percent, because I thought it wouldn’t have a market impact. Well, on this day, that might have been a different feature, 

in some of those critical moments. 

So those are some of the factors that we have looked at. We still 

have to prove out some of the theories. There are a lot of cross-linkages that we are going to study together. 
15 

Senator REED. Based on that, and again, I want your comments, 

is that you cannot assure us that this problem would have been 

self-correcting given the market mechanism in place, is that a fair 

judgment? 

Ms. SCHAPIRO. Well, I think the fact that the market bounced 

back so quickly and prices recovered so quickly suggests that there 

may well have been sufficient liquidity present, but the markets 

couldn’t get to it. It wasn’t detected or it wasn’t accessible. That, 

to me, is a market structure problem, which is why we are doing 

circuit breakers as a way to sort of pause the market, try to bring 

that liquidity back where it is accessible again by the other side. 

It is why we are looking at things like the use of market orders, 

stub quotes, stop loss orders, and all of these other issues. 

But if you are asking me, can we guarantee this won’t happen 

again tomorrow, I wish I could tell you that I am, but we can’t, and 

it is why we are moving so quickly. 

Senator REED. Well, another way to look at the issue is that this 

was an unusually disruptive situation in which there was a recovery. We don’t know really what factors caused it and what factors 

we have to control, and we also really don’t, I think, know what 

factors caused the recovery, the rapid recovery. 

So there is a distinct possibility that this situation might not 

have naturally bounced back, but it could have deteriorated further 

to a point at which the markets were paralyzed and the fall would 

have been much more severe. Without being hysterical about these 

things, does that possibility exist? 

Ms. SCHAPIRO. I think because we really don’t know all the answers yet, I think that possibility does exist. 

Mr. GENSLER. We do know one thing about the recovery in the 

largest futures contract, this E-mini contract, that it took a 5-second pause. There was in the automated system at the Chicago Mercantile Exchange, called Globex, it has a liquidity stop. It is called 

a stop logic functionality, words I hope to forget one day—— 

Senator REED. Sounds like here. 

[Laughter.] 

Mr. GENSLER. Yes. But nonetheless, that 5-second pause to allow 

more orders to come into the book was coincident that the market 

in that contract moved up at the end of it. Seven seconds later, 

broad market exchange traded fund, about a $100 billion fund 

called Spiders, 7 seconds later, that started up, and then the cash 

markets, anywhere from 15 seconds to 2 minutes later started up, 

because that is the natural progression. 

Senator REED. You know, again, we can’t be alarmist, but we 

have to be very sort of tough minded about what potential problems exist there. One could suggest that with all these good things 

happening in Spider and the self-correcting logics, had suddenly 

the government of Greece announced that it was suspending all of 

its payments, those things would have been, I think, might not 

have been sufficient. 

So the point I think we have to look at, also, is what are the 

stand-by arrangements that if you can’t get this right, that if the 

circuit breakers don’t kick in correctly, what are those stand-by arrangements? And, I would dare say, will those arrangements be in 
16 

place in the future? Chairman Schapiro, and then I will ask Chairman Gensler. 

Ms. SCHAPIRO. Senator, we do have in existence and have since 

the 1987 crash—I guess it took about a year to put these circuit 

breakers in place, but there are existing now market-wide circuit 

breakers. They have actually only been triggered, I think, once in 

the last 20-plus years that they have been in place. So if the market goes down 10 percent before 2, and it is based on the Dow, it 

is halted for an hour. Between 2 and 2:30, it is halted for 30 minutes, and so forth, and there are different lengths of halt at a 10- 

percent decline in the Dow, a 20 percent decline in the Dow, and 

a 30 percent decline in the Dow. And at a 30 percent decline in the 

Dow, the market shuts for the rest of the day. 

So there is that ultimate fall-back we have in the market-wide 

circuit breakers. They have rarely ever been triggered. It is a pretty strong signal of big problems if they are triggered, and that is 

the reason we want to recalibrate those. 

Senator REED. What I presume that does is give you time to act. 

Ms. SCHAPIRO. Absolutely. 

Senator REED. What actions can you take, not just the SEC, the 

CFTC, but Federal regulatory authorities? 

Ms. SCHAPIRO. Well, I think that the market participants have 

the opportunity to try to gather liquidity into the market to find 

where there might be buyers to consolidate that interest in buying 

those securities when they reopen the stock in a much more orderly 

way. It is really about giving the markets a time out, human 

beings an opportunity to turn off the algorithms, change the algorithms, do whatever is necessary with respect to all the automated 

trading programs and then to do what market makers and specialists have traditionally done, which is to build interest in the market. 

Senator REED. And are you confident that the market makers, 

given that time in circumstances like that, can get it right without 

any assistance? 

Ms. SCHAPIRO. You know, at the end of the day, the markets are 

going to find their natural level, and if the news is dire enough and 

drastic enough, the best we can hope for, then, I think, is just an 

orderly decline coming off of the new single-stock circuit breakers 

and the market-wide circuit breakers. 

Senator REED. Chairman Gensler, and then I am going to recognize Senator Schumer. 

Mr. GENSLER. I would associate myself with Chairman Schapiro. 

I think the market-wide circuit breakers, it is called inter-market 

circuit breakers that were set up after the 1987 events, which have 

been triggered once, we are going to take a close look. We are going 

to use this advisory panel to look at. But as Chairman Schapiro 

has said, market participants will then have time, whether it is 30 

minutes, or if it was a severe drop right now, the markets are 

closed for the rest of the day, it is overnight, for information to 

come into the market, for humans to be there. 

A lot of these algorithms, just because it is algorithm, don’t think 

smart. A lot of the algorithms are very just rote, even dumb. I 

mean, they just do what they have been programmed to do repeatedly. And so giving the 30-minute pause in the inter-market circuit 
17 

breaker or even overnight if it is a 30 percent decline, for instance, 

today gives humans a chance and information to come in. If it is 

overnight, it even gives the whole Fourth Estate, the news media, 

to comment. So there is a lot, a flood of information. But I agree, 

ultimately, markets will find their way. 

Senator REED. Well, unfortunately, I think when it comes to the 

media, the headlines will be, ‘‘Markets Crash, Close, May Not 

Open,’’ which might be a self-fulfilling prophecy, an unfortunate 

one. 

But anyway, Senator Schumer? 

Senator SCHUMER. Thank you, Mr. Chairman. Thank you for 

holding this hearing. I thank our witnesses. 

We are in a brave new world here. It reminds me a little of that 

movie ‘‘2001,’’ where they started out man and machines, and the 

machines took over and you missed something bad happened when 

machines just took over, and that is what we sort of have here. Everything is now so mechanized with very little human interaction 

that much of the time it works very well, and some of the time it 

doesn’t work well at all, as we saw, and I worry about it. 

I worry that we let the technology get too far ahead of us, and 

I am hopeful that the solution you posed solves it, but I have a feeling we are going to have other kinds of problems because everything is so new and everything is so quick and there is, as you say, 

these machines are very smart and very dumb. OK. 

It is good to see both of you here together, the two agencies cooperating, but I do think there is a problem there, too. This started 

in the futures markets with one of these indexed, one of these indexed things, and we have the circuit breakers imposed in the equities markets but not in the futures markets. What kind of coordination is there, because I think most people agree that what started in futures spread to equities? What are you doing to deal with 

that kind of synapse, because the indexes can cause problems in individual equities and then we jump from the CFTC to the SEC? 

Mr. GENSLER. Senator, we do have these inter-market circuit 

breakers that were set up in the 1980s. We are committed to take 

a look at those, take a look at the outside advisers, see whether the 

levels should be adjusted. So right now if it is a 10-percent decline 

for a certain time, 2 and 2:30—it changes. But then the cross-market stops. The index futures products close, the equity markets 

close, the index options close—everything closes for the 30 minutes 

or hour, depending upon the time of the day. We are going to take 

a look at that very closely. 

Senator SCHUMER. Do you think that—what happened this time? 

Mr. GENSLER. What happened this time—— 

Senator SCHUMER. The circuit breaker did not stop things from 

crossing from the futures—— 

Mr. GENSLER. It was not triggered because the market had not 

gone down 10 percent. 

Senator SCHUMER. I see. 

Mr. GENSLER. The question is whether—— 

Senator SCHUMER. Got it. 

Mr. GENSLER. That is really what it is. 

Senator SCHUMER. So you have got to look at this and re-examine it. 
18 

Mr. GENSLER. Look and re-examine whether to change those levels. 

Senator SCHUMER. Right. The next question relates—it is a little 

along the lines of my opening remarks—to dark pools. SEC, 

NASDAQ, we have registered market makers. We have a little bit 

of that human element. You go to the dark pools and you do not. 

And I am worried that this is a potential area for problems because 

by nature they are dark. 

Now, obviously, they give an advantage. Somebody wants to hide 

what they are doing—‘‘hide’’ not in a pejorative way, but not reveal 

to the market that they are making a large, large purchase. I understand that. But it also may create problems that we do not 

know about. 

Does what has happened in the last couple of weeks make you 

folks feels we ought to re-examine what is happening in dark pools 

as well? 

Ms. SCHAPIRO. Absolutely, and as you know, we have proposed 

requiring that dark pools make their orders available for the public 

so that we do not end up with—— 

Senator SCHUMER. But when? 

Ms. SCHAPIRO. When will we—— 

Senator SCHUMER. No, no. When do they have to make their orders available to the public? 

Ms. SCHAPIRO. Oh, our proposal would have them display 

quotations broadly, not just to a select group of market participants 

as they do now when they receive the order. So the goal is to not 

allow this two-tier market to continue to develop where select market participants get access to quotes that the general public does 

not have access to. 

So our proposal would basically define these indications of interest as bids and offers and require public display, except for very, 

very large blocs where there may be some legitimate interest 

in—— 

Senator SCHUMER. The dark pools would become a little less 

dark. 

Ms. SCHAPIRO. Exactly right. 

Senator SCHUMER. Well, I think that is probably needed. Me, I 

am for openness and sunlight, first and foremost. I worry when we 

do not have it. I worry when we do not have it. 

My final question relates a little bit to what Senator Bunning 

talked about, but I would just like to follow up. Some markets are 

canceling trades that were executed after stocks dropped 60 percent. But there are a lot of investors who sold when their stocks 

were down 20 or 30 percent, and they lost thousands of dollars, 

even though the stocks closed right back where they started. 

What is the SEC doing to help these investors get their money 

back, if anything? 

Ms. SCHAPIRO. On a going-forward basis—and I recognize we 

have to deal with the 20,000 or so broken trades that were done 

arising out of May 6th. And with respect to those, we are looking 

very carefully at whether broker-dealers who handled particularly 

a lot of retail order flow during that period gave best execution to 

their customers, if they were executed 40 or 50 or 60 percent away 

from the market. And we will continue that investigation very 
19 

quickly. There are clearly going to be aggrieved customers given 

the level at which the exchanges set the break threshold. 

Going forward, we have to fix this process. It is badly broken. 

Senator SCHUMER. Can I ask one final question, Mr. Chairman? 

Senator REED. Yes, you may. 

Senator SCHUMER. Thank you. 

One final question to both of you. In general, do you think that 

in this area the rules that apply to equities and options should 

apply to futures, it should be the same kinds of uniform rules 

across the board in general? And I would like each of you to answer 

that. 

Ms. SCHAPIRO. We need to get uniform rules—my first order of 

priority is uniform rules within the equity trading venues, which 

we do not have right now. And so we are very focused on that. 

We have a Joint Advisory Committee that we have convened and 

it will meet on Monday, and one of their tasks will be to look at 

where between the two marketplaces, equities and futures, we have 

disparate rules that might be contributing to market volatility or 

the transmission of volatility from one market to the other. And we 

would expect to use those market experts to help us figure out exactly what ought to be the same. 

Clearly, for things like circuit breakers, they have to operate 

across the market seamlessly. Those must be the same. 

Mr. GENSLER. I would say critically market pauses, circuit breakers have to operate the same. There is something called a single 

stop futures market. It is not traded much but, for instance, that 

has to link into the same single stock, the broad market. Whether 

it is an S&P future, an S&P option, wherever, it has got to be at 

the same time. There are also risk management standards that 

happen in the futures markets, which, frankly, are a little easier 

to do in the futures market because there is not 50 or 70 venues. 

It is not that one is better or worse. It has just been easier to do. 

Senator SCHUMER. Thank you, Mr. Chairman. 

Senator REED. Thank you. 

Senator Bunning. 

Senator BUNNING. I brought this up earlier, but I want to get a 

little clarification of it. I am troubled by the way exchange-traded 

funds and closed-end funds move differently than the stocks they 

are actually supposed to track. As you can imagine, if those funds 

do not accurately reflect the value of the underlying stocks, there 

will be serious consequences as investors lose faith in them. 

What have you found out about what happened to them? 

Ms. SCHAPIRO. It is a great question that is a huge area of focus 

for us. If you look at the canceled trades, 70 percent of the issuers 

who had canceled trades were exchange-traded funds. So we have 

much more work to do in this regard, but here is what we are looking at. 

For example, NYSE Arca is the primary listing exchange for almost all exchange-traded funds. So we want to know did the loss 

of access to Arca’s liquidity pool, when two other exchanges routed 

around them to trade, disproportionately impact the liquidity and 

the trading of the exchange-traded funds. We want to understand 

why it was that the severe ETF price declines generally occurred 

after single stock price declines and how that linkage works. 
20 

Did the inability of market makers, for example, to hedge their 

ETF positions during the volatility contribute to a lack of liquidity? 

Were there more stop loss orders that were entered in the ETF 

markets than with respect to individual stocks? Was that a contributing factor? And did institutional investors short the ETF to 

hedge their broader market exposure as the market was declining? 

And so those are the areas we are looking at very carefully. ETFs 

are a huge part of our marketplace now. There are over 800 of 

them. They have over $700 billion in assets. Real people were impacted when the ETFs were impacted, and we are going to continue to look at this area particularly closely. 

Senator BUNNING. OK. I happened to be watching the market 

very closely when this was going on, and I watched a stock called 

Procter & Gamble at $61 a share and then the next trade was at 

$37 and the next trade was at $39. Now, those do not come within 

those parameters that you set out. In other words, the stock drop 

was not significant enough to be included. 

Ms. SCHAPIRO. My understanding is that Procter & Gamble declined 36 percent in 3 1⁄2 minutes, so the proposed circuit breakers 

of a 10-percent drop within a 5-minute period—— 

Senator BUNNING. Yes, your proposed. 

Ms. SCHAPIRO. Right. 

Senator BUNNING. I am talking about current. 

Ms. SCHAPIRO. No, that is right. Procter & Gamble also recovered 

back to that $60 in about—— 

Senator BUNNING. Yes, they did. I was just going to say it wound 

up at 60-something that day, and what happened to the poor person who sold at $37. 

Ms. SCHAPIRO. That is right. They do not fall within the 60 percent away from the last valid price threshold, I agree, which is, 

again, why we—— 

Senator BUNNING. Where is the market maker in Procter & 

Gamble? Where was the liquidity in the market maker? 

Ms. SCHAPIRO. That would be a great question for the next panel 

of exchanges. 

Senator BUNNING. Oh, OK. I will wait to ask that of the next 

panel. 

When you update the circuit breakers for stock indexes, do you 

expect to harmonize the rules between equities and futures in the 

same index? 

Ms. SCHAPIRO. Absolutely. One of the things we are looking at 

as we think about updating the market-wide indices is whether we 

should move, for example, from the Dow to the S&P. Are the 

thresholds right? Are the trading halt periods—— 

Senator BUNNING. We have a day going today that you may get 

another chance at this. 

Ms. SCHAPIRO. Great. 

Senator BUNNING. I just want you to know, today. 

Ms. SCHAPIRO. Clearly, these have to be highly coordinated 

across these two markets, and not just one. 

Senator BUNNING. Well, I just am worried that by lack of not getting something done we could have a repeat. We are off almost 300 

points on the Dow right now. The S&P is right at 30, and off. And 

the NASDAQ—or the other stock exchange is right around 60. 
21 

Now, if we get bad news out of the IMF or Greece or Portugal 

or something that would have an adverse effect on our own markets, we could see the exact same reoccurrence, and we have not 

done anything. 

Ms. SCHAPIRO. I share your sense of urgency, and we are moving 

very quickly, quicker than I have seen the SEC move in a very long 

time. 

Senator BUNNING. I know that, but that is not quick enough. 

Ms. SCHAPIRO. I understand. It is not quick enough. The existing 

circuit breakers we have will just have to be our fallback until we 

can get it done. 

Senator BUNNING. I think there comes a time when you take 

emergency actions, and if we are in that situation and in a market 

situation where we need emergency powers, all you have to do is 

come here and ask, because we do not want a reoccurrence, and we 

surely do not want to arbitrarily break up trades that were legitimately done under a set of rules. And I would urge you to come 

and directly ask this Committee for emergency powers. 

Senator REED. Senator Schumer. 

Senator WARNER. I have just got one more question. 

Senator REED. Senator Warner. 

Senator WARNER. I think you are all hearing our concern. But 

my only other question is—it is not going to be very articulately 

asked, but we are trying to get in place rules for circuit breakers. 

We are trying to get in place rules if we have this precipitous fall 

on how we make good or break up trades that are a result of this, 

again, as Senator Schumer said, ‘‘technology run amok.’’ You know, 

but I think there is also a bigger problem about market trust here. 

I thought I spent the last year and a half on this Committee trying 

to get up to speed on how we maybe put in place rules to fix the 

last crisis. But my gut just says that we may be looking at the beginnings of what could be the next crisis. I mean, terms that I am 

not sure—just probably not many folks a decade ago really understood the first time folks talked about credit default swaps or 

naked credit default swaps; the new terms of art of ‘‘high-frequency 

trading’’ or ‘‘flash trading,’’ which you have already taken action 

on; collocation, sponsored access, dark pools, you know, ‘‘sniping’’ 

and ‘‘sniffing.’’ 

You have said we are 2 weeks into this and you have not figured 

out—and, again, I am not being critical here, we have not figured 

out what caused the last problem. How do we make sure we have 

not only got rules in place to prevent or ameliorate the next technology run amok? I just in my gut feel like these firms who are 

making hundreds of millions of dollars of investments to get this 

technology advantage are not doing it simply to add liquidity to the 

marketplace. They are not doing it simply as a sign of good corporate citizenship. They are doing it to get a competitive advantage, and who are they getting a competitive advantage over? They 

are getting a competitive advantage over the Jim Bunnings who 

used to trade or the Mark Warners that used to trade or, you 

know, the guy in Schenectady who is trying to see—panicking 

when the market is dropping and trying to take action because he 

is not competing on a level playing field. 
22 

So my appeal is if you need not only action in terms of making 

sure we have got the circuit breakers in place, but how do we also 

make sure you have got the technology and the tools in place to 

make sure that we can give confidence to that investor in Virginia 

Beach who contacted me on May 7th saying, ‘‘What do I tell my 

investors who lost a lot of money on trades they made yesterday?’’ 

Because it was not market reactions, but there was something else 

going on. 

Ms. SCHAPIRO. The technology and tools are absolutely critical 

for us to be able to understand exactly what went wrong here. That 

will inform obviously the kinds of fixes and things we would put 

in place, because we do not have all those answers yet, though we 

do not want to wait to try to ameliorate the impact of what happened. Whatever ‘‘it’’ was—mismatch of liquidity, what happened 

in Greece, whatever the causes were—linkages between the two 

markets. That is why we have moved so quickly on things like circuit breakers, are moving quickly on things we think exacerbated 

the volatility, the use of stop loss orders, the use of market orders, 

and all of these things. 

So we are jumping on the things we can fix immediately to try 

to fix those immediately. We are doing this longer and deeper dive, 

which I hear you all saying pick up the pace on and figure out 

what is really broken in our market structure and get those things 

fixed as quickly as you can. And that is really what we are trying 

to do. 

Senator WARNER. I guess my time is up, but the question I am 

also asking is: As we sort through how we try to prevent this, we 

also have got to sort through to make sure that everybody is operating on a level playing field. 

Ms. SCHAPIRO. There is no question about that, and so much of 

what we are trying—I believe the markets exist for public companies to raise capital, to build businesses, and create jobs, and they 

exist for investors to support that activity. And those are the number one and number two purposes of markets. And everything else 

from my perspective has to be put into the context of those two 

goals. 

Mr. GENSLER. I would agree with what Chair Schapiro said, that 

in this new world of technology, we are not going to stop technology, but we have to make sure that markets are fair and orderly, transparent, as Senator Schumer said, they are not just 

mechanized creatures, again, as Senator Schumer said, but that 

they work for investors, they work for corporations that want to 

hedge their risk or raise capital, and that the pricing in those markets really reflects what buyers and sellers are coming together to 

reflect—you know, the risk and the values of the underlying companies. 

Senator REED. Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman. I want to follow 

up a little bit more specifically on Senator Warner’s fine questioning here. 

You know, we have competition among various exchanges, too, 

and some of them gain an advantage by being less regulated, if you 

will. And I am not so sure that is good or fair. So Direct Edge and 

BATS, for instance, they do not have to have registered market 
23 

makers, nor do they have to have a consolidated audit trail, so it 

is hard to find out what happened even after the fact to correct 

them. Why should they be allowed—why should other exchanges 

like a NASDAQ or an NYSE have these regulations—which they 

should for the good of the markets, but we have other so-called exchanges which do not, even though it seems both those two having 

registered market makers, having a consolidated audit trail, why 

shouldn’t they have those? And why are we letting them do this 

and they are capturing a big share of the market? I am not so sure 

it is because of technology as much as it is because they have less 

regulation. 

Ms. SCHAPIRO. I think over the last several years, over the last 

decade, as the national market system grew and fragmented and 

splintered and there was a view that we have to encourage lots of 

innovation and lots of competition, and that would be good for our 

traditional markets, NASDAQ and the New York Stock Exchange 

in particular. 

We lost sight of the fact that we also have to ensure that there 

are obligations on these other trading venues, that there is transparency, that there is investor-first focus. And I am highly focused 

on that. 

We will have, I believe, a consolidated audit trail. I believe the 

Commission will approve going forward with that next week. And 

that will—— 

Senator SCHUMER. You mean for BATS and—— 

Ms. SCHAPIRO. That will require all of the data, yes, from all of 

the trading venues. 

Senator SCHUMER. Right. And what about the idea of registered 

market makers? No one is saying if someone does not have a faster, better technology that they should not implement it. No one 

should have a monopoly. But if they are gaining share not because 

they have a better technology but because they have fewer obligations to protect investors, we have got big trouble. And I am worried that with these new—Direct Edge, BATS, that is just what we 

have. 

Ms. SCHAPIRO. I understand that, that the self-regulatory obligations do not exist on all of those markets or those trading venues 

the way they exist on our exchanges, and we have to look at that 

very carefully. 

Senator SCHUMER. Well, are you going to put some in? Are you 

looking to equalize it? 

Ms. SCHAPIRO. It is clearly part of what we are looking at in our 

view of market structure. 

Senator SCHUMER. OK. Well, I am going to be watching really 

closely and carefully about that because, again, I do not see—let 

me ask you this question since I have another minute. Is there any 

justification why these two exchanges shouldn’t have a consolidated 

audit trail? Is there any? 

Ms. SCHAPIRO. I cannot speak to what has happened historically. 

My view is no. The SEC has got to have access to consolidated 

audit information and order tracking information across all of the 

trading venues. 
24 

Senator SCHUMER. OK. And the second one, a little harder, but, 

still, any justification why they shouldn’t have registered market 

makers? 

Ms. SCHAPIRO. I do not know the answer to that. I guess I would 

like to come back to you on that. It depends upon the obligations, 

I think, with respect to the market makers. 

Senator SCHUMER. Mr. Chairman, could I ask unanimous consent 

that the SEC Chair, who I have tremendous respect for, have 5 

days to submit an answer to that question in writing for the 

record? 

Senator REED. Is that—— 

Ms. SCHAPIRO. Absolutely. 

Senator SCHUMER. Thank you. 

Thank you, Mr. Chairman. Thank you, my colleagues. 

Senator REED. Thank you, Senator Schumer. 

This has been very useful questioning, and I want to push it a 

bit further. One of the critical events, this confluence of events, 

which we agree was somehow the course, was unusual trading of 

a futures contract regulated by the CFTC. But from Senator 

Bunning’s remarks, this affected a stock like Procter & Gamble, 

which is clearly an exchange-traded, SEC-regulated entity. And it 

begs the question, I think, other than informal cooperation as you 

are exhibiting now, don’t we need some more regular, systematic, 

not only review of the rules but consistent rules that are derived 

by joint rulemaking? That was the essence of the Dodd bill. 

Chairman Schapiro, what is your view on that? 

Ms. SCHAPIRO. I do think we have the opportunity to bring much 

more consistency to these markets that are frequently economic 

substitutes for each other, and that is one reason we created a 

Joint Advisory Committee to help the two agencies understand exactly where we could benefit most from having similar or the same 

rules. And, clearly, under whatever version of legislation passes, we 

will have a fair amount of joint rulemaking to undertake with respect to securities-based swaps. 

Senator REED. Well, the present legislation before us specifically 

excludes most joint rulemaking, so can I assume you would maybe 

not prefer but for the greater good would anticipate or support 

more joint rulemaking? 

Ms. SCHAPIRO. Joint rulemaking has its own challenges, as we 

know, when we have to get ten people to vote and consider and get 

a majority to pass. So whether it is joint rulemaking or parallel 

rulemaking, we need consistency in the regulatory regimes that 

govern these economically equivalent instruments. So whether it is 

identical rules—ideally it would be one regulator. But whether it 

is identical rules or joint rulemaking, we cannot allow there to be 

differences that will be arbitraged and gaps where problematic conduct could be hiding. 

Senator REED. Well, given the institutional arrangements that 

are likely to stay in place and given the fact that in the future 

there might not be the same kind of meeting of minds and cooperative spirit that you both exhibit, there has to be, I think, an institutional structure that guarantees that this will happen. 

Ms. SCHAPIRO. I agree with that. 

Senator REED. Chairman Gensler? 
25 

Mr. GENSLER. I think that through the financial reform package, 

it appears Congress will add some of that. I mean, there is joint 

rulemaking in the over-the-counter derivatives markets and products like mixed swaps and so forth where there are attributes of 

both. There is heavy consultation, I believe, if I remember the last 

drafts of this, that each agency must consult and so forth. We also 

on our own have set up memorandums of understanding, and I 

think that if the financial reform package went there, we should 

embark to update that to include all of the new authorities, because I agree with the Senator that the cooperative relationship 

that we have now—we will be out of these jobs at some point. 

There will be other people and so forth. And the nature of two 

agencies is not always to agree. 

Senator REED. Well, I think we were all sort of—and I think Senator Corker was not only being his usual insightful and charming 

self, but the reality is had we started in this all fresh, there would 

be one agency dealing with these products that virtually can be 

substituted easily one for another. That is not going to happen. 

Senator WARNER. Since we did such a good job on prudential consolidation. 

Senator REED. Right. But I think this notion that we are going 

to let it the good will of the regulators does not work. 

Ms. SCHAPIRO. No. 

Senator REED. Unless we have an institutional structure that 

does not cause excessive delay, that there is an action-forcing device, that it requires not just discussions but actually joint action, 

this situation will still be existing long after we have all left the 

scene. 

Ms. SCHAPIRO. I agree with that. 

Mr. GENSLER. We had even asked, jointly we asked for Congress 

to include on product review a new feature that—I think it is 120, 

but it may be 180 days—that if the two agencies cannot approve 

a product and know which way it goes, that we put in a judicial 

review feature. 

Senator REED. I think that is very sound because I think we will 

anticipate for good reasons and sincere reasons there could be different perspectives, and there has to be an action-forcing device. 

But if we allow this whole enterprise to be based upon the cooperative and collaborative model you have shown, things change, people 

change, and we would be, I think, very foolish. 

There is another aspect of this, too, that I think we have to at 

least recognize for the record, and you might want to comment 

about it. This was an accidental, unfortunate confluence of circumstances, but we all recognize that it could be a very deliberate 

attempt to disrupt trading, either through a physical attack on exchanges or through a cyber attack on exchanges. 

Are you prepared to deal with that? 

Ms. SCHAPIRO. Our staff spends a fair amount of time working 

with the exchanges and major market participants on business continuity planning and back-up and contingency planning for those 

kinds of events. We have requirements for back-up facilities and 

annually review the adequacy of those with the markets that we 

regulate. 
26 

Senator REED. Are you and your staff concerned that this is a 

real possibility, that this is not just a theoretical—— 

Ms. SCHAPIRO. You know, in this world, I have no evidence or 

reason to believe something is imminent or could or will happen, 

but I think we absolutely have to be prepared for that possibility. 

To the extent that we suffer from this very dispersed and fragmented equities market structure, the one good thing is we have 

multiple trading venues where, if we had a physical attack on one 

major institution, we actually can pick up the slack in other places. 

So that is maybe the silver lining of our structure. But we absolutely have to be prepared for that possibility. 

Senator REED. Are you comfortable that the present legislation 

pending in the Senate would prevent any assistance to these entities, exchanges, and clearing platforms if they were subject to such 

a physical or cyber attack? 

Ms. SCHAPIRO. I believe so. 

Senator REED. So you are comfortable that in a situation where 

trading has been disrupted deliberately, the market itself can correct without any assistance from—— 

Ms. SCHAPIRO. No. I am sorry. I misunderstood your question. 

No, I think if there were a major disruption like that, there clearly 

would be some need for—or there likely would be some need for the 

Federal Government’s support in some way. I do not know if it is 

financial support or logistical support or other kinds of support. 

Senator REED. And you are aware that the pending legislation 

would prohibit that support? 

Ms. SCHAPIRO. I am. 

Senator REED. Thank you. 

Chairman Gensler, your comments on these questions? 

Mr. GENSLER. A series of comments. 

On disaster recovery and so forth, we have been working with 

the exchanges. We actually on our own are probably going to put 

out a proposed rule later in this year on strengthening some of the 

back-up recovery and disaster recovery in terms of cyber attacks, 

as you mentioned, and so forth. 

There are a series—and the futures markets maybe were benefited because there are fewer futures markets, but in this regard, 

that there is risk management standards, any contract, any transaction that comes in, has to meet the risk management standards 

of the clearinghouse, and because of that there is a series of filters 

and risk management standards before they come in. That does not 

mean that somebody could not possibly, as you say in a theoretical 

case, come in, but there is a lot of risk management practices. We 

are going to be looking to see if there should be more. 

I think on the third question that you ask about, Federal assistance, I am aware that there is sort of—if I might, there is a little 

bit of—there is in Title 8 of the pending statute allowing for Federal assistance and in Title 7 there is not. So there is an inconsistency there. 

I think that from my perspective the Federal Reserve that has 

had 13(3) authority to come in in an emergency if a situation 

should continue to be allowed, the 13(3) emergency authority, but 

not necessarily have daily access to the discount window. I know 
27 

it might sound like it is slicing this, but I think the emergency authority is probably still important. 

Ms. SCHAPIRO. Mr. Chairman, if I could just clarify. 

Senator REED. Sure. 

Ms. SCHAPIRO. Because I do not think I was very clear. I think 

that—I would agree with a policy of providing the Federal Reserve 

Board the flexibility to provide immediate liquidity if it is needed 

in a rare or an emergency circumstance. And we have long, I have 

long supported ensuring that the systemic risk regime would have 

a second set of eyes in addition to those of the primary functional 

regulators and comfortable with that role at the Federal Reserve 

as well. 

Senator REED. This is an important point, and I think we should 

be clear about it. As Chairman Gensler points out, there appears 

to be contradictory language in the bills, which we will resolve, I 

hope. But Section 7 specifically excludes the ability of the Federal 

Reserve to use its modified emergency powers to assist—or change 

clearing platform in a general way, not one but in a general way. 

And your view would be that that power, the 13(3) power, should 

be preserved. 

Mr. GENSLER. I believe it is Section 716, the vaunted 716 that 

has other issues. But 716, I would retain the part of 716 that limits 

the daily access of the discount window but allow in an emergency 

circumstance for the Federal Reserve to lend to participants in generalized liquidity programs. They would have to put out a rule so 

people would know what it is, but then the participants would be 

able to have that emergency action. 

Senator REED. Thank you very much. 

A final question, which this, again, has been swirling about us, 

and I think you should be asked, too. There are several proposals 

that would essentially ban over-the-counter swaps, in some cases 

make them illegal. Is that from your standpoint, Chairman 

Gensler, a good policy to pursue? 

Mr. GENSLER. I think that derivatives, whether they be on exchanges or what we call over-the-counter, are important risk management tools for municipalities, corporations, and ultimately their 

customers and employees. I am not familiar with the pending 

amendment, but a lot has gone on in the last 24 hours to, quote, 

ban risk management tools of corporations. If they are customized, 

if they are tailored, we still think there should be comprehensive 

regulation of the dealers. I am pleased to see that in the Senate 

substitute there is truly a comprehensive regime. It is standard 

enough to be on a clearinghouse and clearable. And if it is then 

listable, then there is the clearing requirement and, in certain circumstances, a listing requirement. That, I think, is a strong package that you and others have put together. 

Senator REED. Chairman Schapiro, any final comments? 

Ms. SCHAPIRO. Just a brief thought. I assume this is Senator 

Cantwell’s amendment potentially, the—— 

Senator REED. Well, there are several. 

Ms. SCHAPIRO. There are several, OK. 

Senator REED. There is a sizable number of colleagues who are 

thinking about this. This is a question I think should be addressed 

both you and Chairman Gensler. 
28 

Ms. SCHAPIRO. You know, I think the key policy question is 

whether that would provide—or create legal uncertainty for swaps 

that are accidentally not cleared or whether it creates the opportunity to game the system. I actually think those concerns can be 

addressed, but I would note that we already have under the Federal securities laws, under the Exchange Act Section 29(b), a similar although not identical provision, although it has not been applied ever in the context of requiring something to be cleared or 

not. So it might move the Commodity Exchange Act regime more 

in the direction of the Federal securities laws; but, on the other 

hand, it may have the potential to create legal uncertainty 

Senator REED. Chairman Gensler, your final point. 

Mr. GENSLER. Well, if it was a question about—there is one 

issue—I did not understand your earlier question to cover this, but 

if it did, if an over-the-counter derivative is deemed to be clearable 

and the regulators through a public comment period have determined that it must be cleared, which is what is in the substitute, 

in that circumstance there is a mandate that it must be cleared. 

If somebody knowingly does not follow that, what happens? And I 

believe the substitute right now gives the SEC and CFTC a lot of 

authority, but to be clarified to say that that transaction is unlawful seems consistent with actually what the intent is, that it is a 

mandate once you have this public comment period and it is a 

mandate, it is a real mandate. 

Senator REED. I think part of this—and I will not get into the 

details here—is that some reading of these proposals would suggest 

that they go beyond that, saying that, in fact, you have—even as 

an exempt end user—an over-the-counter derivative that you 

present to a clearing platform and they will not clear it, then if you 

enter that contract, then that is illegal. But I think we have provided at least some insight into the proposals, and I thank you for 

that. 

I will invite my colleagues for further questions—— 

Ms. SCHAPIRO. Senator Reed, may I just clarify the record on one 

thing I said in response to Senator Schumer? BATS is actually an 

SRO, as is Direct Edge. He specifically mentioned those two marketplaces, although Direct Edge is not yet operating as such. And 

the decision about whether to have designated or registered market 

makers has been an exchange-by-exchange decision, but it is something we will be happy to look at. 

Thank you. 

Senator REED. Thank you very much, not only for your testimony 

today but for your very vigorous and thoughtful and demanding 

service to the Nation. Thank you. 

Mr. GENSLER. Thank you, Mr. Chairman, Senator Bunning, Senator Warner. 

Senator REED. Let me call up the second panel please. 

Thank you all, gentlemen, for being here today. 

Let me introduce our witnesses. Our first witness is Mr. Richard 

G. Ketchum. He is the Chairman and CEO of the Financial Industry Regulatory Authority, or FINRA, the largest non-governmental 

regulator for all securities firms doing business with the U.S. public. Prior to becoming CEO of FINRA, Mr. Ketchum served as CEO 

of the New York Stock Exchange Regulation and Chief Regulatory 
29 

Officer of the New York Stock Exchange and has also worked for 

Citigroup, NASD, NASDAQ, and the SEC. 

Our next witness is Mr. Larry Leibowitz, the Chief Operating Officer of NYSE Euronext. He joined Euronext in 2007 after serving 

as the Managing Director and Chief Operating Officer at UBS Investment Bank and has also worked for Schwab Capital Markets. 

Our third witness is Mr. Eric Noll, the Executive Vice President 

of Transaction Services for the NASDAQ OMX Group. Mr. Noll 

joined NASDAQ from Susquehanna International Group and has 

also held positions at the former Philadelphia Stock Exchange and 

the Chicago Board’s Options Exchange. 

Our finally witness is Mr. Terry Duffy, the Executive Chairman 

of the CME Group. Mr. Duffy has also served as Chairman of the 

Board of CME and CME Holdings and was President of TDA Trading from 1981 to 2002. 

All of your statements will be made part of the record. If you 

would like to summarize them, we would like it, too. 

Mr. Ketchum, please. 

STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND 

CHIEF EXECUTIVE OFFICER, FINANCIAL INDUSTRY REGULATORY AUTHORITY 

Mr. KETCHUM. Chairman Reed, Ranking Member Bunning, and 

members of the Subcommittee, thank you again for inviting me 

today, and I commend you, Mr. Chairman, for having today’s hearing and I thank you for the opportunity to testify. 

I would also like to commend Chairman Schapiro and Chairman 

Gensler, whom you have just spent a good deal of time talking 

with, for their leadership during the last 2 weeks and in coordinating the review of all relevant market data and efforts to identify 

measures that could be taken quickly to significantly reduce the 

chances of a recurrence of the significant market disruption that 

occurred on May 6. 

Immediately after the market events on May 6, FINRA, in coordination with the SEC and other market SROs, began the process of trying to identify unusual activity that could have contributed to the rapid market drop. Even before the market data had 

been fully collected, FINRA reviewed clearly erroneous trade filings 

and, along with NYSE Regulation, interviewed the approximately 

20 firms with significant activity during the period of the decline 

to determine whether ‘‘fat finger’’ or other trading errors occurred. 

None of the firms identified any trading errors or other unusual activity, nor has any evidence been developed to indicate that a single large trade or basket of trades entered in error played a role 

in the market decline. 

We also contacted over 250 firms to determine the impact of the 

market disruption to the firms and their customers. Our inquiries 

covered a range of issues depending on the type of firm, including 

funding and liquidity, customer exposure, increased margin calls, 

net capital implications, and how firms intended to reestablish 

limit orders that were executed and canceled. While a number of 

operational and other issues were identified, none of them appeared to be systemic in nature. 
30 

We have focused our review of the vast amounts of trading data 

on the approximately 300 stocks that experienced the most traumatic decline and have identified a subset of these stocks for further inquiry based on an analysis of the concentration of order and 

trade activity in the period immediately prior to and during the 

market drop. Focusing on the selling activity in these securities, 

we, along with our fellow regulators, have made inquiries of those 

firms that were most active. Our lines of inquiry include an analysis of short selling during the period and the role that algorithms 

played, including the specific strategies and triggers employed by 

each of the trading firms. 

While there is still much to be done before we can say that we 

have definitively pinpointed the cause or causes of the decline, I 

think we can say that certain basic truths have emerged and that 

we should not wait to adapt to them. We know that the process for 

restoring order following an event like last Thursday should be 

more transparent and predictable. Also, because trading in equities 

is dispersed among many venues, market quality can only be ensured through coordinated activities across all markets. 

In short, while our equity market structure performs well under 

normal conditions, change is urgently needed to address these flash 

market break situations. That is why the coordinated rule filings 

the SEC spearheaded are so important. I won’t spend more time 

discussing the details of them since they were covered in detail at 

the last panel. 

As we look past these shorter-term steps to address what we saw 

in the market 2 weeks ago, longer-term concerns must also be addressed if we are able to reassure market participants that our equity markets are stable and fair. This is true irrespective of whether those issues played a major contributing role in the specifics of 

the decline on May 6. 

First, firms need to ensure that they do not continuously feed orders into the markets once markets have broken with respect to 

precipitous declines or employ market orders in these volatile periods. 

Second, firms must properly supervise customers to whom they 

have given direct access to their markets. 

Third, there should be a continued analysis of various market 

rules regarding circuit breakers and clearly erroneous trades with 

an eye toward consistency and transparency of these rules across 

markets. 

In addition, we should examine various order types, such as market and stop loss orders, and their impact on the events of May 6. 

We should also analyze and potentially eliminate the practice of 

stub quoting. 

Finally, the events of May 6 demonstrate the vital importance of 

the SEC’s current review of market structure and forthcoming proposal relating to establishing a consolidated audit trail. 

The sometimes dizzying speed of change in the markets, which 

puts a premium on innovation and competition, has made it imperative that regulators act now to address the lag between market innovation and regulation. This is particularly important in the increasingly fragmented area of equity trading, where we have seen 

a rapid evolution of how and where trading occurs and how quickly 
31 

and transparently it is executed. Today, orders are routed to some 

50 competing platforms. This complex environment creates opportunities for traders seeking unfair advantage to manipulate markets by exploiting inconsistencies or gaps created when the responsibility of regulatory oversight is divided. 

Regulatory authorities are hampered by the lack of a comprehensive and sufficiently granular consolidated audit trail. Indeed, the 

frustration that many of you have expressed today with respect to 

the time it takes us to recreate what really occurred on May 6 is 

absolutely reflected by the fact that our audit trail today simply 

does not identify each of the entities that significantly impact pricing, but instead focuses on the executing broker-dealer and those 

who clear the trades. 

The most effective way to surveil across the wide range of market centers is to consolidate audit trail data in a single place so 

that violative trading practices can be more readily identified. 

While a consolidated audit trail would not eliminate all the challenges of analyzing the data from a 66 million-trade day, like May 

6, it would make the process significantly more efficient and effective. More importantly, it would enhance oversight of the equity 

markets, ensuring market integrity and protection of investors. 

We look forward to working with the SEC and this Committee 

on these important initiatives that lie at the heart of enhancing 

regulators’ ability to best oversee today’s markets, and I look forward to answering your questions going forward. 

Senator REED. Thank you very much. 

Mr. Leibowitz? 

STATEMENT OF LARRY LEIBOWITZ, CHIEF OPERATING 

OFFICER, NYSE EURONEXT 

Mr. LEIBOWITZ. Chairman Reed, Ranking Member Bunning, and 

members of the Subcommittee, thank you for the opportunity to be 

here today. 

We commend the Subcommittee for your proactive response to 

the events of May 6. If ever we needed one, the events of that day 

are a clarion call for the need to enhance investor and listed company safeguards. May 6 also confirms the wisdom of the SEC’s ongoing efforts to improve the markets, including their broad market 

structural review and their leadership in bringing the markets together to develop the circuit breaker pilot. 

Today, I would like to discuss three things. First, the high-level 

causes of the May 6 events. Second, clarifications about NYSE’s 

market model and how it worked. Third, our recommendations 

going forward. 

It is understandable that everyone is looking for a smoking gun 

behind the May 6 dip. However, the circumstances are more complicated than that. I will leave it to the regulators to link the interactions of various markets, but from our standpoint, we see no evidence of ‘‘fat finger’’ error or market manipulation due to automated trading or otherwise. 

However, we do see the following: Elevated market activity coming from adverse and European news, including a huge and broadly 

based wave of orders and quotes at around 2:40 p.m. A significant 

thinning in the marketplace as liquidity deserted the market 
32 

through the day, accelerating into the downturn. Various microstructure issues which exacerbated the liquidity effect. 

One of the things that we do note is that news and fear get 

transmitted to the market faster than ever before thanks to technology and media advances, and we need to ensure the integrity of 

the market during these periods. 

Now, I would like to briefly turn to the NYSE market model and 

how our actions on May 6 reduced volatility to the benefit of investors and listed companies alike. NYSE has embraced electronic 

trading. We believe our market model provides the best combination of cutting-edge technology with human judgment. NYSE market rules expressly provide mechanisms to mitigate volatility and 

large price swings, which we have always believed is a critical 

piece of our offering to listed companies and their investors. In essence, at the NYSE, we have emphasized price over speed. 

Specifically, the NYSE incorporates a type of circuit breaker 

mechanism known as liquidity replenishment point which temporarily and automatically pauses trading in stocks when significant 

price movement occurs. On a typical day, LRPs are triggered 100 

to 200 times, lasting for seconds, at most. In fact, these are akin 

to the circuit breakers that the CME discussed recently, which is 

a brief pause to allow liquidity to reassemble. 

Let me be clear, the LRP mechanism does not halt trading. 

When LRPs are in effect, our quote is visible to other market participants and new orders are continually accepted. During LRP 

mode, electronic markets may choose to ignore our quotes as permitted under Regulation NMS, although many participants choose 

to continue sending orders to NYSE. LRPs are analogous to taking 

the controls of a plane off autopilot during turbulence. 

I will highlight a few specifics. First, on May 6 during the 2:40 

to 3 period, market share on the NYSE was 5 percentage points 

higher than usual during that time of day and the participation 

rate of our designated market makers, which were formally called 

the specialists, and supplemental liquidity providers was equally 

strong. This is evidence that our liquidity providers did not walk 

away from the market as we actively traded during the downturn. 

Furthermore, to demonstrate that LRPs protected orders in our 

market, stocks listed on other markets had price declines and erroneous executions far greater than NYSE-listed stocks. 

Last, the overall marketplace needed to cancel approximately 

15,000 executions after Thursday’s decline. On NYSE, even though 

we handled the largest share of orders in the marketplace, we had 

to cancel zero trades. In fact, 85 percent of the trades that ultimately were canceled were securities that were not even listed on 

the New York Stock Exchange. 

The bottom line is while there is always room to improve, LRPs 

actually worked reasonably well on May 6, and the response from 

issuers and investors has been uniformly positive. However, the 

mechanism is only truly effective if observed by other trading 

venues, and that is why we applaud Chairman Schapiro’s leadership in helping create an industry-wide trading circuit breaker. 

I also want to mention an area that we believe has been the topic 

of inaccurate information. On May 6, NASDAQ declared self-help 

on NYSE Arca at 2:40 p.m. We were and are still unable to deter-
33 

mine why, as all our systems and communication links were functioning properly. BATS also declared self-help at 2:47, but that was 

because they were sending orders outside of Arca’s price callers, 

and a quick call between the venues resolved the matter. We welcome the SEC’s review of these events and hope they will more 

generally review the use of self-help by venues against each other. 

Last, we need to examine the ripple effect of stock volatility in 

the ETF market and absolutely must make sure that these are included in circuit breaker considerations. 

In terms of recommendations, I want to quickly make a few 

points. First, we are pleased with the recently announced adoption 

of market-wide stock-level circuit breakers. LRPs will continue to 

function, as we believe they provide a significant advantage to companies listed on our exchange. We will review the need for and 

functioning of LRPs once the market-wide circuit breakers are implemented. 

Second, the current market-wide circuit breakers established 

long ago are based on market moves of 10, 20, and 30 percent. 

There has not been a move greater than 10 percent in a single day 

post-2000. We understand the SEC is reviewing these as to whether to broaden these indexes. 

Third, we are working with the regulators and other exchanges 

to establish clearer rules for cancellation of trades, although circuit 

breakers will help mitigate this problem substantially. In fact, I 

would submit that the mere need to cancel trades is the sign of a 

market structure that does not function properly. Since 2008, hundreds of thousands of trades have been canceled from electronic exchanges with stocks such as Cisco Systems trading down to a 

penny during the fourth quarter of 2008. It is time we put a stop 

to this. 

Fourth, brokers should review their order routing practices to ensure they are truly getting the best prices for their clients and also 

see whether allowing market orders and stop loss orders really 

service the investing public or whether there are things we can 

jointly do to educate and protect retail investors from being harmed 

by volatile markets. Similarly, institutional clients should review 

their brokers’ routing practices to ensure that these serve their 

best interests. 

Fifth, to facilitate a review of extraordinary trading events, there 

should be a consolidated audit trail that would allow regulators to 

review market-wide trade data. Ultimately, these and other important actions may be best achieved by consolidating market surveillance in one security self-regulator, probably FINRA, which would 

require an act of Congress. 

In closing, we applaud the SEC and the CFTC for working together to develop a coordinated response to the events of May 6. 

NYSE Euronext is committed to working with these agencies and 

we strongly urge all parties to play an active and responsible role 

in helping our markets function in a way that gives investors confidence. 

Thank you for the opportunity to appear, and I would be happy 

to answer any questions. 

Senator REED. Thank you very much. 

Mr. Noll, please. 
34 

STATEMENT OF ERIC NOLL, EXECUTIVE VICE PRESIDENT OF 

TRANSACTION SERVICES, THE NASDAQ OMX GROUP, INC. 

Mr. NOLL. Good morning, Chairman Reed, Ranking Member 

Bunning, and Senator Warner. Before I begin my formal comments, 

I would like to convey my appreciation and respect for the actions 

of SEC Chairman Schapiro and CFTC Chairman Gensler during 

this important period of time. Their actions and those of their staff 

have been exemplary. 

We have studied the events and have worked closely with the 

SEC and the other exchanges to identify opportunities to improve 

regulation and coordination to combat market instability. We support the SEC’s and CFTC’s actions in four areas: One, updating existing market-wide circuit breakers; two, establishing new stock-bystock circuit breakers that include an element of velocity of price 

changes; three, improving the handling of trade breaks to maximize consistency and rationalize moral hazard; and finally, four, 

changing the use of quotes and specific order types that impacted 

trading on May 6. 

The focus of these changes is consistency. While each individual 

exchange reports that its systems functioned according to design on 

May 6, the changes will improve the collective ability to handle unusual trading events in the future and help to restore investor confidence. Markets like consistency and predictability. They abhor 

uncertainty. Our markets are strong, despite the 17 minutes of 

trading that have garnered public attention. 

Keep in mind that on May 6, the global markets were nervous, 

becoming increasingly volatile and operating during an unusually 

long upward price trend. This volatility was certainly tied to the 

crisis in Greece and Europe. While developing for months, the potential harm seemed to sink into U.S. markets the week prior to 

May 6. Rating agencies lowered the ratings of sovereign debt of 

Greece, Spain, and Portugal, roiling debt markets. The European 

Union was working to fashion bailouts, and violence escalated in 

Athens. The Euro was down 15 percent in the last 6 months, 7 percent in the prior 2 weeks alone. 

Against this backdrop, we arrived at the afternoon of May 6. 

First, the Dow Jones Industrial Average was down 272 points for 

the day, down 500 the previous 3 days. 

Second, there was an unusually large institutional order to sell 

futures tied to the S&P 500 Index on the CME. Futures are a forward indicator for prices of equities. Thus, when S&P futures sank 

rapidly at 2:42, this was followed by rapid declines in S&P-linked 

equities. 

At 2:45 and 30 seconds, S&P futures became so negative the 

CME triggered a stop price logic event, a 5-second pause in trading 

to collect liquidity, effectively a market-wide halt in the futures 

market. When trading resumed, futures leveled off and began to 

climb. Shortly after, equity prices also rose. The CME assures that 

its systems functioned properly and there is no evidence of inappropriate activity by the CME or any of its members. 

Third, the NYSE Arca Exchange, the electronic market operated 

by NYSE, began experiencing communication issues, at least with 

NASDAQ, that hindered electronic linkages with other markets. 

The other exchanges were forced to route around Arca. Again, 
35 

there is no evidence of inappropriate activity in Arca or any other 

problem, but its liquidity became less available to the entire market at a critical time. 

Fourth, simultaneously with Arca, the NYSE hybrid market 

began reporting multiple liquidity replenishment points in gap 

quotes that impacted trading in the NYSE-listed stocks. Under 

SEC Regulation NMS, NYSE is permitted to issue LRPs, but this 

functioned as a signal to other markets that NYSE was experiencing order imbalances or difficulties. This, in turn, allowed other 

markets to stop routing orders to NYSE and to trade elsewhere, 

and that is exactly what happened. NASDAQ and other markets 

routed around NYSE as Reg NMS contemplated. Even Arca, 

NYSE’s own electronic market, stopped routing orders to NYSE. 

NASDAQ’s ongoing analysis indicates that May 6 was triggered by 

a confluence of unusual events, including events outside the equity 

markets. We continue to investigate, but we have not located any 

single smoking gun that caused or fully explains these events. 

I would note also that so-called high-frequency traders appear to 

have played no distinguishing role in this event. They behaved in 

line with other liquidity providers and liquidity takers during that 

day. The SEC is engaged in an important review of market structure and the policies around high-frequency trading and we recommend that Congress allow that review to run its course before 

considering additional policy reactions in this area. 

From a systems standpoint, NASDAQ’s markets operated continuously throughout the day and throughout the critical 17 minutes. Each and every one of our systems functioned as designed 

and intended, our execution engine, market data feeds, and surveillance systems. 

While each exchange is reporting that its systems functioned as 

designed, no market center or regulator can be satisfied with the 

collective performance of our markets on May 6. That is why 

NASDAQ supports and has filed with the Commission rules to implement cross-market single stock trading halts and supports the 

SEC’s recommendation to update market-wide circuit breakers. 

NASDAQ also supports the Commission’s decision to review practices that cause individual markets to pause or go slow to determine if any other practice starves the market of liquidity when it 

is most needed, including the operation of certain order types or 

the practice of market maker quotes. 

Thank you again for the opportunity to share our views. I am 

happy to respond to any questions you may have. 

Senator REED. Thank you. 

Mr. Duffy, please. 

STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE 

CHAIRMAN, CME GROUP INC. 

Mr. DUFFY. Chairman Reed, Ranking Member Bunning, thank 

you for inviting me to testify today. 

CME Group has engaged in a detailed analysis regarding trading 

activity in our markets on Thursday, May 6, 2010. Our review indicates that our markets functioned properly. We have identified no 

trading activity that appeared to be erroneous or contributed to the 

break in the cash equity market during this period. Indeed, our 
36 

markets led the recovery. Moreover, no market participant in our 

markets reported that trades were executed in error, nor did CME 

Group exchanges cancel, bust, or reprice any transactions as a result of the activity on May 6. 

Futures contracts by design provide an indication of the market’s 

view of the value of the underlying stock index. That is why CME 

Group’s E-mini S&P 500 is a leading indicator, not a cause, of a 

decline in the underlying primary market. 

To illustrate this point, I would like to draw your attention to 

these two charts. Chart 1 shows that the E-mini S&P, which is the 

blue line, move virtually in tandem with the S&P 500 Index, which 

is the red line. You can see that at 13:46, the market had had time 

to attract liquidity and rebalance and the E-mini led the recovery, 

ultimately rallying 40 S&P points, or the equivalent of approximately 400 points of the Dow. 

Chart 2 shows price movement in the E-mini S&P futures as 

well as 3M stock. As you can see, the price of 3M stock declined 

much more rapidly starting at 13:45, with the E-mini S&P 500 hitting the low at 13:45:50, at which time you see the market and the 

E-mini S&P reverse while the 3M stock continues to decline. 

Market integrity is of the utmost importance at CME Group. We 

have developed systems that maintain integrity in all our markets, 

including a number of control to protect market users, such as stop 

price logic functionality, price banding, and circuit breakers. Stop 

price logic functionality serves to mitigate artificial market spikes 

that can occur because of the continuous triggering, election, and 

trading of stop orders due to insufficient liquidity. 

On May 6, the stop price logic trigger, a 5-second pause in the 

E-mini S&P Equity Index, allowing the market to locate liquidity 

and to stabilize. We have seen no evidence that high frequency or 

other specific trading practices in any way magnified the decline on 

May 6. In fact, our market indicates that the high-frequency traders in our market provided liquidity on both sides of the market 

on this extraordinary day. 

The CFTC and SEC issued a joint report Tuesday that reflects 

preliminary staff findings resulting from their ongoing reviews of 

the events of May 6. We commend both the Commissions on their 

swift response and look forward to working with them to identify 

constructive solutions. 

In particular, we are pleased and concur with those recommendations seeking harmonization across the national market system. As 

the report suggests, circuit breakers, including circuit breakers for 

individual stocks, such as those implemented by the NYSE, must 

be harmonized across markets. Stop logic functionality should be 

adopted across markets to prevent cascading downward market 

movements as the report confirms it did on May 6 in the E-mini. 

Last, the current circuit breaker levels and the duration of the halt 

should be reevaluated and updated to current market conditions. 

I thank the Committee for this opportunity and I look forward 

to answering any questions. 

Senator REED. Well, thank you very much, gentlemen. 

Listening today to the testimony, I think we all would be more 

relieved if it was the fault of ‘‘fat finger,’’ who sounds suspiciously 
37 

like a character in a Mike Myers James Bond spoof, but that is not 

the case. 

We are still left, I think, based on your testimony, with the conclusion that we are not quite sure what was the decisive precipitating course. There were several factors, and I will give you the 

chance to comment about that. But it strikes me, too, that one 

thing is clear. We have highly interrelated markets and we have 

different rules in those markets. Some of these rules, I presume, 

were crafted with the awareness of other rules, but perhaps not 

consciously and deliberately complemented or syncopated or whatever the word is, and that part of the effort here is to begin to harmonize rules and ask tough questions about whether that harmonization means to make them all the same, which could exacerbate 

a crisis or at least make them responsive to and reflective of the 

other rules. 

So with that long, long sort of introduction, the basic first question is can you comment about sort of the status of what do we 

know and what don’t we know about May 6 and also about the 

need for a much more coordinated structure of rules. Mr. Ketchum 

first, and we will go right down the line. 

Mr. KETCHUM. Thank you, Chairman Reed, and I think your 

points are well made. 

I would agree with a great deal of what Chairman Gensler said 

earlier. We do know a great deal about what happened on that day 

at this point. While we are cautious not to characterize everything 

without fully understanding all of the underlying activity of customers behind it, a few things seem pretty clear, and you categorized it fairly well. 

This was not the result of one single program. It was the result 

of large numbers of programs that operate very similarly together. 

It was the result of real selling activity with respect to real things 

happening in the marketplace, but the response of the concentrated 

selling activity and the speed in which liquidity can disappear from 

the market is close to absolute. And that is combined with an environment now, as you discussed in earlier panels and discussed in 

the opening statements, where there aren’t consistent market 

maker obligations across markets at this point, and without that, 

where there isn’t an ability for participants to be able to pause and 

reinsert buying activity. That is simply unacceptable. 

The first step, the pauses are important and they need to move 

beyond the S&P 500 once they are appropriately crafted to ETFs 

and other securities. That will allow for the ability for algorithms 

and people to understand and be able to reinsert buying activity. 

It is not that it will miraculously appear, but computers are designed when they don’t understand something to withdraw. You 

need enough time to determine that the world actually hasn’t 

ended and that there are reasons to continue to buy stocks. 

That needs to be combined with consistency across each market 

and stocks and futures. You are right. These are not always identical things, but with respect to areas like pauses and circuit breakers, they should be absolutely consistent. 

Senator REED. Mr. Leibowitz, any comments in this whole—— 

Mr. LEIBOWITZ. Sure. While I think it is very comforting, it 

would be comforting to know what the triggering cause of this was, 
38 

I think it is largely irrelevant. It is like airport security. We all 

take our shoes off because someone happened to put a bomb in his 

shoes, and we all wondered what would happen if somebody put it 

in their pants, and they did. 

I think what we need to do is take the step back and say, what 

are the factors in our market in terms of the order types that retail 

traders use, stop losses, things like that? What do we do about liquidity obligations, how fast the markets react to news now, and 

can liquidity get there in time, because we have talked about liquidity thinning. It actually thinned on the sell side, as well. It 

didn’t just disappear from the buy side. 

And so I think we have to look at the factors that make up our 

market structure, which actually functions very well on a normal 

day, but during times of stress actually sometimes doesn’t, because 

I think what we have is a loosely coupled, fragmented market that 

is very deep at the top of the book, but when the market moves 

through that top of the book very quickly, then it is not nearly as 

efficient as it was in the past. 

Senator REED. Thank you. 

Mr. Noll? 

Mr. NOLL. Thank you, Chairman Reed. Like Mr. Leibowitz and 

Mr. Ketchum, I don’t think we are ever going to identify the precise, exact cause of May 6. However, we believe that if we can solve 

what we think are some of the negative outcomes of May 6, that 

we will avoid the issues of what the precise cause was and be able 

to move forward with a very robust market. So those are obviously 

coordinated responses across circuit breakers across all markets. 

We don’t believe markets should compete on circuit breakers. We 

don’t believe that markets should compete on volatility halts. We 

think that those things need to be consistent. 

I think it is probably fair to say that we should have been able 

to identify that before this had occurred, but the market had never 

experienced this kind of liquidity dearth and this kind of an event 

before. So we now recognize that as a flaw and we are moving very 

quickly, working with one another, to fill that hole. 

I do think that there are lots of positives to innovation in our different market models. NASDAQ is very proud of its market model. 

I know NYSE is very proud of its market model, and there is still 

going to be room for us to be competitive and compete on innovation and drive down costs and provide better service to investors. 

But in areas like this, I think it is incumbent on us to cooperate 

with one another and we are doing so. 

Senator REED. Thank you. 

Mr. Duffy, please. 

Mr. DUFFY. Senator, I think that the harmonization of rules is 

absolutely essential, but when you are talking about 50, 60, or even 

more pools of liquidity, some with certain protocols, some with no 

protocols, it is going to be very confusing for a marketplace. So 

when an order gets entered into one marketplace where there is 

NYSE, NASDAQ, or BATS and they don’t find the liquidity because 

of the protocols being in place, these things are trading in microseconds. They are seeking liquidity. There are going to so many other 

pools trying to find liquidity. Then you can find out why the prices 

did what they did. I don’t think it is a big secret. 
39 

I think the 10, 20, and 30 percent circuit breakers need to be revisited. They may be a bit wide. We have not hit the 10 percent, 

as everybody has said here, so that needs to be done. 

I think the stop logic functionality that the CME Group has put 

in place, this is patented technology. It clearly worked. The charts 

don’t lie. The numbers don’t lie. The markets stopped and we had 

an opportunity to replenish our liquidity. That stop market 

functionality kicked in in the six-handle range, which is the equivalent of a half of 1 percent of the value of the S&P contract. To us, 

that makes sense. 

We have offered this up publicly to give it to the marketplace, 

even though it is under a patent by the CME Group. We think it 

makes sense. So we think that there are a lot of good things that 

we could be a part of the solution to. 

Senator REED. Let me—I think it is important to try to continue 

to find what the course might be, because it will make the response, I think, much more attuned and much more fine. But I 

think the point that Mr. Leibowitz makes is we already know there 

are problems there and that we just can’t sort of say that this is 

a one-off experience and it will never happen again. As fact, as I 

suggested in my questions to the two Chairmen, this was an accidental confluence of bad news from Europe, some trading irregularities, et cetera, but we all have to plan for a very deliberate attempt 

to undermine the market, either through some physical or some 

technological attack. 

So in this context, do you think that you are prepared for it, one, 

and two, if you are not prepared for it, are you planning, at least 

implicitly, that in a serious enough situation that there will be support from the government to get you through a difficult moment? 

Mr. Duffy? 

Mr. DUFFY. On an operational standpoint, there is no question 

that we are prepared for it. We prepared for it pre-September 11 

of 2001. So we have been building remote facilities going back to 

1999 and 2000. We have redundancy in multiple different locations 

in the Chicago metropolitan area. We don’t even actually run all 

of our facilities out of the CME Group any longer. So we have the 

same set-up in New York because of our New York operations. So 

we are, without question, prepared for whatever needs to go forward. 

As far as the legislation, we do believe that there are certain situations where everybody should have access to the discount window. I disagree with Chairman Gensler and Chairman Schapiro. I 

think that the CME Group or any other clearing entity, now that 

we are going to be potentially forced into taking clearing of some 

of these OTC products, we may not have an opportunity to get to 

our bank lines in a reasonable time. We settle our markets twice 

daily, and that is the reason why we haven’t had the flaws in the 

150 years in our system. 

So I think it is important, even though we have never gone to 

the discount window to borrow, that we still have that ability, and 

not just under emergency procedures. 

Senator REED. Let me just raise a point that I would like to 

make, or at least to put on the table, is that there was a presumption a decade ago that securitization of mortgages are not particu-
40 

larly dangerous because, after all, who defaults on your mortgage. 

It is 20 percent down and if the FICO is 680. But the mortgage of 

1999 was not the mortgage of 2005, where it is nothing down, no 

income statement, no FICO, and yet we were still treating those 

and securitizing those. 

Now, this is not the exact analogy, but essentially, we are going 

to ask under this legislation the clearing platforms to take much 

different types of products that they are clearing today, probably 

more risky because they are not being cleared today—if they 

weren’t risky, they would probably be able to make some money 

and do it yourself. And that, I think, goes to the point that you are 

making, Mr. Duffy, about that in rare circumstances, we hope, 

there might be need for support. So I just—— 

Mr. DUFFY. There is no question, sir. In the legislation, it also 

calls for the clearinghouse to have the right to refuse an over-thecounter transaction, which we think is critically important, because 

if you can’t risk manage these things, the only thing they did was 

transfer the risk from you to me and then said you are going to 

blow me up. So we don’t think that is a good solution. So we need 

to have the risk management tools in place, which we do, and we 

do think one of them is also to have access to the Fed window if 

we need it. 

Senator REED. Mr. Noll, your comments, and we will go right 

down the line, and then I will recognize Senator Bunning. 

Mr. NOLL. So from a physical security point of view, we, too, are 

well prepared for any break in our technology or any attack or any 

other break in the way our technology operates. So we have multiple facilities that back one another up and they are hot sites. 

They are connected to one another and the rest of the marketplace. 

And they are multi-State, as well, so they aren’t all in the same 

general area. They are spread out quite a bit. So from a physical 

security point of view and a technology point of view, we feel quite 

confident that we are prepared for any sort of event like that. 

In terms of clearing and access to the Fed window, while 

NASDAQ OMX does not operate a U.S.-based equity clearinghouse, 

we are a significant investor in a clearinghouse called International 

Derivatives Clearing Group, which is designed to clear interest rate 

swaps. So like most of the other participants at this table, we 

would think that, at the end of the day, we think clearing is a better solution than not clearing these products, but in the eventuality 

of ultimate risk, we do think that at some point we may need access to the Federal Government’s support in the event of a major 

crisis. 

Senator REED. Mr. Leibowitz? 

Mr. LEIBOWITZ. Yes, thanks. To echo what the two previous 

speakers have said, I think we have hot back-up and, in fact, we 

are examined in rigor by our regulator to make sure that we are 

living up to certain standards of disaster recovery, business continuity planning of all sorts. We also have people who have security 

clearance for such things as with Homeland Security and other 

agencies, and we work very tightly with those agencies in terms of 

things that could come over the Internet, you know, denial-of-service attacks, other hacking events. 
41 

I agree also that the clearinghouse is going to be an issue in 

terms of knowing risk exposure across instruments. The world has 

gotten a lot more complex. We started to analogize with the financial meltdown, and I actually think you are dead on, which is, during the financial meltdown, we had a bunch of quantitative models 

that all said nothing could really be that bad. Each individual player thought that they were protected, and they just had not really 

taken account of the fact of what if it all goes bad at once and what 

if we all have to go through the same exit door at once and what 

if these things are worse than we thought. And I think we need 

to approach how we structured the market, how we structures our 

back-up, how we structure clearing facilities with all of those 

things in mind, or we are actually not doing a good job. 

Senator REED. Final word, Mr. Ketchum. 

Mr. KETCHUM. Again, while FINRA as a regulator is in a very 

different business than these two gentlemen for delivering realtime market executions and being involved in the clearing side, we 

also feel very good about our ability from a physical security standpoint, disaster back-up standpoint. We also focus intensely on potential intrusions, denial-of-service efforts, and we feel good about 

our protections from that side. 

I will not repeat what Mr. Leibowitz said, but I think he said it 

extremely well. 

Every conception should be challenged, and challenged regularly 

with markets that are changing as quickly as these are. That certainly demands some flexibility from the standpoint of the clearing 

changes that are going to occur and some capabilities to ensure 

that there remains liquidity and they remain sound. 

So, FINRA feels in very good shape from the standpoint of being 

able to respond to attacks of any sort, but this is an appropriate 

issue for Congress to continue to focus on. 

Senator REED. Thank you very much. 

Senator Bunning, and take as much time as you want, Jim. I 

apologize for the lengthy time of my questioning. 

Senator BUNNING. That is all right. Thank you. 

Mr. Noll, I am going to start this question with you since you 

talked about it more in your written statement than anyone else, 

but I would like the others to respond as well. 

As I said in my statement, I am concerned about the way some 

trades were canceled. Given that everyone seems to agree the system worked the way it was set up to do, how do you justify canceling trades and protecting sellers from their bad decisions? 

Mr. NOLL. I share much of your concern, Senator Bunning, and 

it was a very difficult day to make that decision. It was done in 

coordination with all of the other markets on an ongoing discussion 

that, quite frankly, lasted many hours trying to decide what the 

appropriate decision was there. So we were trying to balance the 

needs and requirements of what we would call moral hazard issues, 

which is making people aware and bear the consequences of their 

activities in the marketplace, for good or for ill, with what was 

clearly a dysfunctional marketplace that was not functioning as it 

should function. 

So in the absence of any clearly erroneous trade, we looked at 

the decay of what we would call price discovery and the provision 
42 

of liquidity, and we tried to draw that line, admittedly somewhat 

more arbitrarily than I think any of us are comfortable with, draw 

that line in an appropriate area where we did not reward anyone 

for bad behavior but we did solve the problem of what we considered to be a dearth of liquidity. 

That being said, I think we are very confident that the stock-bystock circuit breakers that we are putting into place will prevent 

a reoccurrence of this kind of situation. 

Senator BUNNING. Looking back, we all have 20/20. 

Mr. NOLL. I think that is true. So we believe that we would like 

to put the stock-by-stock circuit breakers in place. We think that 

will prevent this going forward, these kind of events going forward, 

but more importantly, we endorse Chairman Schapiro’s desire that 

we have transparent, understandable, agreed upon across all markets, trade-break, clearly erroneous rules that remove the discretion from any one market actor or any group of market actors so 

that everyone knows visibly and clearly what those events are and 

how they will be triggered. 

Senator BUNNING. Anybody else like to jump in. Go ahead. 

Mr. LEIBOWITZ. Sure. So I had the fortune of sitting on the 

NASDAQ Quality of Markets Committee at the time that the first 

erroneous trade policy went in, and I think, Rick, you were actually—— 

Mr. KETCHUM. I was there. 

Mr. LEIBOWITZ.——the CEO at the time or COO at the time. And 

it troubled me then and it troubles me now. Markets that have to 

resort to breaking trades as a response to conditions are just not 

orderly markets in my mind. That is not the way we should do our 

business. 

I think in this case, the big challenge was not—we had institutional investors who made a mistake. You know what? You are 

right. They should pay the price. The challenge here was that we 

had retail investors who had submitted market orders that essentially went into a black hole. They had stop loss orders in high-cap 

stock—— 

Senator BUNNING. But I am sorry, sir. Sophisticated—even if 

they are not sophisticated, anybody that puts a market order in 

knows exactly what is going to happen to a market order. 

Mr. LEIBOWITZ. So I would agree with you that their broker probably does, and maybe the answer is the broker should have stood 

up for that trade. I would submit to you that a lot of the public 

does not. And I will tell you—— 

Senator BUNNING. A lot of the public does not know that if you 

put a market order in, it is executed? 

Mr. LEIBOWITZ. They think maybe it will go, you know, be a dollar—— 

Senator BUNNING. Rather than a limit order? 

Mr. LEIBOWITZ. Well, they do not realize that when I trade 

Accenture, it is going to be down 99 percent. What are they getting 

now? 

Senator BUNNING. I agree with that. 

Mr. LEIBOWITZ. And that is—— 

Senator BUNNING. But if you put a market order in, that is your 

execution. 
43 

Mr. LEIBOWITZ. You are absolutely right in that regard, and I 

think we have to make sure that it just cannot happen in the market. We also need to talk about whether market orders should be 

allowed at all and how we educate people so these things do not 

happen. 

But I agree, there should not be the moral hazard of breaking 

trades. It is not the right way to make a market function properly. 

Senator BUNNING. Anyone else? Go. 

Mr. DUFFY. I do believe that you need to have clarity on rules, 

and we have bust rule clearly put on our website so anybody that 

is going to participate in the CME Group markets, they know the 

rules prior to making a trade on our exchange. 

As far as busting trades, you know, every order in our place has 

to have a limit on it. You cannot just order—send in a market 

order. So what Mr. Leibowitz is referring to is you can order—you 

have to have a limit on every order—— 

Senator BUNNING. I understand limit orders. 

Mr. DUFFY. So we do not accept market orders is my point, and 

that is the reason why our system works. And I think that is a 

very important point—— 

Senator BUNNING. In other words, you did not have any big 

losses on your market. 

Mr. DUFFY. There were losses. I am not saying there were not 

losses, sir, because the market had a lot of up and down in it. But 

it was important to note that the orders were not these heat-seeking missiles that could go to infinity or to zero like it did on the 

future. 

Senator BUNNING. The one. 

Mr. DUFFY. Correct, sir. Also, we think that is important. 

Another reason with busting trades is if someone buys a trade 

and gets busted out of that trade, he might have elected to liquidate that trade prior to the bust rule coming into place. He goes 

home to go to sleep, and now he is short the market and had no 

idea he was short the market. There are some serious unintended 

consequences when the rules are not clear. 

Senator BUNNING. Absolutely. That is what I am getting at. 

What should be done so that it will be predictable when trades 

will be broken in the future, other than what has been suggested? 

Mr. NOLL. Senator Bunning, I think what we are planning to 

do—as a matter of fact, Mr. Ketchum just called a meeting for all 

of the exchanges and the SEC early next week—I think it is on 

Tuesday—to come up with a set of standards about clearly erroneous and how we are going to move forward in addition to the circuit breakers that we are putting into place. So how are we going 

to move so that we have a very clearly defined standard of when 

trades are going to stand and when they will not so that we do not 

ever face this issue again. 

Senator BUNNING. If I am in Schenectady, New York, and I am 

dealing with a broker-dealer in Schenectady, any broker—I am not 

going to give anybody a plug here—how do I compete with the electronic traders that have nanosecond access? 

Mr. DUFFY. I will make a comment on that, and this is more in 

your line, but in capital formation markets, sir, most participants 

coming in for the public are not trying to compete on the bid-offer 
44 

in a nanosecond market. They are buying or selling stocks for probably a period of time—— 

Senator BUNNING. Hold. They are going to hold the stock. 

Mr. DUFFY. They are more of a holder participant. Whereas these 

people that are trading in what we refer to as microseconds, we 

think of them as liquidity providers. They have actually tightened 

up the markets, but they are actually not in for that. So they are 

actually competing against each other—— 

Senator BUNNING. They may be day traders. They may be someone who is in it just for a very short period. 

Mr. DUFFY. Yes, sir. 

Senator BUNNING. Mr. Leibowitz, since most exchange-traded 

funds are listed on one of your exchanges, I am going to start this 

question with you, and anyone else who wants to add something 

can. Why do you think we saw a more severe move in exchangetraded funds than in the underlying stocks? Should investors be 

worried that these products are not as reliable as everyone thinks 

they are? 

Mr. LEIBOWITZ. So I think the important think to first say is the 

fact that ETFs got hit as hard as they did was an effect, not a 

cause. They did not cause the market meltdown. They had no role 

in it. They were essentially the victim of the market as it went 

down. 

Normally, there is a pretty tight arbitrage mechanism between 

the ETFs and the underlying instruments that make up that. During this period, that mechanism broke down because the traders 

who were bidding on the stocks could not tell where the actual 

stocks underlying the ETF were trading. 

So, for example, if Accenture or some other stock, PG, was in 

that index, was PG at 39 or 56, or even at 39, it would lead you 

to bid in a very crazy place. 

The other thing that is unique about ETFs is they do not tend 

to have deep liquidity books on the book. There is not a lot of retail 

orders. A lot of executions occur in wholesalers above the market. 

So what happens is wholesalers are committing capital to keep that 

market really tight. 

There is an article in the Wall Street Journal today that suggests 

that two of the major wholesalers actually had system problems 

during this meltdown, and what that probably did is suck capital 

out of the market to commit to the ETF product and other products 

that allowed it to tighten up. If you couple that with stop losses, 

which triggered into the market—you know, and no pause in that 

market. The difference between what happened on NYSE and what 

happened in Arca is this: Both markets have market makers with 

obligations. But in the ETF market, both on NASDAQ’s listing and 

Arca’s, there are these things called LMMs. They have obligations. 

The problem was trading did not pause long enough for the books 

to refill and for them to commit capital. They were basically looking into a black hole, and so the function did not work properly. 

So we are looking at this with the issuers and with the market 

in terms of how do we fix the market structure so that it works 

better during these periods. I think it is imperative that ETFs be 

included in the circuit breaker pilot. 
45 

Mr. KETCHUM. Senator, if I can, let me just add on to that point. 

I would first underline that it is imperative for ETFs be included 

in the pilot as quickly as possible for two reasons. First, ETFs, like 

futures, are aggregated vehicles that are the most convenient, efficient, and effective way to react when you see market risk, as you 

know, being involved in the industry. Therefore, they will almost 

always be hit very quickly with respect to any market reaction 

from the standpoint of selling activity or buying activity. 

Second, unlike futures, as Larry indicated, they often are not 

that liquid, at least given the wide range of those products that 

have been developed over time. So this is an area where we absolutely have to move quickly to include beyond the S&P 500. 

I also have to just note, Senator, as someone who was born and 

raised in Schenectady, I want to thank both you and Senator Warner for particularly singling out your concerns in Schenectady. I 

will speak for the city, and we appreciate it. 

Senator BUNNING. Schenectady, it is an old town I played ball in, 

so I remember it very well. 

Mr. KETCHUM. I actually watched you when you played for the 

Blue Jays. 

Senator BUNNING. You are not that old. 

[Laughter.] 

Mr. KETCHUM. I am pretty close. 

Senator BUNNING. Mr. Ketchum, I am going to start you with 

this question since you mentioned it in your written statement, but 

I would like to hear from anyone else, also. 

In your statement, you said that changes in the marketplace 

have eliminated meaningful market makers’ obligations. What 

changes should be considered to market makers’ rules to reflect the 

current marketplace and the rules of new type of liquidity providers? 

Mr. KETCHUM. Well, Senator, I think that is a very good question, without a simple answer. I start by believing in competition, 

and much of the reason for changes in market maker obligations 

have been by the SEC’s effort to encourage competition across markets. But it is a reality that today in a number of marketplaces 

there are not obligations ‘‘reasonably related to the market.’’ 

I would say two things need to happen quickly. The first thing 

is where there is not an obligation to quote reasonably related to 

the market, there should not be two-sided quote obligations, and 

perhaps they should not benefit from a margin and capital standpoint. But you have to eliminate stub quotes to avoid these ridiculous trades down at a penny, 5 cents, et cetera. 

Second, I think there needs to be an evaluation—and Chairman 

Schapiro committed to it afterwards—to look hard at whether the 

requirements that used to exist—that required regular quoting and 

participation in the market if you were to benefit from market 

making status—should be reconsidered. You raised that question 

earlier because I know you have been involved in the industry, and 

personally I believe that ought to be reviewed and reconsidered. 

Senator BUNNING. Anybody else? 

Mr. LEIBOWITZ. Sure. I think this is a really serious question, 

which is: Where is all the liquidity in the market? And who has 

got an obligation to the market? 
46 

For one thing dark pool liquidity may have been sitting off on the 

side, and when the market went down, it was not included at all. 

It did not help essentially provide a backstop to the market. 

Over time, a lot of the markets have evolved to speed over obligation, and so what happens is, for example, we have DMMs on 

NYSE. LMMs exist on both Arca and NASDAQ for ETFs. Looking 

at the stub quotes, that is a sign of a problem, not a problem itself. 

What really happened—I am dating myself again—is the NASDAQ 

market makers used to have a requirement for quoting close to the 

market, but they also had a requirement of how deep they made 

the market and what size they had to buy at every price. As the 

market evolved to a faster, more electronic marketplace, those market makers were not able to keep up, and as a result, their requirements kept getting thinned out to the point where really the only 

requirement is that they have equity in the market, it does not 

matter where. Hence, the penny at a thousand. What that does is 

it gives them other rights in the marketplace, like internalizing orders. 

The real question is: What do you owe to the market in exchange 

for that right that you have got? And that is the sort of thing that 

we all need to look at, you know, in our individual—— 

Senator BUNNING. Or the market maker. 

Mr. LEIBOWITZ. And collectively. 

Senator BUNNING. OK. Thank you. 

Senator REED. Well, thank you, Senator Bunning. Your experience is obvious in terms of the thoughtful questions that you have 

not only posed today but consistently. 

I think the hearing has indicated that you gentlemen and the 

regulators have a lot of work to do, and we have got a lot of work 

to do. This is an evolving issue, and we fortunately missed the 

worst outcome in this situation. But I cannot feel after today we 

can assure ourselves that we will not have other challenges ahead. 

In fact, I think we all understand we have to do a lot more to understand this problem, series of problems, and to take effective action. 

I thank you. This has been a very helpful beginning, as I suggest, of a series of hearings that we shall hold about the status of 

the markets, high-frequency trading, market makers’ responsibilities, and the interconnection of all of these aspects. 

If my colleagues have any written statements or additional questions, I would ask them to submit them no later than next Thursday, May 27th. I would also ask the witnesses to submit responses 

to questions within 2 weeks. And, obviously, all of the written testimony that you submitted will be made part of the record, and any 

other items that you would like to submit to the record will be 

made part of the record. 

Without additional information, the hearing is adjourned. 

[Whereupon, at 12:01 p.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
47 

1My testimony is on my own behalf, as Chairman of the SEC. The Commission has not voted 

on this testimony. 

PREPARED STATEMENT OF CHAIRMAN JACK REED 

I want to welcome Chairman Schapiro, Chairman Gensler, and our other witnesses to today’s hearing, and thank them for making time in their very busy schedules to testify on this important topic. 

I also appreciate their efforts following the events of May 6th to coordinate the 

investigations, report their findings, and quickly propose circuit breaker and other 

changes in response. 

This week the Senate is on the verge of making fundamental and urgently needed 

changes to reform Wall Street and protect consumers and investors. In the midst 

of this important debate, Senator Bunning and I felt it was important to hear your 

thoughts on the causes of the events of May 6th, and to discuss any changes that 

may be needed to ensure that our markets function in a fair and orderly way going 

forward. 

As we know, on May 6, 2010, starting around 2:40 p.m., the stock market plummeted, but then quickly recovered. At its lowest point during this 20-minute incident, the Dow Jones Industrial Average had fallen 9.2 percent, erasing more than 

$1 trillion in market capitalization within a matter of minutes. 

Although the Dow average rebounded to end the day down only 3.2 percent, the 

May 6 intraday trading loss on the Dow index not only exceeded the extreme market volatility that occurred during the height of the financial crisis in the fall of 

2008, but it also represented the index’s largest intraday percentage drop since the 

October 1987 crash. 

This Committee has regularly held hearings examining the equity markets, most 

recently in October to discuss dark pools, flash orders, and high-frequency trading. 

Today’s hearing is another check-up on our equity markets, particularly amidst concerns that technological developments in recent years may be posing new risks to 

investors and/or the markets more broadly. 

Electronic trading has evolved dramatically over the last decade, and it is important that regulators keep evolving with these developments. Trading technology 

today is measured not in seconds or even milliseconds, but in microseconds, or one 

millionth of a second. 

Today’s hearing will help to answer some important questions about the causes 

of the May 6 market volatility. In addition to speaking about the causes of the 

plunge, I’ve asked today’s witnesses to discuss what role automated trading, highfrequency trading, and other technological advances may have played in the market 

disturbance. 

I’ve also asked them to discuss the extent to which disparate trading conventions 

and rules across various markets contributed to the down and up spike. And I’ve 

asked them to discuss any changes to Regulation NMS or other laws or regulations 

may be necessary to mitigate such market fluctuations in the future. 

Finally, I’d like to discuss whether the regulators have all the tools and authorities they need to investigate market disturbances or whether legislative or other 

changes may be needed to help them more quickly identify the causes of extreme 

market disturbances. 

PREPARED STATEMENT OF MARY L. SCHAPIRO 

CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION

MAY 20, 2010 

I. Introduction 

Chairman Reed, Ranking Member Bunning, and Members of the Subcommittee: 

I appreciate the opportunity to testify concerning the market disruption that occurred on May 6, 2010.1 The sudden decline and recovery of the U.S. financial markets on that day was unprecedented in its speed and scope. It is vital that investors 

and listed companies feel confident in the integrity of the prices generated by our 

equities markets. 

During a 20-minute period during the afternoon of May 6, the U.S. financial markets failed to live up to their essential price discovery function. That period of gyrating prices directly harmed those investors who traded based on flawed price discovery signals, and it undermined the confidence of investors in the integrity of the 

markets. We are committed to taking all necessary steps to identify causes and con-
48 

2 Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues, May 18, 2010. http://www.sec.gov/sec-cftc-prelimreport.pdf. 3Joint Report of the SEC and the CFTC on Harmonization of Regulation, October 16, 2009. 4See Appendix A, Figures 2 and 3. 

tributing factors and are already working to reduce the likelihood of a recurrence 

of that day. 

Over the last 14 days, the SEC has focused intensely on moving forward on two 

separate, but related, fronts. First, we, along with the Commodity Futures Trading 

Commission (CFTC), have been engaged in a comprehensive investigation into the 

events of May 6 to gain a full understanding of what caused the volatility. Second, 

even as we work to understand the causes of the volatility, we have worked with 

the exchanges to fashion effective measures that will operate to help protect against 

a recurrence by imposing a limit on the extent to which prices can move in individual stocks before there is a pause in trading. We are also addressing a number 

of additional areas that may have contributed to the volatility. These are discussed 

below. 

With respect to our investigation, this past Tuesday, SEC and CFTC staff issued 

a joint report of their preliminary findings regarding the market events of May 6 

to the Joint CFTC–SEC Advisory Committee on Emerging Regulatory Issues (Staff 

Report).2 The establishment of the Committee was one of the recommendations included in the agencies’ joint harmonization report issued last year.3 The Staff Report sets forth the preliminary findings of the ongoing review of the events of May 

6. It briefs the Advisory Committee regarding the events and provides context regarding the current structure of the equity and futures markets, and the regulatory 

framework for those markets. The Staff Report is intended to assist the Advisory 

Committee as it works with us to review the events of May 6. I expect that the 

Committee will advise the Commission with respect to market structure problems 

that may have led to the volatility experienced on that day and suggest potential 

approaches. 

In addition, earlier this week, the stock exchanges and the Financial Regulatory 

Industry Authority (FINRA) filed proposals that would aid in preventing the type 

of severe price swings that some individual stocks in the S&P 500 experienced on 

May 6. These rules would establish a market-wide 5-minute trading pause in the 

event that the price of a stock in the S&P 500 moves more than 10 percent during 

the preceding 5 minutes. The pause would give the markets the opportunity to attract additional liquidity in the stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. 

My testimony today first will summarize the events on May 6, using the best information that is available at this point. Next, it will give a brief summary of initial 

steps taken to identify the causes and contributing factors of the unusual market 

activity on May 6, as well as initial steps to help protect against such activity from 

occurring in the future. Finally, I will discuss various potential regulatory responses 

that need to be considered in determining how best to maintain fair and orderly financial markets and to prevent subsequent severe market disruptions. 

II. Summary of Events on May 6, 2010 

A. Chronology of Trading 

On Thursday May 6, the stock markets had spent much of the morning and early 

afternoon in moderately negative territory, with the Dow Jones Industrial Average 

(‘‘DJIA’’) declining 161 points, or approximately 1.5 percent, by 2:00 p.m. (ET). Concerns over the financial situation in Greece, uncertainty concerning elections in the 

United Kingdom, and an upcoming jobs report, among other things, hung over the 

market. Shortly after 2:30 p.m., however, the market decline began to steepen and, 

by 2:42 p.m., the DJIA was at 10,445.84, representing a decline of approximately 

3.9 percent. The DJIA then suddenly dropped an additional 573.27 points, representing an additional 5.49 percent decline, in just the next 5 minutes of trading, 

hitting 9,872.57 at 2:47 p.m., for a total drop of 9.16 percent from the previous day’s 

close (which, as discussed below, was not sufficient to trigger the existing circuit 

breaker trading halt). 

Our preliminary analysis shows that this precipitous decline in stocks (and the 

subsequent recovery) followed very closely the drop (and recovery) in the value of 

the E-mini S&P 500 future (which tracks the normal relationship between futures 

and stock prices for the broader market). Similar declines were seen in stock market 

indexes other than the DJIA, such as the S&P 500 Index. In addition, the CBOE 

Volatility Index (‘‘VIX’’), a widely followed measure of market volatility sometimes 

known as the ‘‘fear index,’’ climbed above 40, a level not reached in over a year.4
49 

As quickly as the market dropped, it suddenly and dramatically reversed itself, 

recovering 543 points in approximately a minute and a half, to 10,415.65. By 3 p.m., 

the total daily decline in the DJIA had been reduced to 463.05 points (4.26 percent). 

The DJIA ended the day at 10,520.32, down a total of 347.80, or 3.20 percent, from 

the prior day’s close. This represented a significant down day for the markets, but 

the closing numbers belied the market’s dramatic moves down and then up during 

approximately 20 minutes of trading in the mid-afternoon. In addition, as has been 

widely reported in the press, many individual securities experienced much larger 

swings in their trading activity. For example, two DJIA components—Procter & 

Gamble and 3M—experienced declines of approximately 36 percent and 18 percent, 

respectively. In addition, trades in certain stocks were executed at absurdly low 

prices, such as one stock which opened above $40, was traded at one point at a 

penny, and then closed the day above $40. Figure 1 in Appendix A illustrates the 

volatility of this activity. This extreme volatility in the markets suggests the occurrence of a very severe temporary liquidity failure, rather than the effect of any economic factor that might explain price discovery indicating that the equity value of 

U.S. listed companies truly could drop and recover such a large amount in just a 

few minutes. 

In addition, a large number of registered investment companies known as Exchange Traded Funds (‘‘ETFs’’) traded for short periods of time with massive 

intraday price swings. The shares of more than 25 percent of all ETFs experienced 

temporary price declines of more than 50 percent from their 2:00 p.m. market 

prices. One large ETF sponsor reported to us that 14 of its domestic stock ETFs experienced executions of $.15 or less per share (including five ETFs that had executions of one cent or less) while also observing that its domestic bond ETFs appeared 

to execute at reasonable prices. We also will explore whether the practice of shorting 

ETFs by institutional investors to effectively eliminate broad market exposures 

might have contributed to the intraday price swings experienced by certain ETFs. 

B. Breaking of Clearly Erroneous Trades 

As the markets closed on May 6, officials from each of the equity markets, pursuant to exchange rules, worked out a common standard to cancel trades that were 

effected at prices that were sharply divergent from prevailing market prices (socalled ‘‘clearly erroneous’’ trades). The exchanges determined to cancel any trades 

effected from 2:40 p.m. to 3 p.m. at prices 60 percent away from the last trade at 

or before 2:40 p.m. Transactions in 326 individual securities were canceled in this 

manner. In addition, on Friday May 7, several options exchanges similarly decided 

to cancel certain options trades from the afternoon of May 6. 

A significant number of broken trades were in the shares of ETFs. These funds 

are hybrids—they are mutual funds that have shares that trade throughout the day 

like ordinary stocks. ETF sponsors reported to us that, internally, they experienced 

no significant problems in managing the funds on May 6. Stability had returned to 

the market by the 4:00 p.m. market close and, as a result, these funds were able 

to calculate their net asset values based on the market prices of the securities in 

their portfolios as required by our rules. From the viewpoint of the ETFs, they saw 

nothing out of the ordinary or unusual compared to any other day in computing 

their end-of-day net asset values. 

Information on broken trades clearly suggests that ETFs as a class were affected 

more than any other category of securities. We continue to investigate precisely why 

they were affected so dramatically. 

C. Evaluation of Trading 

The Commission is committed to understanding fully and exactly what occurred 

on the afternoon of May 6, and has been aggressively investigating and analyzing 

the events of that day. We believe it is critical to understand the causes and effects 

of this event so that we can work to ensure that it does not occur again. Throughout 

this time, the Commission and its staff have been in close and continuous contact 

with the CFTC and other Federal agencies, as well as the larger national securities 

exchanges, FINRA, and clearing organizations. In addition, we have been in contact 

with a wide variety of market participants, including broker-dealers, proprietary 

trading firms, and asset managers. We have obtained extensive data from the exchanges and other market participants and are in the process of analyzing that data 

to ascertain the triggers and impacts of trading that day. 

The Commission also has been in close contact with our foreign counterparts. 

Some of our counterparts have circuit breaker-like market intervention mechanisms 

linked to our own and others have market intervention mechanisms that halt trading on specific securities affected by unexpected market volatility. This coordination 
50 

5 The report setting forth the events of the October 1987 Market Break was released months 

later, in January 1988. 6Our initial options analysis suggests that there were not triggers originating from the options markets. 

will continue as we seek information on specific trades or events that may have precipitated any problems. 

The various regulatory authorities are making substantial progress in analyzing 

the trading on May 6 and sifting through the voluminous trading records involved 

(including more than 17 million trades in listed equities between 2:00 p.m. and 3:00 

p.m. alone). We will continue to provide investors and the public with information 

on the events that may have contributed to this volatility as it becomes available, 

as we have done with our preliminary staff report issued this week, but we should 

recognize that it will take time to fully analyze the data and cross test our different 

hypotheses.5 Although developments in the markets and in technology may help 

speed access to market data, they also greatly complicate our efforts to analyze the 

complex web of trading arrangements and market dynamics that have developed 

since 1987. For example, the key day in the 1987 Market Break Study involved a 

trading session processing a little over 600 million shares in NYSE stocks. On May 

6, the markets processed 10.3 billion shares in NYSE stocks alone. 

In addition, the interconnections among markets and among equity securities and 

derivatives have grown immensely more complex over the past few years. Orders 

in one stock directed to one market can now ricochet to other markets and trigger 

algorithmic executions in other stocks and derivatives in milliseconds. By contrast, 

in 1987, investigators could focus their attention on discrete transactions largely effected on only one or two markets. 

To conduct our analysis, we are obtaining and reviewing data regarding order 

books and order audit trails from various sources to understand the behavior of providers and consumers of liquidity. This involves billions of data elements regarding 

millions of trades in thousands of securities executed in milliseconds. This data will 

be the subject of targeted analysis by SEC staff. 

We plan to examine in more detail data on options transactions and quotes to better understand the role that participants in this market may have played.6 We also 

expect to examine existing data on institutional mutual fund and ETF holdings, as 

well as data from broker-dealers that will help attribute trades to specific brokerage 

accounts. In addition, we will examine trade and order characteristics to determine 

whether specific order types played a role in the breakdown of the price discovery 

mechanism. 

Another key component of our analysis is examining the behavior of groups of 

market participants. For example, we will continue to examine the role of providers 

of liquidity, including market participants who have formal obligations under the 

Federal securities laws or SRO rules. To the extent that data is available, we will 

seek to understand the impact of traders following high-frequency or algorithmic 

trading strategies. Many proprietary trading firms engage in automated strategies 

that continually monitor the various markets and products for disparities in prices. 

When the trading systems for these firms spot such disparities, they can generate 

in microseconds an enormous volume of orders that are intended to capitalize on 

these disparities. We also will examine the activities of ETF Authorized Participants 

in order to understand what, if any role, they played, in the markets of May 6. 

Even as our investigation into this matter continues, a preliminary picture is beginning to emerge. At this point, we are focusing on the following working 

hypotheses and findings— 

(1) possible linkage between the precipitous decline in the prices of stock index 

products such as index ETFs and the E-mini S&P 500 futures, on the one 

hand, and simultaneous and subsequent waves of selling in individual securities, on the other, and the extent to which activity in one market may have 

led the others; 

(2) a generalized severe mismatch in liquidity, as evinced by sharply lower trading prices and possibly exacerbated by the withdrawal of liquidity by electronic market makers and the use of market orders, including automated stop 

loss market orders designed to protect gains in recent market advances; 

(3) the liquidity mismatch that may have been exacerbated by disparate trading 

conventions among various exchanges, whereby trading was slowed in one 

venue, while continuing as normal in another; (4) the use of ‘‘stub quotes’’, 

which are designed to technically meet a requirement to provide a ‘‘two sided 

quote’’ but are at such low or high prices that they are not intended to be executed; 
51 

7Professional liquidity providers are proprietary traders in the business of providing liquidity 

to the market, often through the submission of limit orders that rest on the electronic order 

books of exchanges and other trading venues. They include registered entities, such as exchange 

specialists and market makers, as well as unregistered proprietary trading firms that engage 

in passive market making and other types of trading strategies. 

(4) the use of market orders, stop loss market orders and stop loss limit orders 

that, when coupled with sharp declines in prices, for both equity and futures 

markets, might have contributed to market instability and a temporary breakdown in orderly trading; and 

(5) the impact on ETFs, which suffered a disproportionate number of broken 

trades relative to other securities. 

We have found no evidence that these events were triggered by ‘‘fat finger’’ errors, 

computer hacking, or terrorist activity, although we cannot yet completely rule out 

these possibilities. 

As we move forward in our inquiry into the events of May 6, we are focusing on 

several important issues. 

1. Linkages between Futures and Securities Markets 

One focus has been the role of the E-mini S&P 500 future in leading the market 

decline and recovery. To a great extent, this concern reflects a basic fact of market 

dynamics—much of the price discovery for the broader stock market occurs in the 

futures markets. Those who believe that the broader market is overpriced (or underpriced) often will first sell (buy) futures for a broad market index rather than sell 

(buy) the individual stocks that make up that index. Moreover, many professional 

traders study the relationship between futures prices and stock prices. If they see 

a decline (rise) in the price of the futures compared to the price of the stocks, they 

will sell (buy) the underlying stocks in expectation that the stock prices quickly will 

follow the futures price. Indeed, this type of activity helps assure that stock prices 

will closely follow futures prices up or down. 

Accordingly, given that the E-mini S&P 500 futures price fell by more than 5 percent in a few minutes and then quickly recovered all of the 5 percent decline, it 

should be no surprise that the broader stock market indexes showed similarly fast 

and similarly large declines and recoveries. It must be recognized, however, that the 

fact that stocks prices follow futures prices chronologically does not demonstrate 

what may have triggered the price movements. The triggering factor may have been 

an event in the futures market (such as an exceptionally large order), but it could 

have been other factors as well. In the coming days, we intend to pursue this critically important linkage between the derivatives and equities markets that so significantly affects the price discovery that indicates the value of individual listed companies and of investor portfolios. 

2. Absence of Professional Liquidity Providers 

According to anecdotal evidence, as well the large number of trades that executed 

against stub quotes, as discussed below, it appears that some professional liquidity 

providers 7 temporarily did not participate in the market on the buy side in many 

stocks that suffered particularly egregious price declines, whether because of an intentional decision to withdraw or because of specific market practices. Some types 

of professional liquidity providers have ‘‘affirmative’’ obligations to provide liquidity 

whether the market is up or down, as well as ‘‘negative’’ obligations not to take liquidity in ways that would destabilize the markets. Other professional liquidity providers do not have such responsibilities, including some of the high frequency proprietary trading firms that also are discussed below. 

There is evidence that some firms that had previously been active participants in 

the markets withdrew their liquidity after prices declined rapidly. These firms may 

have acted appropriately under current rules, as a firm’s risk models may have concluded that the action in the market presented too substantial a risk. As discussed 

below, however, we are looking at the data and considering the types of obligations 

that should apply to certain liquidity providers. 

3. Disparate Exchange Practices 

The decline in the market on May 6 also focused attention on disparate exchange 

practices for dealing with major price movements and other unusual trading conditions. One of these is the NYSE’s mechanism for ‘‘liquidity replenishment points’’ 

(‘‘LRPs’’). The NYSE utilizes a hybrid floor/electronic trading model, unlike most 

other markets today which are fully electronic. There are disagreements regarding 

whether the one model performed better than another in these circumstances. 
52 

Although the ultimate answer to that question requires additional study and analysis, it is useful to describe the effect a certain feature of the NYSE had on market 

movements that day. In attempting to meld the traditional open-outcry floor-based 

auction model with today’s technology, the NYSE’s trading system utilizes what are 

known as ‘‘liquidity replenishment points,’’ or LRPs. LRPs are best thought of as 

a ‘‘speed bump’’ and are intended to dampen volatility in a given stock by temporarily converting from an automated market to a manual auction market when a 

price movement of sufficient size is reached. In such a case, trading on the NYSE 

in that stock will ‘‘go slow’’ and pause for a time period to allow the Designated 

Market Maker to solicit additional liquidity before returning to an automated market. This ‘‘speed bump’’ occurs even when there may be additional interest beyond 

the LRP price point. 

On days of major market volatility, stocks with significant and continual declines 

may cause NYSE trading to remain in the ‘‘go slow’’ mode for extended periods or 

to intermittently return to automated execution status before quickly again hitting 

another LRP and thereby ‘‘going slow’’ again. Some have suggested that this practice caused a net loss of liquidity as orders were routed to other markets still offering automated executions. Others believe that the LRP mechanism served to attract 

additional liquidity that helped soak up some of the excess selling interest. We will 

examine the role and operation of LRPs to assess their effect on overall market 

quality and intend to promptly finalize this analysis. If any adverse effects on overall market quality are identified, we will take immediate steps to rectify that impact. We are focusing on whether the disparity in exchange practices can be addressed to promote more consistency in how orders are handled in the context of 

rapidly changing prices without undermining the benefits of individual market practices. 

An exchange typically will route an order to another exchange when the other exchange is displaying a better price. The routing exchange does this to avoid ‘‘trading 

through’’ the other exchange, that is, executing the order at a price worse than is 

available at the other exchange. When one exchange believes that another exchange 

is experiencing systems problems, the exchange may declare what is called ‘‘selfhelp’’ against the other exchange. After declaring ‘‘self-help,’’ the declaring exchange 

may trade through the quotations of the other exchange. The result of a self-help 

declaration is that the declaring exchange will exclude the quotations of the other 

exchange from its determination of whether the other exchange has a better ‘‘protected’’ price to which it must route orders for execution. Appendix B provides additional detail on Regulation NMS. 

On the afternoon of May 6, just prior to the steep market decline, NASDAQ and 

NASDAQ OMX BX declared self-help against NYSE Arca, thereby excluding NYSE 

Arca’s quotations (and liquidity) from their routing tables. The NYSE Arca has asserted that it did not experience systems problems that would warrant the declaration of self-help. We are investigating these issues and whether there needs to be 

greater consistency in exchange practices with respect to the self-help mechanism. 

4. Exchange-Traded Funds 

Of the U.S.-listed securities with declines of 60 percent or more away from the 

2:40 p.m. transaction prices, which resulted in their trades being canceled by the 

exchanges, approximately 70 percent were ETFs. This suggests that ETFs as a class 

were affected more than any other category of securities. 

Based on our analysis to date, we are focused on a number of issues that may 

have contributed to the ETFs’ experience, including: 

• Because ETFs generally track securities market indices, the extraordinary price 

declines in certain individual securities likely contributed to the ETF price declines. For the most part, the severe ETF price declines followed, in time, the 

sharp decline in the broad markets. ETFs that track bond indices generally did 

not experience severe price declines. We therefore are reviewing the linkages 

between ETF price declines and the declines in the equity market. 

• The role of market makers and authorized participants in ETFs, and whether 

an inability to hedge their ETF positions during periods of severe volatility may 

have contributed to a lack of liquidity in ETF shares. 

• The use of ETFs by institutional investors as a way to quickly acquire (or eliminate) broad market exposures and whether this investment strategy led to substantial selling pressure on ETFs as the market began to decline significantly. 

We also will explore whether the practice of shorting ETFs by institutional investors to effectively eliminate broad market exposures might have contributed 

to the intraday price swings experienced by certain ETFs. 
53 

• The impact of ETF stop loss market orders, particularly from retail investors, 

on the overall ETF market price declines. 

• Given that NYSE Arca is the primary listing exchange for almost all ETFs, 

whether the impact that the declaration of ‘‘self-help’’ against NYSE Arca by 

other exchanges may have impacted NYSE Arca-listed stocks generally and 

ETFs in particular. The loss of access to NYSE Arca’s liquidity pool may have 

had a greater impact on market liquidity and trading for ETFs. 

5. Other Factors 

A variety of other factors likely contributed to or potentially exacerbated the 

events of May 6. For example, many of the securities that were subject to trade cancellations were thinly traded, including certain exchange-traded funds and preferred 

stocks. For such illiquid securities, a large order or influx of orders easily can soak 

up available liquidity across the market, resulting in an order, particularly if it is 

a market order, breaking through many price levels in an effort to obtain an execution at any price. A market order is an order to buy or sell a stock at the best available current price. Market orders do not require an execution at a specific price or 

price range. With market orders, the order submitted generally is assured an execution; however, there is no limit on what the execution price can be. This contrasts 

with limit orders, which are submitted with a specified limit price. Limit orders 

guard against executions at prices at which the order submitter is not willing to 

trade, though the tradeoff is that the order may not be executed if the market suddenly moves away from the suggested limit price. 

In addition, the effect of market orders on prices may have been further exacerbated on May 6 by the use of stop loss market orders. These orders turn into market 

orders when the stop price of the order is reached. When an investor places a stop 

loss market order, the investor is instructing the broker to sell a stock at the market 

if it falls to a certain price. In a normal market, where liquidity exists as the stock 

price goes up or down, this strategy can protect an investor from taking a major 

loss if the stock drops significantly by selling at a predetermined price to minimize 

the loss. However, on May 6, the use of market orders when stop loss orders were 

triggered may have led to automated selling that resulted in executions at aberrant 

prices. 

Furthermore, the absurd result of valuable stocks being executed for a penny likely was attributable to the use of a practice called ‘‘stub quoting.’’ When a market 

order is submitted for a stock, if available liquidity has already been taken out, the 

market order will seek the next available liquidity, regardless of price. When a market maker’s liquidity has been exhausted, or if it is unwilling to provide liquidity, 

it may at that time submit what is called a stub quote—for example, an offer to 

buy a given stock at a penny. A stub quote is essentially a place holder quote because that quote would never—it is thought—be reached. When a market order is 

seeking liquidity and the only liquidity available is a penny-priced stub quote, the 

market order, by its terms, will execute against the stub quote. In this respect, automated trading systems will follow their coded logic regardless of outcome, while 

human involvement likely would have prevented these orders from executing at absurd prices. As noted below, we are reviewing the practice of displaying stub quotes 

that are never intended to be executed. 

Finally, we are examining the effect of short selling during the decline in prices. 

While short selling did not account for a disproportionate percentage of trading volume over the course of the day, our analysis thus far of broken trades has found 

that short sales accounted for a very high percentage (70–90 percent) of executions 

against stub quotes between 2:45 p.m. and 2:55 p.m. Notably, short sale executions 

against stub quotes would be subject to the alternative uptick rule (Rule 201) adopted by the SEC in February 2010, with a compliance date in November 2010. 

6. Initial Steps 

On the Monday following the events of May 6, I met here in Washington with 

the leaders of six markets—New York Stock Exchange, NASDAQ Stock Market, 

BATS Exchange, Direct Edge ECN, International Securities Exchange, and Chicago 

Board Options Exchange—and FINRA, to discuss the causes of market events of 

May 6, the potential contributing factors, and possible market reforms. The meeting 

was productive and collaborative, and there was a strong consensus that the type 

of aberrational volatility experienced on May 6 is wholly unacceptable in our markets. 

Earlier this week, the national securities exchanges and FINRA filed proposed 

rules for uniform market-wide circuit breakers for individual securities in the S&P 

500 Index that experience a rapid price movement. 
54 

Under the proposed rules, which are subject to Commission approval following the 

completion of a comment period, trading in a stock would pause across U.S. equity 

markets for a 5-minute period in the event that the stock experiences a 10 percent 

change in price over the preceding 5 minutes. The pause would give the markets 

the opportunity to attract additional liquidity in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. Initially, 

if approved, these new rules would be in effect on a pilot basis through Dec. 10, 

2010. The markets can use the pilot period to make appropriate adjustments to the 

parameters or operation of the circuit breaker as warranted based on their experience, and to expand the scope to securities beyond the S&P 500 (including ETFs) 

as soon as practicable. 

The proposed rules are available on the SEC’s website as well as the websites of 

each of the exchanges and FINRA. The Commission is publishing the proposed rules 

for a 10-day public comment period, and will determine whether to approve them 

shortly thereafter. Circuit breakers for individual securities across the exchanges 

should help to limit significant volatility, promote orderly markets, and bolster investor confidence. 

In addition, during the pilot period, I have asked the SEC staff to consider ways 

to address the risks of market orders and their potential to exacerbate sudden price 

moves, as well as to consider steps to deter or prohibit the use by market makers 

of ‘‘stub’’ quotes, which are not intended to indicate actual trading interest. The staff 

also will study the impact of other trading protocols at the exchanges, including the 

use of trading pauses by individual exchanges that supplement the market-wide circuit breakers, and ‘‘self-help’’ protocols that allow the markets to avoid routing to 

exchanges that are perceived to be responding too slowly. The SEC staff also will 

continue to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring speed and consistency across markets. Another 

area of review is the need to consider recalibrating market-wide circuit breakers 

currently on the books—none of which were triggered on May 6. 

As noted above, SEC and CFTC staff recently issued a joint report of preliminary 

findings regarding the market events of May 6 to the Joint Advisory Committee on 

Emerging Regulatory Issues. The Committee will hold its first meeting Monday. The 

Commission looks forward to working with the Committee, whose first charge is to 

review the market break and make recommendations related to market structure 

issues that may have contributed to the volatility experienced on that day, as well 

as disparate trading conventions and rules across various markets. 

The following week, on June 2, the Commission will hold a roundtable with various market participants to discuss the structure of the securities markets. In publishing notice of the roundtable in the Federal Register, the Commission has solicited public comment on the current market structure including how well it is serving various market participants. The roundtable will provide an open forum for market professionals, investors, and academics to express their views on the current 

market structure, possible causes of the unusual trading activity on May 6, and 

ways to improve the markets to ensure that, first and foremost, our markets are 

fair and orderly. 

Finally, our inspections and enforcement staff also have been fully integrated into 

our review of the events of May 6. I am deeply concerned about the effects that this 

volatile market had on investors, especially retail investors whose trading orders 

may not have behaved as they were intended or who otherwise may have been unfairly harmed. The SEC has received numerous complaints from investors, for example, who used stop loss orders to protect them from rapidly declining markets. It 

appears that some investors’ accounts were liquidated as share prices plummeted 

only to have stock prices close significantly above their sale prices. We are looking 

at a wide variety of actions on May 6 involving the full range of market participants. We will examine such things as whether market professionals fully met their 

obligations, including, where applicable, their best execution obligations, and whether the decision to bust trades was made and applied fairly and consistently among 

investors. If we identify any activity that violates the securities laws, we will take 

appropriate action. 

III. Potential Regulatory Responses 

To the extent there was anything positive in the events of May 6, it was that the 

markets proved to be resilient and recovered quickly. Nevertheless, such a severe 

market disruption harms investors and the markets generally. First, it harms those 

investors who may have traded at erroneous prices. For example, many investors 

use stop loss orders that are triggered by significant price moves and can liquidate 

positions at very unfavorable prices. Other investors may see a precipitous price de-
55 

cline and initiate new orders to sell to minimize losses. These new orders likewise 

may liquidate positions at very unfavorable prices for the investor. 

Some of these trades may be canceled and some may not. But even for trades that 

are canceled, they may cause losses for those investors and traders who stepped in 

and bought during the midst of a severe price decline. These investors and traders 

accepted the risk of a market meltdown and significant losses, but, if their trades 

are canceled, were not rewarded for their willingness to buy when everyone else was 

selling. Finally and more generally, such disruptive price movements undermine the 

confidence of investors in the integrity and fairness of our markets, undermining the 

essential function of supporting capital formation. 

In response to the global economic crisis and evolving market practices, the Commission had already undertaken a number of initiatives to strengthen the integrity 

our markets, even before the events of May 6. In February, for example, the Commission adopted a short sale circuit breaker. That rule is designed to limit short 

selling where an individual stock is under stress and has experienced a decline of 

10 percent from the previous day’s close. At that point, the restrictions of the rule 

provide assurances to investors that short sellers are not taking the stock down, 

while retaining the value of short selling in the price discovery process. In so doing, 

we believe that the rule will promote investor confidence. 

The market events of May 6 add greater urgency for the Commission to vigorously 

pursue a number of meaningful initiatives to promote investor confidence in the integrity and fairness of the securities markets, including a number of proposals already underway. I first will address additional initiatives relating to time out mechanisms, destabilizing short-term trading strategies, and correction of erroneous 

trades. I will conclude by noting various initiatives already proposed or soon to be 

considered that may help address disruptive market conditions. 

A. New Initiatives 

In January, the Commission published a concept release on equity market structure (‘‘Market Structure Concept Release’’) that highlighted many aspects of today’s 

highly automated markets and requested public comment on a wide variety of 

issues. The Market Structure Concept Release was designed to further the Commission’s broad review of market structure to assess whether its rules have kept pace 

with, among other things, changes in trading technology and practices. 

The events of May 6 implicate a number of issues raised in the Market Structure 

Concept Release. For example, it asked whether the current market structure appropriately minimizes the short-term volatility that can be harmful to long-term investors. It asked whether the relatively good performance of the market structure 

in 2008 indicated that systemic risk was appropriately minimized in the current 

market structure and, if not, what further steps the Commission should take to address systemic risk. Finally, it noted the dominant role of HFT firms in today’s market structure and observed that they had largely replaced the role of specialists and 

market makers with affirmative and negative obligations for market quality. More 

specifically, the Market Structure Concept Release asked whether there is any evidence that proprietary firms increase or reduce the amount of liquidity provided to 

the market during times of stress. It also discussed various types of short-term trading strategies, including ‘‘directional’’ strategies, such as ‘‘momentum ignition,’’ that 

could present serious problems in today’s market structure by exacerbating shortterm volatility. 

The public comment period on the Market Structure Concept Release ended on 

April 21. The Commission has received more than 100 comment letters reflecting 

a broad range of perspectives. Many of the letters set forth detailed views on very 

complex issues, and the Commission continues to review them carefully. 

In addition, the Commission has published a series of concrete market structure 

proposals that are designed to strengthen the U.S. securities markets and to protect 

investors. These include the proposal to prohibit flash orders and the proposal to 

increase the transparency of ‘‘dark’’ pools of liquidity, as well as the market access 

proposal (discussed below) to strengthen broker-dealer risk management controls 

and the large trader reporting proposal (also discussed below) to enhance the Commission’s surveillance and enforcement capabilities. 

The events of May 6 demonstrate the urgency and importance of these efforts and 

provide a valuable concrete example of how the market structure performed under 

particularly stressful conditions. As such, they highlight particular regulatory steps 

that warrant close attention in the near future. 

1. Destabilizing Short-Term Trading Strategies 

In addition to focusing on liquidity, we must also consider the sources of the selling pressure that can suddenly generate such enormous demand for liquidity to buy. 
56 

What triggered the selling pressure? What types of market participants were selling 

and what types of trading strategies were they pursuing? 

For example, to what extent, if at all, did the wave of selling on May 6 come from 

proprietary firms employing ‘‘directional’’ strategies triggered by signals that attempt to exploit short-term price movements? These directional strategies were discussed in the Market Structure Concept Release and include ‘‘momentum ignition’’ 

strategies that are designed to start and exacerbate price movements. It is too early 

to know whether short-term professional trading strategies played any role in the 

events of May 6. If they contributed significantly to the precipitous decline, however, 

we must consider whether additional regulatory requirements are necessary. 

For example, in the past, professional liquidity providers with the best and fastest 

access to the markets were charged with affirmative and negative obligations to promote market quality. One of the most significant negative obligations was a restriction on ‘‘reaching across the market’’ to take out quotations and thereby drive prices 

up or down. Many of the most active and sophisticated traders in today’s market 

structure are not subject to any obligations with respect to the nature of their trading. If active trading firms exploited their superior trading resources and significantly contributed to the severe price swings on May 6, we must consider whether 

regulatory action is needed to address the problem. 

2. Fair and Consistent Process and Policies for Correcting Erroneous 

Trades 

We also must work with the various exchanges and other trading venues to assure that the process and policies for dealing with the correction of erroneous trades 

are fair for investors and consistently applied—both in the context of a single event 

and across different events. Currently, the threshold level for correcting trades is 

set by the exchanges on a case-by-case basis. The particular level that is chosen may 

affect investors and other market participants in profound and varying ways. Obviously, the primary objective should be a market structure that minimizes to the 

greatest extent possible any need to correct erroneous trades. When necessary, however, the process and policies should be applied in a consistent manner under established rules that are fair to investors. 

B. Ongoing Initiatives 

1. Market Access Proposal 

In January, the Commission proposed a rule that would require effective risk 

management controls for broker-dealers with market access, including those providing customers sponsored access to the markets. Our proposal would effectively 

prohibit the growing practice by some broker-dealers of providing ‘‘unfiltered’’ sponsored access, where a customer is permitted to directly access the markets using the 

broker-dealer’s market participant identifier but without the imposition of effective 

pre-trade risk management controls. All broker-dealers accessing the markets 

should implement controls to effectively manage the risks associated with this activity, and our proposal would unequivocally require them to do so. These risks include 

the potential breach of a credit or capital limit, the submission of erroneous orders 

as a result of computer malfunction or human error, and the failure to comply with 

regulatory requirements. Effective risk management controls for market access are 

necessary to protect the broker-dealer, the markets, the financial system, and ultimately investors. Such controls would help prevent trading activity that could trigger a market disruption. We have received numerous comment letters on our sponsored access proposal and the staff is considering those comments and will soon 

make a recommendation to the Commission. I expect the Commission to act on this 

important proposal by this summer. 

2. Large Trader Reporting Proposal 

Last month, the Commission proposed to create a large trader reporting system 

that would enhance our ability to identify large market participants, collect information on their trades, and analyze their trading activity. To keep pace with rapid 

technological advances that have impacted trading strategies and the ways in which 

some market participants trade, the Commission must be able to readily identify 

large traders operating in the U.S. securities markets, and obtain basic identifying 

information on each large trader, its accounts, and its affiliates. In addition, to support its regulatory and enforcement activities, the Commission must have a mechanism to track efficiently and obtain promptly trading records on large trader activity. 

The current system for collecting transaction data from registered broker-dealers 

is generally utilized in more narrowly focused investigations involving trading in 

particular securities, and is not generally conducive to larger-scale market recon-
57 

structions and analyses involving numerous stocks during periods of peak trading 

volume. In addition, existing tools often require weeks or longer to compile trading 

data to identify potentially large traders. The Commission’s need to develop the 

tools necessary to readily identify large traders and be able to evaluate their trading 

activity is heightened by the fact that large traders, including certain high-frequency traders, are playing an increasingly prominent role in the securities markets. 

The proposed rule would enhance the Commission’s ability to identify those ‘‘large 

trader’’ market participants that conduct a substantial amount of trading activity 

in U.S. securities, as measured by volume or market value. In addition, the proposal 

would facilitate the Commission’s ability to obtain from broker-dealers records of 

large trader activity. By providing the Commission with prompt access to information about large traders and their trading activity, the proposed rule is intended to 

facilitate the Commission’s efforts in reconstructing market activity and performing 

analyses of trading data, as well as assist in investigations of manipulative, abusive, 

and other illegal trading activity. 

3. Consideration of Consolidated Audit Trail Proposal 

One of the challenges we face in recreating the events of May 6 is the reality that 

the technologies used for market oversight and surveillance have not kept pace with 

the technology and trading patterns of the rapidly evolving and expanding securities 

markets. There are mechanisms already in place to coordinate surveillance among 

markets. For example, the Intermarket Surveillance Group provides a framework 

for the sharing of information and the coordination of regulatory efforts among exchanges trading securities and related products to address potential intermarket 

manipulations and trading abuses. However, audit trail requirements vary between 

markets, resulting in a lack of current, readily accessible securities order and execution data. Today’s fast, electronic, and interconnected markets demand a robust consolidated audit trail and execution tracking system. 

Since last summer, SEC staff have been working, in consultation with SROs and 

others, on a rule proposal that would require the SROs to jointly develop, implement 

and maintain a consolidated order tracking system, or consolidated audit trail. Next 

week, the Commission will consider this rule proposal, which should result in a continuous reporting mechanism for market participants that would capture the data 

needed for effective cross-market surveillance. The proposed changes will significantly improve the ability to conduct timely and accurate trading analyses for market reconstructions and complex investigations, as well as inspections and examinations. Indeed, I expect that the proposed consolidated audit trail would result in our 

ability to access in real time the majority of the data needed to reconstruct the type 

of market disruption that occurred last week, with remaining information available 

within a matter of days rather than weeks. A consolidated audit trail would be invaluable to enhance the ability to detect and monitor aberrant and illegal activity 

across multiple markets, and would greatly benefit investors and help to restore 

trust in the securities markets. 

IV. Conclusion 

In conclusion, the events of last week are unacceptable. The SEC is engaging in 

a comprehensive review and is taking the necessary steps to implement additional 

safeguards to prevent the type of unusual trading activity that occurred briefly last 

week. The Commission is considering a number of proposals that will address key 

issues raised on May 6 and we will move expeditiously to address all issues we determine caused or contributed to those events. 
58 
59 
60 
61 
62 
63 
64 
65 
66 
67 
68 
69 
70 
71 
72 
73 
74 
75 
76 
77 
78 
79 
80 
81 
82 

PREPARED STATEMENT OF RICHARD G. KETCHUM 

CHAIRMAN AND CEO, FINANCIAL INDUSTRY REGULATORY AUTHORITY

MAY 20, 2010 

Chairman Reed, Ranking Member Bunning and Members of the Subcommittee: 

I am Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory 

Authority, or FINRA. On behalf of FINRA, I would like to thank you for the opportunity to testify today. 

I would also like to commend SEC Chairman Mary Schapiro and CFTC Chairman 

Gary Gensler for their leadership during the last 2 weeks. They swiftly engaged 

with exchange leaders and regulators and established a collaborative process to coordinate review of all relevant market data, as well as to identify measures that 

could be taken quickly to significantly reduce the chances of a recurrence of the severe market disruption that occurred on May 6. 

There remains much more work to do, both in terms of diagnosing what led to 

the market drop May 6 and identifying additional proactive steps we may want to 

take to ensure that our markets are able to function more efficiently under highly 

volatile conditions. Ultimately, we all realize that the extreme market volatility 2 

weeks ago underscored the need for regulators, and others operating in and around 

financial markets, to step back and recognize that with the immense changes in the 

market, there is a serious need to look at market structure, and identify a variety 

of measures that can enhance the information regulators receive to ensure market 

integrity and the protection of investors. 

Efforts Undertaken Since May 6 

Immediately after the market events on May 6, FINRA, in coordination with the 

SEC and other self-regulatory organizations (SROs), began the process of trying to 

identify unusual activity that could have contributed to the rapid market drop. Even 

before the market data had been fully collected, FINRA staff reviewed clearly erroneous trade filings and, along with NYSE Regulation, interviewed the approximately 20 firms with significant activity during the period of the decline. Along with 

NYSE Regulation, we contacted the firms to determine whether ‘‘fat finger’’ or other 

trading errors occurred, either as a result of proprietary or customer activity. None 

of the firms contacted identified any trading errors or other unusual activity on 

their part, nor has any firm come forward since, nor has any evidence been developed to indicate that a single large trade or basket of trades entered in error played 

a role in the market decline. 

On May 7, we contacted over 250 firms to determine the impact of the market 

disruption to the firms and their customers. Our inquiries covered a range of issues 

depending on the type of firm, including funding and liquidity, customer exposure, 

increased margin calls, net capital implications and how firms intended to reestablish limit orders that were executed and then canceled. We followed up with particular firms last week to ensure that appropriate steps had been taken to address 

any issues identified in our initial discussions. While firms cited a number of operational and other issues, none appeared to be systemic in nature. In addition, we 

are examining the flow of customer complaints to both us and the firms concerning 

order handling and execution practices during the market decline. 

We have focused our review of the vast amounts of trading data on the approximately 300 stocks that experienced the most dramatic decline during the 30-minute 

period in question. That list, unsurprisingly, coincides with the list of securities that 

were the subject of cancellations and reversals by the markets on the evening of 

May 6. We continue to review order entry and trade reporting data for the 300-plus 

stocks, and have identified a subset of these stocks for further inquiry, based on an 

analysis of a concentration of order and trade activity in the period immediately 

prior to and during the market drop. Focusing on the selling activity in these securities (some of which, incidentally, are exchange-traded funds), we, again working 

closely with both SEC staff and staff from the other markets, contacted those firms 

that were most active. Our lines of inquiry, while quite broad, include an analysis 

of short selling during the period and the role that algorithms played, including the 

specific strategies and triggers employed by the trading firms. Finally, we are talking to the largest broker-dealer alternative trading systems to determine whether 

they had system issues that may have contributed to the market drop. 

While there is still much to be done before we can say that we have definitively 

pinpointed the cause or causes of the decline, I think we can say that certain basic 

truths have emerged, and that we should not wait to adapt to them. First, we know 

that the process for restoring order following an event like last Thursday should be 

more transparent and predictable. 
83 

Second, this event demonstrated that the conventional wisdom that the futures 

markets tend to move first continues to hold, as does the notion that the market 

is highly efficient in shifting that momentum from the derivatives side to the cash 

side, creating fast and focused selling pressure across wide numbers of stocks and 

ETFs. That point, that the equities markets can find themselves dramatically influenced by external market movements, now has a clear corollary completely self-contained in the equities space. 

Specifically, as we’ve seen exchange barriers to entry drop, competition rise and 

market structure policy compel connectivity among exchanges and between exchanges and other execution venues, we see that market quality can no longer be 

ensured by a single exchange acting in a siloed fashion. Moreover, while the market 

fragmentation that has occurred has lowered barriers to entry and created fierce 

competition resulting in narrow quotation spreads and a high level of liquidity in 

good times, it also results in the fact electronic removal of liquidity when markets 

are stressed. It also generally resulted in the elimination, in many cases, of meaningful market maker obligations while retaining residual regulatory requirements 

for two-sided quotes that has led to the ‘‘stub quoting’’ phenomenon that contributed 

to the extreme price volatility. In short, while our equity market structure performs 

well under normal conditions, change is urgently needed to better address these 

flash market break situations. 

Taking note of that last point, FINRA was pleased to have participated in a series 

of discussions with the U.S. equities and options exchanges, at the direction of the 

SEC, to establish a framework for market-wide, stock-by-stock circuit-breaker rules 

and protocols. The result of this coordinated effort are the rule changes filed on 

Tuesday by each of the exchanges and FINRA to implement the following stock-bystock circuit-breaker protocols on a pilot basis for all securities included in the S&P 

500: 

• If the price of a security changes by 10 percent within a rolling 5-minute period, 

trading in that security will be halted for 5 minutes. 

• A message will be sent simultaneously to all the markets and FINRA. 

• The primary market for the security will employ its standard auction process 

to determine the opening print after the 5-minute halt period. 

• The authority will apply from 9:45 a.m. to 3:35 p.m., Eastern Time. 

This solution will allow a pause in trading that will allow market participants to 

better evaluate the trading that has occurred to correct any erroneous ‘‘fat finger’’ 

orders and to allow a more transparent, organized opportunity to offset the order 

imbalances that have caused the volatility. In this way, this regulatory response 

should reduce the negative impacts of sudden, unanticipated and otherwise unexplained dramatic price movements in individual securities. This is far preferable to 

the markets having to be in the position of going back after the fact to determine 

what trades should be broken when markets go close to zero. 

Additional implementation and technological issues will be discussed and resolved 

by the relevant markets in the coming weeks, with the goal of implementing the 

new circuit-breaker authority within 30 days after Commission approval. Once implemented, the markets and FINRA will be monitoring continuously the application 

and effectiveness of the rule’s framework and protocols to determine the most efficient and effective permanent approach, in anticipation of such authority being expanded to a broader range of securities. 

Next Steps 

As we look past these shorter term steps to address what we saw in the market 

2 weeks ago, longer term concerns must also be addressed if we are to reassure market participants, including retail investors, that our equities markets are stable and 

fair. And this is true irrespective of whether these issues played a major contributing role in the specifics of the decline on May 6. 

First, firms need to ensure that they do not continuously feed in orders once markets have broken with respect to precipitous declines. 

Second, firms must properly supervise customers to whom they have given ‘‘direct 

access’’ to the markets, thereby allowing a customer to trade on an exchange using 

the firm’s market participant identification code. Any firm that provides its name 

to and/or sponsors a transaction has a responsibility to ensure the proper reviews 

for those transactions are in place. 

Third, there should be a continued analysis of various markets’ rules regarding 

circuit breakers and clearly erroneous trades, with an eye toward consistency and 

transparency of these rules across markets. As Chairman Schapiro has said, ‘‘the 

primary objective should be a market structure that minimizes to the greatest ex-
84 

tent possible any need to correct erroneous trades. When necessary, however, the 

process should be applied in a consistent manner under established rules that are 

fair to investors.’’ I also agree with Chairman Schapiro that the practice of displaying stub quotes should be analyzed and potentially eliminated. 

Finally, and most broadly, the events of May 6 demonstrate the vital importance 

of the SEC’s current review of market structure, rule proposals on direct market access and large trader reporting, and the forthcoming proposal related to establishing 

a consolidated audit trail. 

Market Structure Review and the Need for a Consolidated Audit Trail 

The sometimes dizzying speed of change in the markets, which puts a premium 

on innovation and competition, has made it imperative that regulators act now to 

close regulatory gaps that ineffectively discourage illicit activity in the shadows. The 

lag between market innovation and regulation is particularly pronounced in the increasingly fragmented area of equity trading. There, we have seen a rapid evolution 

of how and where trading occurs, and how quickly—and transparently—it is executed. High-frequency trading, dark pools and direct access are now commonplace, 

compelling regulators to adapt to ensure that market participants play by the rules. 

A generation ago, the vast majority of activity occurred on the equity market that 

listed the security. Today, orders are routed to some 50 competing platforms. This 

complex environment creates opportunities for traders seeking unfair advantage to 

manipulate markets. How? By exploiting inconsistencies or gaps created when the 

responsibility of regulatory oversight is divided. Regulatory gaps and splintered 

oversight make it possible for trading abuses—such as market manipulation, marking the close and front-running customer orders—to be carried out furtively across 

multiple markets, with a reduced chance of detection. 

By spreading trading activity across different market centers, firms can attempt 

to disguise abusive trading activity by exploiting the existing gaps in audit trail 

data. Although regulatory authorities currently examine for, investigate and prosecute abusive trading activity when it violates existing regulatory obligations, we 

are hampered by the lack of a comprehensive, sufficiently granular and robust consolidated audit trail across the equity markets. The most effective way to surveil 

for these trading practices across the wide range of market centers is to consolidate 

audit trail data in a single place so that violative trading practices can be more 

readily identified. 

Each market is required to have in place rules that, among other things, seek to 

prevent fraudulent and manipulative acts and practices, and protect investors and 

the public interest. Although each market is responsible for regulating and 

surveilling the trading conducted on its market, as markets become increasingly 

fragmented and securities trade on multiple venues, regulation of activity that 

crosses markets becomes a vital component of ensuring overall market integrity and 

maintaining investor confidence. This is particularly so because trading abuses such 

as insider trading, market manipulation, marking the close and trading ahead of 

customer orders so easily can be conducted across multiple markets. FINRA believes 

that a consolidated audit trail across markets, and eventually across investment 

products, is essential to ensure comprehensive surveillance of the equity markets 

and related markets so that abusive trading activity can be detected in a more timely, efficient and comprehensive manner. 

Today, regulation of the equity markets is split among FINRA and other SROs, 

and no single regulator has a full picture of all trading activity in the U.S. equity 

markets, either on a product-specific, firm-specific or, under certain circumstances, 

even an order-specific basis. 

The announcement on May 4 that FINRA will assume market regulation for 

NYSE Euronext’s U.S. platforms is a major step toward establishing such a unified 

approach to market oversight. Under the plan, FINRA—which already conducts 

market surveillance for the NASDAQ Stock Market and trading occurring off-exchange—will be responsible for aggregating and regulating approximately 80 percent of trades in equities made at U.S. market centers. The benefits for market integrity and investor protection are profound. But perhaps more importantly, empowering a single set of eyes to oversee the majority of transactions will facilitate the 

necessary progress toward a truly holistic approach to regulation that addresses the 

realities of today’s marketplace. 

Quite simply, technological advances in trading systems, coupled with market 

fragmentation, have led to a situation where comprehensive intermarket surveillance is essential to ensuring the overall integrity of the equity markets. Moreover, 

the major hurdles of just a few years ago to consolidated market surveillance have 

been significantly reduced due to the progression of market structure and the convergence of many aspects of exchanges’ business models. With the changes to mar-
85 

1 NYSE Euronext is a leading global operator of financial markets and provider of innovative 

trading technologies. The company operates cash equities exchanges in five countries and derivatives exchanges in Europe and the United States, on which investors trade equities, futures, 

options, fixed-income and exchange-traded products. With more than 8,000 listed issues, NYSE 

Euronext’s equities markets—the New York Stock Exchange, NYSE Euronext, NYSE Amex, and 

NYSE Arca—represent nearly 40 percent of the world’s equities trading, the most liquidity of 

any global exchange group. NYSE Euronext also operates NYSE Liffe, the leading European derivatives business, and NYSE Liffe U.S., a new U.S. futures exchange. We provide technology 

to more than a dozen cash and derivatives exchanges throughout the world. The company also 

offers comprehensive commercial technology, connectivity and market data products and services through NYSE Technologies. 

ket structure resulting from Regulation NMS and virtually all aspects of trading becoming electronic, the previous distinctions between market types are quickly fading 

away, minimizing many of the prior obstacles to consolidated audit trail data and 

oversight. 

Since the adoption of Regulation NMS in 2005, there has been a significant increase in market linkages, the result of which is that trading activity that originates 

on one market often has a profound effect on other markets. This, of course, creates 

a much greater possibility of cross-exchange market manipulation where, for example, trading on one market is used to artificially affect a security’s price and trading 

on another market is used to take advantage of that price change. A similar problem exists when surveilling for compliance with rules that prohibit firms from trading ahead of a customer order, such as limit order protection rules and front running rules. In these cases, the proprietary trading may be executed on one market 

while the customer trade is executed on another. These problems are exacerbated 

by the fact that some firms trade using multiple market participant identifiers 

(MPIDs) or trade pursuant to market access arrangements whereby the firm’s trading is identified with an MPID assigned to a different firm. 

FINRA believes there should be consistent and uniform gathering of order, trade 

and quote information across all equity and options markets, and that the audit 

trail must be sufficiently granular to enable regulators to readily identify trading 

activity by market participants across markets. A consolidated audit trail would not 

eliminate all the challenges of analyzing the data from a 66 million trade day like 

May 6, but it would make the process significantly more efficient and effective. 

We look forward to working with the SEC, and with this Committee, as we continue our work on these important initiatives that lie at the heart of enhancing regulators’ ability to best oversee today’s markets. 

Conclusion 

We will continue to work with our fellow regulators to diagnose and identify corrective measures to address the significant market disruption 2 weeks ago. The SEC 

and CFTC spearheaded a process that has resulted in a coordinated, market-wide 

proposal that will quickly and dramatically lessen the chances for an event like that 

we saw May 6. But the effort is far from over. 

Further analysis of rule changes, highlighted by both the market drop and the 

SEC’s current market structure review, can and will strengthen our system to further ensure that rules and regulators are best positioned to ensure the continued 

integrity of U.S. markets and to protect all investors who participate in those markets. 

Again, I appreciate the opportunity to share our views. I would be happy to answer any questions you may have. 

PREPARED STATEMENT OF LARRY LEIBOWITZ 

CHIEF OPERATING OFFICER, NYSE EURONEXT

MAY 20, 2010 

Introduction 

Chairman Reed, Ranking Member Bunning and Members of the Subcommittee, 

my name is Larry Leibowitz and I am Chief Operating Officer for NYSE Euronext.1

I appreciate the opportunity to share with the Subcommittee our written testimony 

on the subject of today’s hearing. 

We commend the Subcommittee for its proactive response to the trading events 

of May 6, 2010. We agree with the Subcommittee that an orderly trading environment is fundamental to ensuring the reliability and integrity of our financial markets, fostering investor confidence in the markets, and safeguarding the U.S. financial system and economy. NYSE Euronext has always worked and will continue to 
86 

strive to be the standard for accountability and transparency in the regulated marketplace. Thus, we believe it is essential to carefully examine the market events 

that occurred on May 6, 2010 and to consider potential market design and regulatory actions that could mitigate any similar occurrences in the future. NYSE 

Euronext is firmly committed to working with regulators and market participants 

toward achieving this critical objective, and we strongly urge all parties to play an 

active and responsible role in helping our market function in a way that gives investors confidence. The trading events of May 6 are indicative of broader changes to 

markets and trading practices for which recent advances in technology have been 

a catalyst, and which the SEC wisely has opened for review. We particularly applaud the extraordinary effort and professional dedication of the SEC and CFTC in 

producing a thoughtful preliminary report on the events of May 6th in such a short 

timeframe. 

Today I would like to discuss: 

• the trading events of May 6, 2010; 

• the role automated trading and high frequency trading played in the market 

disturbance; 

• the actions, and rationale behind those actions, that the New York Stock Exchange took during those events; and 

• our recommendations for market design and regulatory changes to avoid similar 

events and enhance investor safeguards in the future. 

The May 6, 2010 Market Drop 

On May 6, 2010, from 2:40 p.m. to 3 p.m. Eastern time, the U.S. equity trading 

markets experienced a precipitous decline. At its lowest point, the Dow Jones Industrial Average suffered an intraday decline of 998.5 points, representing approximately $1 trillion in market value, with the most severe trading pressure occurring 

between 2:40 p.m. and 3 p.m. Some individual stocks lost nearly 100 percent of their 

market value. 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. The Securities and Exchange Commission (the ‘‘SEC’’) and the Commodity Future Trading Commission (the ‘‘CFTC’’) are 

aggregating and analyzing trading data from all of the equity and derivatives markets and, in addition to their preliminary findings issued on May 18, 2010, will form 

a complete picture of the situation. We and other markets are working with the 

SEC and CFTC to supply and interpret this data, but we cannot do so on our own, 

as any single exchange has access only to the data from trades sent to or executed 

on that exchange. 

From our standpoint, we see no evidence of fat finger error or market manipulation, due to automated trading or otherwise. However, we do see the following: 

• Elevated market activity coming from adverse European news, including a very 

large and a broadly based wave of orders and quotes at around 2:30 p.m.; 

• A significant reduction in marketplace liquidity as measured by the size of 

order books through the day, which accelerated dramatically through the downturn; 

• Increased downward pressure exacerbated by the triggering of retail Stop Loss 

orders, which sent market sell orders into an already weak market; and 

• Various microstructure issues that resulted in certain marketplaces not interacting with one another, which exacerbated the liquidity effect. 

Trading activity like we experienced on May 6 underscores the importance of the 

broad market structure review that the SEC is undertaking at present. As you 

know, in 2005 the SEC adopted Regulation NMS, which is the main set of regulations that govern the interaction of the competing markets in equity securities. Regulation NMS has resulted in a number of benefits to the equity markets, including 

narrower spreads and a greater use of technology, positioning the equity markets 

to handle the extreme market stresses that began in the fall of 2008. Additionally, 

Regulation NMS resulted in vibrant competition in the markets. We strongly support competition in the equity markets, but competition among trading centers and 

models has also resulted in significant market fragmentation. There are currently 

upwards of 40 market centers in the equities markets, including registered exchanges and alternative trading systems. 

Moreover, the broader market structure has evolved to one that values speed over 

most other factors, while on the New York Stock Exchange we have put a special 

emphasis on arriving at the right price. When a trading problem occurs, such as 

the May 6 experience, there is no central mechanism to coordinate a market-wide 
87 

response, or better yet to briefly pause, reassess what is happening in the marketplace and re-aggregate liquidity for the express purpose of conducting price discovery. Exchanges have rules for trading halts regarding pending news and trading 

problems and also have had to implement rules to address erroneous trades, most 

of which would not occur in a well functioning market structure. And while the securities and futures exchanges, along with the Financial Industry Regulatory Authority (FINRA), have adopted the market-wide circuit breakers developed after the 

1987 market crash, there were no pre-established mechanisms in place on May 6 

to address precipitous declines on a stock-by-stock basis, or trading problems that 

result in market-wide drops of less than 10 percent. 

We are confident that the May 6 market drop will inform the SEC’s current examination of the changes in the markets, and in particular how certain recent advances in technology may have fostered trading practices that negatively impact the 

entire market, and how practices that in the past were considered standard do not 

function well in today’s market. We are committed to working with the SEC and 

the CFTC as they consider these important issues. 

It is worth noting that a theme in some responses to the outstanding SEC market 

structure review is that policymakers should refrain from tinkering with the equity 

capital markets because they operate smoothly and efficiently, with deep liquidity 

and narrow spreads. While we do not disagree with many of these observations on 

the whole, we believe May 6th highlights why we do in fact need to focus on new 

rules and frameworks to avoid potential issues that arise in our fragmented marketplace, in a manner that is sensitive to maintaining an innovative environment. At 

the same time, we do not think it is right to point blame at professional traders 

or one category of liquidity providers, but rather believe that events of May 6 further highlight some of the issues raised in the SEC’s Concept Release regarding 

market maker commitments to the marketplace, dark liquidity and overall transparency. 

In this regard, I want to say a few words about high frequency trading. One of 

the challenges in addressing the topic is that there is no accepted definition of high 

frequency trading, but for present purposes I use the term to refer to a variety of 

high-speed techniques that have effectively filled the void left by human market 

makers who could no longer compete when decimalization greatly shrunk spreads. 

The New York Stock Exchange Euronext believes that high frequency trading 

adds liquidity to the markets, to the benefit of investors. It is most common in highvolume stocks and research demonstrates that since 2002, quoted spreads between 

bid and offer on stocks have tightened the most in high volume stocks compared to 

lower volume ones, presumably showing the benefits of high frequency trading. 

Moreover, the New York Stock Exchange Supplemental Liquidity Provider (SLP) 

program gives high frequency traders an economic incentive to quote at the best 

price a certain percentage of the time, thus rewarding the provision of liquidity. 

I want to be clear that the New York Stock Exchange Euronext does not favor 

high frequency trading or any other type of strategy over others. Rather, our role 

is to provide liquid, transparent and well-regulated exchanges, and let customers 

choose how they wish to access our markets. 

Before describing our actions on May 6, I believe it would be useful to explain 

the rules of the New York Stock Exchange that are designed to mitigate volatility 

which arises out of brief bursts of liquidity demand. 

The New York Stock Exchange’s Market Model 

The New York Stock Exchange has embraced electronic trading, and we believe 

our market model provides the best combination of cutting-edge technology and 

human judgment. The New York Stock Exchange market rules expressly provide 

mechanisms to mitigate volatility and large price swings—which we have always believed is a critical piece of our offering to listed companies and their investors. 

Specifically, the hybrid design of the New York Stock Exchange incorporates in 

its trading structure a type of circuit breaker mechanism, known as Liquidity Replenishment Points (‘‘LRPs’’), which temporarily and automatically pause trading in 

stocks when significant price moves occur. The LRPs are triggered by specific criteria based on the prices of particular stocks, which criteria are included in our rule 

book and were approved by the SEC. On a typical day, LRPs are triggered a few 

hundred times, lasting for seconds at most, and served the market well during the 

recent financial crisis. 

LRPs are designed to allow pauses and judgment to supplement artificial intelligence when trading appears irrational. The New York Stock Exchange’s human liquidity providers absorb the news and trading patterns with respect to individual 

stocks and can conduct auctions of order imbalances. To be clear, the LRP mechanism does not halt trading and does not allow liquidity providers to Written State-
88 

ment of Larry Leibowitz, step away from the market. Instead, for a short time, trading is automatically paused to facilitate more accurate price discovery, mitigate confusion and reduce panic, and prevent the market from experiencing a sudden and 

significant move. During this pause our quote is visible to other market participants 

and new orders are accepted. Our LRPs are analogous to taking the controls of a 

plane off autopilot during turbulence. 

Necessarily, and beneficially, this process is more deliberate and time consuming 

than fully electronic trading. Although Regulation NMS permits electronic trading 

to ignore the New York Stock Exchange when we are in our circuit-breaker mode, 

many market participants specifically chose our mode of trading in this time of 

stress: during the 20-minute period of focus on May 6, including the periods when 

the New York Stock Exchange was in LRP mode, market share on the New York 

Stock Exchange was 5 percentages points higher than usual during that time of day, 

and the participation rate of our Designated Market Makers (formerly known as 

Specialists) and Supplemental Liquidity Providers was actually higher than usual. 

This is evidence that our liquidity providers did not walk away from the market as 

we actively traded during the downturn. 

Once the New York Stock Exchange’s circuit breakers were triggered, prices on 

the New York Stock Exchange were dramatically different from prices on electronic 

exchanges that did not have in place a similar circuit breaker mechanism. Because 

the New York Stock Exchange had switched to LRPs, and because Regulation NMS 

allows traders to bypass us, orders were routed to electronic markets that had not 

mitigated the volatile price declines and which had limited amounts of liquidity on 

their books. 

To demonstrate that LRPs protected orders in our market, stocks listed on other 

markets had price declines and erroneous executions far greater than stocks listed 

on the New York Stock Exchange. For instance, while Proctor and Gamble traded 

no lower than $56.00 on the New York Stock Exchange during the 20-minute period 

of focus, it traded as low as $39.37 on electronic exchanges. In terms of erroneous 

executions, the overall marketplace needed to cancel approximately 15,000 executions after Thursday’s decline. On the New York Stock Exchange—even though we 

handled the largest share of orders in the marketplace—we had to cancel ZERO 

trades because of the protective measures in our market—while still trading more 

shares than any other venue. In fact, 85 percent of the trades that ultimately were 

canceled were securities that were not listed on the New York Stock Exchange. 

I emphasize these points to dispute the notion that the New York Stock Exchange 

stepped away from the marketplace during this crisis. 

We should note that LRPs are not intended to prevent the market from falling; 

indeed that is not the role of an exchange, and could not be achieved by any one 

market. Rather, our LRPs are designed to protect the integrity of our market by 

preventing a panic-led downdraft and mitigating systemic risk. Yet, when we are 

in this ‘‘slow’’ mode, other electronic markets may choose to ignore our quotes, as 

permitted under Regulation NMS. Thus, a circuit breaker on a single trading market, such as the New York Stock Exchange, is not able to staunch volatile and panicked trading on other markets especially if those markets choose not to participate 

in our circuit-breaker mechanisms. 

The bottom line is that while there is always room to improve LRPs and other 

such mechanisms, these actually worked well on May 6th. However, the mechanism 

is only truly effective if observed by other trading venues, and that’s why Chairman 

Schapiro’s plan for an industry-wide trading circuit breaker is needed. 

Recommendations 

One clear lesson of May 6 is that our markets need a predictable, preestablished, 

coordinated way to respond to extreme and rapid market volatility. The LRP system 

has worked, but market-wide circuit breakers are necessary and will be even more 

effective. The listing and trading venues, under the SEC’s guidance, have filed proposals to adopt stock-level circuit breakers to pause trading when the price of a security has changed by 10 percent in a 5-minute period. Once circuit breakers have 

been triggered in a security, they will apply to all trading in the security, wherever 

it takes place, with the decision to invoke and reopen governed by the primary listing market. In this regard, we would also highlight the order protection rules under 

Regulation NMS. The original intent of the rule may have been to give automated 

markets the option of bypassing a market that was temporarily operating in a manual mode. In practice, however, the ability of markets to bypass a manual market 

by default resulted in a situation where markets effectively chose to ignore and 

trade around our quotes once our Written Statement of Larry circuit breakers were 

triggered. While we feel the LRPs helped the market overall on May 6th and certainly did not exacerbate the problems, most of the benefit accrued to orders on the 
89 

NYSE marketplace, and the events of May 6 have demonstrated that it may be time 

to reconsider routing practices that trade through functioning quotes as a default 

matter. 

Second, the current market-wide circuit breakers were established long ago and 

are based on market moves of 10 percent, twenty percent and thirty percent. There 

has not been a move greater than 10 percent in a single day post-2000. These levels 

should be tightened, and the circuit breaker should be based on a broader index 

rather than a narrow Dow Jones index. 

Third, the rules on cancellation of trades should be further defined. On May 6, 

it was announced after markets closed that any trades executed at 60 percent above 

or below the last price at 2:40 p.m. would be canceled. This action was not predictable and caused confusion in the markets. We are working with regulators and 

other exchanges to establish clear cancellation rules for the future, which set 

thresholds and circumstances under which trades will be canceled or adjusted, to 

correct errors rather than market-wide movements. 

Fourth, brokers should review their order routing practices to ensure they are 

truly getting the best prices for their clients, and also see whether allowing market 

orders and Stop Loss orders really service the investing public, or whether there are 

things we can jointly do to educate and protect retail investors from being the victims of volatile markets. 

Fifth, to facilitate a review of extraordinary trading events, there should be a consolidated audit trail that would allow regulators to easily review market-wide trade 

data. Having such a mechanism in place very likely would have aided the review 

of the May 6 events. We understand the SEC is developing such a proposal, and 

we are committed to assisting in that effort. 

We also note that the SEC has recently proposed regulations that would govern 

the risk controls applicable to providers of market access, to provide more transparency to the equities markets more broadly, and more generally review the functioning of the equities markets, and we have expressed our support for many of 

these proposals. In order to both avoid similar trading events and to facilitate surveillance, there should be uniform standards across markets that govern the risk 

controls and procedures that market access providers are required to implement. In 

addition, the SEC has proposed rules to gather information from large traders. 

These proposals may address some of the problems associated with aggregating and 

reviewing trading activity. 

Ultimately, these and other important actions may best be achieved by consolidating market surveillance in one securities self-regulator—probably FINRA, which 

would require an act of Congress. We also need to ensure both the SEC and FINRA 

have the funding required to perform these duties. 

Finally, the SEC should continue its broad-based market review to help find ways 

to improve our current market structure. 

Conclusion 

The events of May 6, 2010 demonstrate that the markets would benefit from a 

comprehensive structural review of the rapid advances in technology and their effect 

on trading practices and market integrity. As you know, the SEC has already commenced such a review, issued several rule proposals and has indicated that other 

proposals are forthcoming. We are committed to working with the SEC in these initiatives, and we strongly urge all parties to play an active and responsible role in 

helping our market function in a way that gives investors confidence. In addition, 

we applaud the SEC and the CFTC for working together to review the events that 

transpired on May 6, their extraordinary effort in producing their May 18, 2010 preliminary findings, and their continued work to develop a coordinated solution to prevent a recurrence of those events. 

Once again, thank you for the opportunity to appear before the Subcommittee. I 

would be happy to answer any questions you have. 

PREPARED STATEMENT OF ERIC NOLL 

EXECUTIVE VICE PRESIDENT, THE NASDAQ OMX GROUP, INC. 

MAY 20, 2010 

Good afternoon Chairman Reed, Ranking Member Bunning and Subcommittee 

members. Thank you for offering the NASDAQ OMX Group, Inc. the opportunity to 

share our perspective on the events of May 6th. As Executive Vice President of 

NASDAQ U.S. Transaction Services, I have responsibility for trading of equities and 

options on the NASDAQ Stock Market, as well as trading on NASDAQ’s markets 

in Philadelphia and Boston, NASDAQ OMX PHLX and NASDAQ OMX BX. 
90 

NASDAQ understands the critical role of capital markets in the U.S. economy and 

the obligations of all national markets to protect U.S. investors. We have studied 

the events of May 6th and what they suggest about the current operation of the 

U.S. equities markets. It is important to learn the lessons that are available from 

May 6th and to prevent a repeat of those events. 

To accomplish that, we have worked closely with the Securities and Exchange 

Commission, the CFTC, the New York Stock Exchange, and other national securities exchanges to protect investors. We have met with senior officials and staff at 

the SEC to identify opportunities to improve regulation and to develop a coordinated 

strategy to combat market instability. We support the Commission’s and the CFTC’s 

actions in four areas: 

(1) Updating existing market-wide circuit breakers to include tighter parameters 

and a broader index reference point; 

(2) Establishing new stock-by-stock circuit breakers that include an element of 

‘‘velocity’’ or rapidity of price changes, 

(3) Improving the handling of trade breaks during unusual market events to 

maximize consistency and rationalize moral hazard; and 

(4) Changing the use of quotes and specific order types that impacted trading on 

May 6th. 

The focus of these changes is consistency. While each individual exchange reports 

that its systems functioned according to design on May 6th, the changes currently 

being considered will improve the markets’ collective ability to handle unusual trading events in the future and help to restore investor confidence in the safety of U.S. 

markets. Markets like consistency and predictability; they abhor uncertainty. 

We believe NASDAQ is qualified to assist the Commission at times of market 

stress. We are the world’s largest exchange company. We list over 3,700 public companies, operate 22 markets and 10 clearinghouses worldwide, provide technology to 

over 70 exchanges, clearing organizations and central securities depositories in over 

50 countries, and regulate the trading and clearing of equities, options, commodities, 

and derivatives across the globe. We understand the role we play in serving and 

protecting millions of investors in the United States and around the world that rely 

on the safety and predictability of our markets to grow their savings and safeguard 

their futures. 

U.S. capital markets are the deepest, fairest, most effective markets in the world. 

Our cash equities markets have been and remain the engine of sustainable economic 

growth, allowing U.S. companies to raise trillions of dollars in capital, create millions of jobs, and spur new industries around the globe. Cash equities markets functioned without interruption during the financial meltdown of 2008 and 2009, unlike 

the credit and derivatives markets. Our markets are strong, despite the seventeen 

minutes of unusual trading that occurred between 2:39 and 2:56 p.m. on May 6th. 

In fact, the markets’ rapid recovery that day confirms that our markets are resilient 

and strong even under extraordinary strain. 

We have been studying and will continue to study the data and behaviors recorded on May 6th. To understand fully the events of May 6th, it is important to 

understand the information the markets were trying to process. Markets were nervous. Equity markets had experienced an unusually long and large upward price 

movement, with the NASDAQ Composite Index nearly doubling between March 9, 

2009 and April 26, 2010. Market analysts will tell you that following such gains, 

it is not unusual for markets to experience a price correction. 

Markets were becoming increasingly volatile. NASDAQ monitors the CBOE Volatility Index or VIX, which measures the implied volatility of the S&P 500 expected 

over the next 30 days. The VIX generally measures below 20. It rose during the financial crisis, reached a high of 89 on October 24, 2008, and then gradually declined 

throughout 2009 and early 2010. From February 26, 2010 through April 26, 2010, 

the VIX continuously stayed below 20, dropping below 16 on April 12th and April 

20th. Volatility returned on April 27th, when the VIX once again broke above 20 

and began rising steadily. By May 5th the VIX reached the upper 20s, and on May 

6th and 7th it closed above 30. 

This increased volatility was tied to the escalating financial crisis in Greece and 

the Eurozone. Although the issues in Greece had been developing for several 

months, the potential harm seemed to sink in to U.S. markets only within the week 

prior to May 6th. Credit ratings agencies had just lowered their rating of the sovereign debt of Greece, Spain and Portugal, roiling sovereign debt markets; the European Union and International Monetary Fund were working to fashion workable 

bailouts; and social tensions and violence escalated in Athens. The Euro had lost 
91 

15 percent of its value in the last 6 months, including 7 percent in the prior 2 weeks 

alone. 

Against this backdrop, we experienced a unique confluence of events beginning at 

2:35 p.m. on the afternoon of May 6th. First, the Dow Jones Industrial Average was 

already trading off 272 points for the day and 500 points in the previous 3 days. 

Market conditions were already volatile. 

Second, the Chicago Mercantile Exchange received an unusually large institutional order to sell futures tied to the S&P 500 Index. Futures are a forward indicator for prices of equities and options that are also tied to the S&P 500 Index. 

Thus, when S&P futures prices begin sinking rapidly at 2:42, this was followed 

closely by rapid price declines in S&P-linked equities. At 2:45:30, S&P futures trading became so negative that the Chicago Mercantile Exchange triggered a ‘‘Stop 

Price Logic Event’’ that caused an automatic 5-second pause in S&P futures trading 

to collect liquidity. Given CME’s near-100 percent market share in S&P futures, the 

Stop Price Logic Event was, effectively, a market-wide halt. When trading resumed, 

futures prices immediately leveled off and began to climb rapidly. Shortly after, equities prices also rose rapidly. After a thorough review, the CME has announced 

that its systems functioned properly that day and that there was no evidence of 

wrongdoing or clear errors by CME or CME members. 

Third, the NYSE Arca Exchange, the all-electronic market operated by NYSE, 

began experiencing data communication issues that hindered the electronic linkages 

between it and NASDAQ, the BATS Exchange, and the Chicago Board Options Exchange. When Arca became unable to communicate properly, this signaled other 

markets to stop sending orders to it. This is exactly what happened; NASDAQ, 

BATS and CBOE each stopped sending orders to Arca at a critical point in time. 

Again there is no evidence of inappropriate activity at Arca. Nevertheless, its liquidity became less unavailable at a critical time. 

Fourth, simultaneous with events at NYSE’s electronic Arca exchange, the NYSE 

hybrid market began reporting multiple ‘‘Liquidity Replenishing Points’’ and ‘‘gap 

quotes’’ that impacted the trading of individual S&P stocks in the NYSE market. 

Under SEC Regulation NMS, the NYSE is permitted to issue LRPs and gap quotes. 

What this did, in our view, was to signal other markets that NYSE was experiencing order imbalances or other difficulties. This, in turn, signaled that other markets may stop routing orders to NYSE and trade at other markets instead. This is 

exactly what happened; NASDAQ and other markets stopped routing orders to 

NYSE. Even Arca, NYSE’s own all-electronic market, stopped routing orders to 

NYSE. NYSE was the only market to issue LRPs or gap quotes on May 6th. 

This confluence of events caused a rapid drop in the markets. From 2:39 to 2:47 

p.m. the Dow dropped 723 points to 9869, its low for the day and down 995 points 

total from the prior close. From 2:47 to 2:56 the Dow recovered just as rapidly, 

risings 612 points from 9862 to 9974, down 387 points for the day. From 2:56 p.m. 

to the close the Dow rose another 45 points, ending the day down 342 points. 

How should we respond to these events? As you know, the markets and market 

participants are subject to multiple layers of regulation; the Securities and Exchange Commission oversees trading and markets, including regular and special examinations of markets and market participants. There was in place a market-wide 

circuit breaker that limits aggregate movement of market indices, but it was not 

triggered. NASDAQ and other markets have ‘‘collars’’ that limit the impact of individual market orders, but there were limited numbers of market orders entered that 

day. Members have obligations to have procedures, controls, and systems in place 

to limit aberrant trading and control risk. The Financial Industry Regulatory Authority, acting as NASDAQ’s agent, examines firms to ensure that those procedures, 

controls, and systems are in place and effective. Should these safeguards have prevented the rapid decline and recovery in the markets on May 6th? We have already 

begun to re-examine each of these safeguards in light of those events. 

From a systems standpoint, NASDAQ’s market operated continuously throughout 

the day and throughout the critical seventeen minutes. Each and every one of 

NASDAQ’s electronic systems functioned as designed and as intended. Its execution 

engine, market data feeds, and surveillance systems all functioned as designed. 

Each exchange is reporting that its individual systems functioned as designed. That 

said, no market center or regulator can be satisfied with the collective performance 

of the markets on May 6th. As discussed earlier, the Commission and the exchanges 

are developing coordinated strategies to improve the exchanges’ collective ability to 

respond to unusual trading events. 

What did NASDAQ See and Do? NASDAQ operates one of the most heavily 

monitored exchanges in the world. NASDAQ’s MarketWatch and Trading Operations departments monitor our equities markets from 6:30 a.m. to 8 p.m. using sophisticated technology that looks for trading anomalies, market rumors and manipu-
92 

lations. These departments process 17,000 phone calls in the average month and 

MarketWatch reviews more than 50,000 issuer press releases in the average year. 

At 2:23pm NASDAQ’s automated surveillance systems began issuing alerts in 

multiple securities exhibiting unusual price movements. In response to the alerts, 

NASDAQ’s regulatory staff in the MarketWatch and Trading Operations departments began reviewing trading activity. NASDAQ’s MarketWatch group uses high 

speed technology to oversee trading in the NASDAQ equity venues. On average the 

MarketWatch’s surveillance system processes 1.9 billion equity related messages a 

day. On May 6 there was a large spike in surveillance alerts generated that coincided with the largest drops in the Dow Jones Industrial Average. 

At 2:30 p.m. the Chicago Board Options Exchange issued a communication stating 

‘‘The CBOE has declared Self Help against NYSE/ARCA as of 1:30 CT. The NYSE/ 

ARCA is out of NBBO and unavailable for linkage. All CBOE systems are running 

normally.’’ Under SEC Rule 611 under Regulation NMS, CBOE’s announcement signaled that CBOE had stopped attempting to trade with NYSE’s all-electronic Arca 

exchange pending renewed communication from that exchange 

At 2:36:59 NASDAQ systems also detected a data disruption at NYSE Arca and 

NASDAQ also declared ‘‘Self Help’’ against that exchange. At 2:42 p.m., NASDAQ 

published a ‘‘System Status’’ update on its member website stating ‘‘NASDAQ has 

declared Self Help against NYSE ARCA (ARCA) as/of 14:36:59 E.T. All NASDAQ 

systems are operating normally.’’ 

At 2:43 p.m. NASDAQ issued another System Status update stating that 

NASDAQ OMX BX had also declared Self Help against NYSE Arca as of 14:38:40. 

All NASDAQ systems were operating normally. 

At 2:45:30, trading in E–Mini futures became so volatile and negative that the 

Chicago Mercantile Exchange triggered an automatic 5-second pause in E–Mini futures trades. 

At 2:48 p.m., NASDAQ MarketWatch communicated with NYSE Arca’s regulatory 

staff about regulatory alerts being generated by NASDAQ’s market surveillance systems. NYSE Arca staff confirmed that they also had detected unusual trading activity. Neither market had received any communication from members regarding system malfunctions or errant orders that might have contributed to price movements. 

At 2:49 p.m. the BATS Exchange declared Self-Help against the NYSE Arca Exchange. As of 2:49 p.m. four markets had declared Self-Help against NYSE’s all-electronic Arca exchange. 

At 3:00 p.m., NASDAQ staff opened an internal call including key NASDAQ personnel from multiple departments. NASDAQ uses this procedure where necessary 

to gather knowledge quickly and to respond effectively to unusual trading activity. 

The call lasted until nearly 1:00 a.m. the following morning. 

At 3:16 p.m. NASDAQ took the lead and initiated a market-wide call for the entire national market system. The triggering of a market-wide call is designed to establish communication and ensure coordination among exchanges that trade the 

same securities. It has become a critical procedure for exchanges to manage events 

such as this that involve cross-market trading activity. At 3:56 p.m. observers from 

the SEC’s MarketWatch and Trading and Markets staff joined the market-wide call 

initiated by NASDAQ. 

At this point, NASDAQ began focusing communication on the identification and 

treatment of ‘‘clearly erroneous trades’’, those trades that might be broken or 

unwound as a result of the market events. NASDAQ issued the following System 

Status update on its website at 3:37 p.m. ‘‘NASDAQ is currently working with other 

markets to review the broad market activity that occurred between 2:00 and 3:00 

p.m. today. NASDAQ will advise when more information is known.’’ 

At approximately 4:00 p.m. the markets jointly determined to review and potentially break trades that occurred between 2:40 and 3:00 p.m. The markets briefly 

considered breaking trades executed between 2:30 p.m. and 3:00 p.m. but they then 

decided collectively upon the 2:40 p.m. start time instead. Trades outside this period 

were still eligible for review by individual exchanges under their own authority. At 

4:24 p.m. NASDAQ issued another System Status update announcing the decision 

to review trades that occurred between 2:40 and 3:00 p.m. 

After jointly determining which trades to review, the markets jointly continued 

to discuss which trades to break. There was debate among the exchanges regarding 

the proper break point for trades executed between 2:40 and 3:00 p.m. After extended discussion, the exchanges each agreed on a joint market ruling to cancel 

trades during the review period that deviated by greater than 60 percent from the 

consolidated last sale price in that security at 14:40 or immediately prior. Each exchange communicated this information to its members; NASDAQ announced the decision to its members via a System Status update published at 6:03 p.m. 
93 

NASDAQ staff continued reviewing trades until after midnight on May 7th. 

NASDAQ regularly communicated rulings to its members by issuing System Status 

updates at 8:24 p.m., and 12:25 a.m. Additionally, at 8:28 p.m. NASDAQ issued a 

press release describing the market events and the decision of all markets jointly 

to break trades. It is important that trades be broken quickly, if at all, to avoid negative impact on clearing and settlement. 

Multiple equities and options exchanges broke trades executed between 2:40 and 

3:00 p.m. on May 6th. In addition to over-the-counter trades broken by FINRA, and 

trades broken by the BATS Exchange, NYSE’s electronic Arca exchange broke over 

4,000 trades, and NASDAQ broke over 10,400 trades representing 1,410,692 shares 

in 236 unique securities. To put this into perspective, from 2:40 to 3:00 p.m., 

NASDAQ executed over 2.4 million trades representing over 500 million shares 

traded. In other words, NASDAQ broke less than one half of 1 percent of trades and 

roughly one-quarter of 1 percent of shares executed during the 20-minute period 

from 2:40 to 3:00 p.m. on May 6th. 

NYSE called LRPs or slow quotes in all 42 stocks listed on its main market in 

which NASDAQ broke trades. Over 90 percent of the 236 securities in which 

NASDAQ broke trades were listed on NYSE, NYSE Arca or NYSE Amex. Over 87 

percent of the trades and 89 percent of the executed shares broken by NASDAQ 

were in NYSE-listed securities. NASDAQ declared no slow quotes in the 20 stocks 

listed on its market in which trades were broken. 

Why Do The Markets Break Trades? Markets break executed trades when the 

price discovery process ceases to function properly and trade prices cease to reflect 

a true market. For such circumstances, the SEC has approved uniform clearly erroneous rules across all U.S. cash equities markets giving the exchanges the self-regulatory authority to cancel clearly erroneous trades executed by their systems. We 

followed those rules. 

The exchanges can review trades and exercise this authority on their own initiative in response to extraordinary market conditions, or, upon the timely request of 

a party to a particular trade(s). Trade-break authority exists to nullify trades that 

take place in market conditions where errors, be they human or technological, or 

other unanticipated events, preclude fair and proper price-discovery. The primary 

topic of the market-wide call was to determine whether the exchanges would coordinate their regulatory efforts to break trades that were considered ‘‘clearly erroneous.’’ 

NASDAQ’s clearly erroneous trade policies strive to maximize consistency, transparency and finality regarding trade-break decisions. NASDAQ pioneered the use of 

standardized numerical parameters that seek to define how far a trade must deviate 

from previous transactions in order to be considered erroneous. By focusing on objective numerical criteria rather than subjective criteria, NASDAQ avoids even the appearance of bias in the trade break process. These standardized criteria have now 

been adopted by all U.S. exchanges. It is important to remember that every trade 

has two parties—generally one will be happy to break the trade and avoid a loss 

while the other will want to keep the trade and any gain he or she has made. Therefore, it is important that NASDAQ use its authority only where necessary. 

One key component to NASDAQ’s approach to clearly erroneous trade processing 

is the belief that it is important, where possible, to allow transactions priced close 

to the inside market or other reference price to stand, even if the transactions directly resulted from a mistake or system error. This ensures that market participants have economic incentives to develop and maintain internal controls with a 

goal of preventing erroneous trading activity. NASDAQ refers market participants 

for investigation by the Financial Industry Regulatory Authority (‘‘FINRA’’) in its 

capacity as NASDAQ’s regulatory services provider in all circumstances where a 

firm’s erroneous trades raise questions as to the adequacy of the firm’s computer 

systems and internal controls. 

What Lessons Can We Learn From Trading On May 6th? 

NASDAQ’s preliminary analysis indicates that unusual trading activity on May 

6th was triggered by a confluence of unusual events, including events outside the 

cash equities markets. Aggressive, nervous selling of S&P 500 options and futures 

migrated to trading of closely correlated cash equities. Cash equity markets then experienced several challenging conditions as described above. NASDAQ experienced 

no system malfunctions or aberrations. No NASDAQ member has identified to 

NASDAQ a system error or aberration within their own systems. We have at this 

point in time detected no system malfunction or errant trade by a NASDAQ member 

interacting with the NASDAQ Stock Market. NASDAQ continues to investigate the 

events of May 6th, but has at present located no ‘‘smoking gun’’ that singlehandedly caused or explains those events. 
94 

We note that although index products such as ETFs linked to the S&P 500 Index 

were involved in the trading events on May 6th, there is no evidence that ETFs 

caused those events. To the contrary, the unusual trading and subsequent trade 

breaks in ETFs can be explained by existing market structure and characteristics 

of ETF trading. ETFs are widely used as a tool for gaining exposure to the broad 

market, particularly during periods of high volatility. Therefore, demand for ETF liquidity was likely rising during the May 6th trading event. While ETF demand was 

increasing, ETF liquidity was decreasing. NYSE Arca, which lists ETFs and is a 

source of ETF liquidity (particularly for thinly traded ETFs) was experiencing communications and linkage issues. Three markets had stopped routing orders to it, effectively removing Arca’s liquidity from the marketplace. The resulting liquidity imbalance in ETFs exacerbated the rapid price changes that many stocks were experiencing at that time. In other words, the events of May 6th affected ETFs more than 

many other securities but not differently. 

NASDAQ supports the rapid and holistic response by the Securities and Exchange 

Commission. We support the Commission’s recommendation to update market-wide 

circuit breakers that limit large price changes. The proposed circuit breaker would 

automatically halt trading in all stocks and in all markets in measured stages. As 

currently contemplated, trading will be halted for fifteen minutes when the S&P 500 

Index declines by 5 percent; for 1 hour when the Index declines by 10 percent; and 

for the remainder of the trading day when the Index declines by 20 percent. 

NASDAQ also supports the Commission’s decision to implement cross-market single-stock trading halts. The important characteristics of these halt are initiation and 

resumption by the primary market, as well as consistency across all markets. The 

markets have taken a flexible approach that recognizes that stocks trade in different 

ways, rather than a one-size-fits-all approach that treats all stocks identically. 

These single stock circuit breakers will greatly reduce the occurrence of clearly erroneous broken trades by preventing them from executing in the first instance. 

In addition to endorsing and assisting Chairman Schapiro in achieving the goal 

of consistency and cooperation across all markets, NASDAQ also supports regulators’ decision to review practices that cause individual markets to pause or go 

slow. As stated in the joint SEC and CFTC report issued on May 18, 2010, ‘‘Preliminary Findings Regarding the Market Events of May 6th’’, while such practices are 

designed to dampen volatility, a determination must be made whether they also ‘‘inappropriately impede liquidity.’’ 

Finally, NASDAQ is exploring other ideas which may encourage high-quality and 

continuous quoting on all markets. Other options to consider that may reduce the 

number of disruptive trading events are: (1) requiring priced orders rather than 

market orders; (2) eliminating or limiting the practice of ‘‘stub quoting;’’ and (3) creating better incentives to provide liquidity during periods of market stress. 

NASDAQ has already been a leader in promoting more aggressive risk management 

controls for al orders entered into all market centers. NASDAQ has actively supported the Commission’s proposal to improve regulation of all forms of market access that create systemic risk in our markets. 

Thank you again for the opportunity to share our views. I am happy to respond 

to any questions you may have. 

PREPARED STATEMENT OF TERRENCE A. DUFFY 

EXECUTIVE CHAIRMAN, CME GROUP INC. 

MAY 20, 2010 

I am Terrence A. Duffy, executive chairman of CME Group Inc. Thank you Chairman Reed and Ranking Member Bunning for inviting us to testify today. You asked 

us to discuss issues surrounding the activity in the equity markets on Thursday, 

May 6, 2010, particularly to review the causes and implications of the market activity as well as to identify what policy changes may be necessary to avoid a recurrence 

of such activity. 

CME Group is the world’s largest and most diverse derivatives marketplace. We 

are the parent of four separate regulated exchanges, including Chicago Mercantile 

Exchange Inc. (‘‘CME’’), the Board of Trade of the city of Chicago, Inc. (‘‘CBOT’’), 

the New York Mercantile Exchange, Inc. (‘‘NYMEX’’) and the Commodity Exchange, 

Inc. (‘‘COMEX’’). The CME Group Exchanges offer the widest range of benchmark 

products available across all major asset classes, including futures and options on 

futures based on interest rates, equity indexes, foreign exchange, energy, metals, agricultural commodities, and alternative investment products. The CME Group Exchanges serve the hedging, risk management and trading needs of our global cus-
95 

tomer base by facilitating transactions through the CME Globex® electronic trading 

platform, our open outcry trading facilities in New York and Chicago, as well as 

through privately negotiated CME ClearPort transactions. 

I. Introduction 

Since May 6, 2010, CME Group has engaged in a detailed analysis regarding trading activity in its markets on that day. Our preliminary review indicates that our markets functioned properly. We have identified no trading activity that appeared 

to be erroneous or that caused the break in the cash equity markets during this period. Moreover, no market participant in our markets reported that trades were executed in error nor did the CME Exchanges cancel (‘‘bust’’) or re-price any transactions as a result of the activity on May 6th. Moreover, the CME markets provided 

an important price discovery and risk transfer function on that day and served as 

a moderating influence on the markets. 

In the following sections, we discuss: (1) the functioning of and the role played 

by our markets on May 6, 2010, (2) the existing circuit breaker rules and the need 

for consistent and transparent rules across markets and (3) CME electronic 

functionality, particularly CME Stop Price Logic functionality and price banding, 

among others, which serve to protect our markets. Finally, we have also included 

certain recommendations as to changes that could avoid a recurrence of this type 

of event in the future. 

II. The CME Markets Functioned Properly on May 6, 2010 

a. CME Has Conducted an Initial Review of Detailed Trading Records 

CME Group analyzed trading volume and activity throughout May 6 and focused 

particularly on the activity taking place during the period of 1pm to 2pm Central 

Time. Total volume in the June E-mini S&P futures on May 6th was 5.7 million 

contracts, with approximately 1.6 million or 28 percent transacted during the period 

from 1pm to 2pm Central Time. During that hour, the market traded in a range 

of 1143.75 to 1056, or 87.75 points—beginning the hour at approximately 1142 and 

ending the hour at approximately 1113. More than 250 CME Globex execution firms 

and 9,000 User IDs were active in the market during this period of time. 

During most of that hour, the bid/ask spread was a tick wide (.25 points) and the 

market traded in a largely orderly manner despite the significant sell off and subsequent rally. At approximately 1:45:28, following a sharp 12.75 point decline over a 

period of approximately 500 milliseconds on the sale of 1100 contracts by multiple 

market participants, the bid/ask spread widened to 6.5 points or 26 ticks for less 

than one millisecond. 

At that point, one of CME Globex’s risk management functionalities, a CME 

Globex Stop Price Logic event, which is discussed in more detail below, was triggered. As a result, the market was automatically paused for 5 seconds to allow liquidity to come into the market. The market subsequently reopened at 1056.75, and 

thereafter rallied more than 40 points to 1097 in the following 3 minutes. 

The Market Regulation Department reviewed a significant amount of activity during this period, a period that included more than 3 million system messages, and, 

in particular, examined the activity of participants whose trading activity during the 

1-hour period was significant or otherwise warranted further review. The review 

conducted by Market Regulation staff has not identified any evidence of improper 

or illegal activity by market participants. 

b. CME Markets Provided an Important Price Discovery and Risk Transfer 

Function on May 6 

From a broader perspective, the cumulative record of May 6 trading activity underscores the fact that CME’s futures markets, due to their high level of liquidity, 

provided an important price discovery and risk transfer mechanism for all market 

participants on that day. 

The equity index futures contracts traded on CME Group designated contract 

markets provide an essential risk management function, allowing investors to hedge 

their exposure against a portfolio of shares or equity options. The most significant 

equity index futures contract traded on the CME Group Exchanges is the E-mini 

S&P 500 futures contract. In 2009, the E-mini contract traded over 556 million contracts, which represents an average daily volume in excess of 2.2 million contracts, 

making the E-mini S&P futures contract the most liquid equity index futures contract worldwide. Throughout the challenging market conditions on May 6, market 

participants utilized the liquidity and efficiency of the E-mini S&P 500 futures contracts to meet their risk management needs; the contract effectively facilitated customer demand to hedge exposure to a declining broader market and, as will be 

shown below, represented a moderating factor during the session. 
96 

1See Floros, C. and Vougas, D. V. (2007) Lead-Lag Relationship between Futures and Spot 

Markets in Greece: 1999–2001, International Research Journal of Finance and Economics, 7, 

168–174. 2Kavussanos, Manolis G., Visvikis, Ilias and Alexakis, Panayotis, The Lead-Lag Relationship 

between Cash and Stock Index Futures in a New Market. European Financial Management, Vol. 

14, Issue 5, pp. 1007–1025, November 2008. 

The primary purposes of futures markets are to provide an efficient price discovery and risk management mechanism. In particular, the academic literature underscores the efficacy of futures markets as a tool of price discovery. According to 

one study, ‘‘[e]mpirical results confirm that futures market plays a price discovery 

role, implying that futures prices contain useful information about spot prices.’’1 As 

such, stock index futures frequently represent the venue in which price information 

is revealed first, generally followed closely by spot markets. In fact, most researchers find that ‘‘futures lead the cash index returns, by responding more rapidly to 

economic events than stock prices.’’2

Futures contracts, by design, provide an indication of the market’s view of the 

value of the underlying stock index. Casual observation may lead to the conclusion 

that the E-mini S&P futures prices appeared to lead the decline in the cash market. 

However, the decline was consistent with declines in the most complementary equity derivative products, ETFs based on the same index, trading in the cash market. 

Unlike the cash market, the decline in the futures market was then mitigated by 

the operation of our risk management technology which halted the market for a 

short period to enable additional liquidity to enter into the futures market. Attached 

as Exhibit 1 is a chart which illustrates the comparative value of the E-mini, traded 

on the futures market, as compared to the equities markets. The ETF most comparable to the E-mini S&P 500 futures is the SPDR S&P 500 ETF Trust (SPY). The 

chart demonstrates that the E-mini S&P moved virtually in tandem with the comparable cash instrument until the moment when our Stop Price Logic was triggered 

which caused our matching engine to pause for 5 seconds while continuing to allow 

new orders to be entered. At the time the Stop Price Logic was triggered, the Emini S&P ceased its drop, while certain individual stocks in the cash market continued their steep decline. Following the halt, the E-mini S&P then rallied sharply. We 

believe this recovery was positively influenced by our Stop Price Logic functionality 

which stabilized market activity. This type of functionality is not available in the 

securities market. Consequently, even while the broad based index markets—SPYs 

and CME E-mini S&P—were substantially recovering, there were continued price 

declines in individual stocks which persisted for minutes (not seconds). 

More specifically, to illustrate this point, we reviewed the period from 13:30 to 

14:00 (CT) during which the market activity occurred as depicted in Exhibit 2. Emini S&P 500 futures were declining after 13:30 (CT) followed by spot equity markets including Proctor & Gamble (PG), 3M (MMM) and Accenture (ACN). The June 

2010 E-mini S&P 500 futures traded at its low of 1,056.00 at 13:45:28 (CT), at 

which point the Stop Price Logic functionality was triggered halting the decline, and 

the market rallied following the 5-second halt. PG, MMM and ACN continued to 

slide even after futures hit their low and began to recover. Those stocks were put 

into a reserve mode by the New York Stock Exchange (NYSE) per its Rule 1000(a), 

Liquidity Replenishment Points, at 13:45:52, 13:50:36, 13:46:10 (CT), respectively; 

however, these stocks continued to decline. We believe that this decline continued 

because orders were re-routed to possibly less liquid security trading venues which 

were not coordinated with NYSE Rule 1000(a). PG printed a low of $39.37 at 

13:47:15 (CT); MMM printed a low of $67.98 at 13:45:47 while ACN printed a low 

of $0.01 at 13:47:54 (CT). Thus, the E-mini S&P 500 futures were rallying while PG, 

MMM and ACN continued to decline. 

As stated above, we believe that this temporary de-linkage between the futures 

and stock markets may be attributed to inconsistent rules across the equity markets 

which enabled the stocks to decline even further. 

The trading activity during this time period also evidences that the futures markets provided an important source of liquidity which served as a moderating influence in the markets. There is strong evidence that the E-mini S&P futures contract 

was much more liquid than the fragmented underlying stock market on May 6. During the period between 1:40 and 2 CST, the volume of E-mini S&P futures (notionally adjusted) was 3 to 4 times greater than the SPY volume and, at the peak of 

the market’s volatility, was to 8 to 10 times greater. As noted above, E-mini S&P 

500 futures slightly lead SPYs during the downturn. Both E-mini S&P 500 futures 

and SPDRs turned around near 13:45:28. But, as shown in Exhibit 1, the rally in 

futures was relatively consistent and orderly in contrast to the rally in SPYs which 
97 

was very uneven and was highlighted by a significant increase in cash equity market spreads. 

The second-by-second trading range, which is an indicator of the liquidity in the 

market, was much tighter in E-mini S&P 500 futures than in the comparable equity 

product, the SPYs. In examining the ratio of the futures trading range relative to 

the SPYs (SPDR) trading range in 1-minute intervals between 13:30 and 14:00 (CT), 

the respective trading ranges were very similar at the beginning of the period. By 

the height of the incident near 13:45–13:50, however, the ratio had fallen to as low 

as 20 percent that of the SPDR range. While all the markets were less liquid than 

in normal times, the liquidity in the futures market degraded much less than in the 

SPY market (which, in turn, degraded much less than the individual stocks, especially those stocks that are thinly traded.) This suggests that the futures order book 

was much deeper and more resilient than the SPDRs order book. In other words, 

the E-mini S&P 500 futures market continued to absorb trading volume and trade 

in an orderly fashion even in the face of apparent crisis in spot equity markets when 

liquidity was most sorely needed. As such, futures represented a moderating factor 

throughout the incident. 

If the futures market had not been available as an alternative, the selling would 

have manifested itself through another venue, potentially in a less liquid market, 

such as the underlying stock market or the OTC derivatives market. The relative 

tightness of the spread in the futures market underscores the fact that a concentration of liquidity supported the important price discovery and risk transfer role of 

the futures market. 

III. Circuit Breaker Levels Should be Reviewed In View of May 6 and Rules 

Should be Consistent Across Markets. 

One of the mechanisms that exchanges have implemented to curb market volatility are ‘‘circuit breaker’’ rules. Circuit breaker rules require an automatic halt in 

trading when pre-determined price thresholds are reached. CME Group Exchanges 

currently have circuit breaker rules in effect for equity index products which are 

consistent with the circuit breaker rules in the underlying equity markets. 

Circuit breaker rules were originally introduced following the September 1987 

market crash. The circuit breakers were implemented uniformly across all equities 

and options exchanges and were set at a fixed price level tied to the DJIA. This rule 

was embodied in NYSE Rule 80B. On October 27, 1997, the circuit breakers were 

triggered for the first time and the circuit breaker rules were subsequently modified 

to employ percentage declines of 10, 20 and 30 percent in the DJIA established at 

the start of each calendar quarter in lieu of the fixed point triggers previously used. 

That rule remains in effect. 

In addition to the coordinated circuit breakers, CME adopted price limit rules for 

its equity index contracts. The price limit structure and levels changed several times 

as the Exchange acquired more experience and as the trading halt rules in the equity market were modified.In January 2008, however, CME harmonized its price 

limit percentage thresholds to be fully consistent with the percentage thresholds reflected in NYSE Rule 80B (and also consistent with the methodology employed by 

the CBOT with respect to the DJIA futures). CME did, however, retain the references to the specific stock index that is the subject of the futures contract rather 

than tying these limits to movements in the DJIA, meaning, for example, that the 

E-mini S&P 500 price limits are tied to price movements in the related index. 

CME implements an unconditional futures trading halt in the equity index futures when the primary stock market is halted, regardless of whether a particular 

index product has hit a limit or not. CME also enforces a 5 percent limit bid or offer 

policy during overnight electronic trading hours; if equity index futures are locked 

limited at 8:15 a.m. Central Time (‘‘CT’’) and remain so at 8:25 a.m. CT in the lead 

month futures contract, there will be a trading halt in effect until the commencement of regular trading hours (floor and electronic trading). During the trading halt, 

the Exchange will provide an Indicative Opening Price of the re-opening of trading 

on CME Globex, if applicable. If the lead month futures contract is no longer locked 

limit at 8:25 a.m. CT, trading will continue with the 5 percent limit in effect. At 

8:30 a.m. CT, the 5 percent overnight electronic trading hours limit no longer will 

be applicable. 

On May 6, the declines in the DJIA were just short of 10 percent at a time of 

day when the 20 percent trigger was in effect. As a result, the circuit breakers in 

the primary and the futures markets were not triggered. Accordingly, we believe 

that the current circuit breaker levels of 10, 20 and 30 percent, the duration of the 

halt and the time of day at which such triggers are applicable, should be reevaluated in light of current market conditions to determine whether any changes are 

warranted 
98 

After May 6, CME staff reviewed the relevant processes and rules across the CME 

and equities exchanges to determine what protections existed in the operating rules 

of the numerous equities platforms in the event of a market disruption. Due to the 

fragmented nature of the equity markets, it appears to us that there is a lack of 

consistency across this market which could exacerbate issues in time of market 

stress. 

For instance, as noted above, we believe that the lack of consistency and coordination among equity platforms in the establishment of circuit breakers for individual 

stocks led to extreme market disruptions; when the NYSE rule circuit breaker rule 

was invoked with respect to trading in individual stocks, order flow circumvented 

the NYSE market and trading continued on other platforms which did not have 

comparable protections. Consequently, as a result of the lack of liquidity on these 

other platforms, trading in those individual stocks suffered significantly. 

We also note that in the aftermath of the May 6 incident, there was significant 

confusion in the equity markets over the cancellation or ‘‘busting’’ of trades. The 

standards for cancellation of trades are not consistent or transparent across the equity markets as a whole. At the CME, we have clear standards for the implementation of ‘‘no bust’’ ranges (i.e., ranges within which trades may not be canceled) and 

error trades. These policies are clearly set forth in our rulebook and are posted on 

our website. 

We believe that, to ensure the integrity of the market and to promote market confidence among users, there must exist a clearly defined rule set which is transparent to market users, understood by market users and which is consistent across 

all markets. 

IV. CME Has Risk Management Controls to Mitigate the Potential for Disruption of its Markets 

In addition to the circuit breaker and price limit rules described above, CME has 

in place numerous risk management processes, procedures and systems to preserve 

the integrity of its market in light of the many risks associated with maintaining 

a primarily electronic market. For example, CME is the only exchange in the world 

that requires pre-execution credit controls which become mandatory in June 2010. 

Appended as Exhibit 3 is a detailed list and description of the multitude of controls 

that the CME employs on its CME Globex system, including credit controls, messaging volume controls and risk protection policies and procedures. 

There are certain risk protection tools employed by the CME which are important 

to note individually and which are relevant to today’s discussion. One of these tools, 

CME Globex Stop Price Logic functionality, was employed on May 6—its operation 

and effect are also described below. In addition, CME Exchanges have a number of 

other policies and procedures, such as our messaging policy and practice of registering Automated Trading Systems (‘‘ATS’’) that provide us with the tools to monitor and maintain orderly administration of the electronic markets and provide real 

time surveillance and oversight of trading activity. 

a. Stop Price Logic Functionality 

The CME Globex system has a Stop Price Logic functionality which serves to mitigate artificial market spikes that can occur because of the continuous triggering, 

election and trading of stop orders due to insufficient liquidity. If elected stop orders 

would result in execution prices that exceed pre-defined thresholds, the market 

automatically enters a brief reserved state for a predetermined time period, ranging 

from 5—10 seconds. During this period, no orders are matched but new orders other 

than market orders may be entered and orders may be modified and canceled. The 

momentary pause that occurs when Stop Price Logic is triggered allows market participants the opportunity to provide liquidity and allows the market to regain equilibrium, thereby mitigating the potential for disruptive market moves. 

The stop spike price and time parameters in the E-mini S&P futures are 6 index 

points (approximately 1⁄2 of 1 percent of the S&P 500 index value) and 5 seconds, 

respectively. 

The Stop Price Logic was triggered on May 6th in the E-mini S&P 500 equity 

index. At 1:45:27, 1 second prior to going into reserve state, the front month E-mini 

S&P 500 equity index futures contract was trading just under the 1070.00 level. 

Multiple parties entered the market selling and taking the market down to 1062.00. 

There was a stop order to sell 150 contracts at 1062.00 which moved the markets 

to 1060.25, and elected additional stops that were filled down to 1059. The trades 

at 1059 triggered another 150 lot stop at 1059.00 which was executed down to a 

level of 1056.00, which would have elected additional stops. 

However, at this point, following the 6 point move from 1062 to 1056, the front 

month E-mini S&P 500 equity index futures market went into reserve state as a 
99 

result of Stop Price Logic functionality being triggered at 13:45:28. The market 

came out of this reserve state 5 seconds later. As a result of this brief suspension 

of trading, the decline in the E-minis was halted and the market came out of the 

reserve state with an initial price of 1056.75, after which it rallied sharply. Consequently, we believe that the triggering of this functionality served its intended 

purpose of allowing market participants the opportunity to provide liquidity and 

permitting the market to regain its equilibrium. 

b. Price Banding Functionality 

To ensure fair, stable and orderly markets, CME Globex subjects all orders to 

price verification using a process called price banding. The platform utilizes separate mechanisms for futures price banding and options price banding. Price banding 

prevents the entry of erroneous orders such as a bid at a price well above the market or an offer at prices well below the market which could trigger a sequence of 

market-moving trades that require subsequent cancellations. In order to determine 

the level of price banding, CME Exchanges use the most current and relevant market information, including, for futures, trades, best bid and offer and implied bid 

and offer or indicative opening price, and for options, last price of an option or 

spread and a theoretical options price based on options pricing algorithms. 

c. Protection Points for Market and Stop orders 

This CME Globex functionality automatically assigns a limit price (Protection 

Point) to futures market orders and stop orders to preclude the execution of these 

types of orders at extreme prices in situations where there is insufficient liquidity 

to support the execution of the order within an exchange-specified parameter of the 

current market. 

The Protection Point values vary by product, and in the E-mini S&P futures the 

Protection Point is established at 3 index points. The CME Globex system calculates 

the limit price for a Market Protected Order by applying the Protection Point value 

to the best bid or offer price (depending on the order’s side of market) and by applying the Protection Point value to the trigger price for a Stop Protected Order. Any 

unmatched quantity remaining for a Market Protected or Stop Protected Order after 

it is executed to the Protection Point limit becomes a Limit Order at the Protection 

Point limit price. 

d. Maximum Order Size Protection 

Maximum order size functionality on CME Globex prohibits entry of an order into 

the trading engine which exceeds a pre-determined quantity. For E-mini S&P 500 

futures, the order size is 2,000 contracts. This functionality provides protection 

against the so-called ‘‘fat finger’’ trades. 

In addition, we would like to point out certain risk management practices and 

measures we take which, in addition to the risk management tools noted above, 

serve to mitigate potential problems that could result from electronic trading, particularly with high frequency trading. 

e. Messaging Policies 

CME has in place certain controls and policies which are designed to avoid problems associated with excessive messaging by market participants. CME has instituted a CME Group Messaging Policy that encourages market participants to trade 

and quote appropriately without harming market liquidity or performance. Inefficient messaging slows system performance, negatively impacts other market participants and increases system capacity requirements and costs. To mitigate this, CME 

has implemented automated controls which monitor for excessive new order, order 

cancel and order cancel/replace messaging. If a session exceeds a designated message per second threshold over a 3-second window, subsequent messaging will be 

rejected until the average message-per-session rate falls below this threshold. 

CME has also instituted a policy of fining for excessively high messaging rates. 

This policy benefits all customers trading on CME Globex by discouraging excessive 

messaging abuses, which in turn helps to ensure that CME Globex maintains the 

responsiveness and reliability of the system. Under the CME Globex Messaging Policy, each clearing member firm must not exceed product-specific benchmarks, individually tailored to the valid trading strategies of each market. CME Group calculates benchmarks based on a per-product volume ratio, defined as the number of 

messages submitted for each executed contract in a given product. 

f. Registration of ATS 

All Automated Trading Systems (‘‘ATS’’) using CME Globex are required to identify themselves as an ‘‘ATS’’ and register with the CME Group Exchanges. Subsequent to their registration, the CME Group Exchanges are able to monitor the trad-
100 

ing activity of ATSs on both a real time and post-trade basis. CME has required 

ATS registration for its equity index products since 2006. This policy has now been 

expanded to ATS’ for all products and we currently have over 10,000 ATS registered.ATSs are treated like any other market participant and are subject to the 

messaging policy. This, in turn, enables CME to prevent a malfunctioning trading 

system from impacting our markets. 

V. High Frequency Trading Enhances Liquidity 

An important issue raised in this discussion is the contribution of high frequency 

traders (‘‘HFTs’’) to the current situation and their future role in the markets. As 

recently described in the SEC’s Concept release on market structure, high frequency 

trading was identified as one of the most significant market structure developments 

in recent years. Although HFT is not clearly defined, ‘‘it typically is used to refer 

to professional traders acting in a proprietary capacity that engage in strategies 

that generate a large number of trades on a daily basis.’’ 

CME believes that HFTs play an important role in the markets, particularly when 

such activities are engaged in the types of risk management procedures detailed in 

the previous section. HFTs are an important part of daily trading activity in the 

marketplace and have evolved in response to advancements in technology. This represents the natural evolution of technological advancements and improvements in 

the marketplace and the percentage of trading volume attributable to HFTs will 

likely continue to increase in the future. There is evidence that HFTs increase liquidity and transparency in the marketplace and narrow spreads which allows investors to buy and sell securities at better prices and at lower costs. 

It is also important to note that not all HFTs are alike. A significant proportion 

of HFTs on the CME promote liquidity by providing continuous markets in our 

products. As illustrated by the events of May 6, in analyzing the role of several 

HFTs, a majority of those entities’ trading executed during the relevant 1-hour period was related to the firm’s market making activities. Thus, before considering restrictions on HFT activity, consideration should be given to the beneficial role 

played by HFTs in providing liquidity during normal market activity as well as during times of increased market stress. 

The use of high frequency trading by proprietary trading firms, investment banks, 

hedge funds and index traders, among others, has made the marketplace more efficient and competitive for all market participants. Careful consideration should be 

given to any decision to place significant restrictions or limitations on HFTs that 

would be harmful to the marketplace and result in less efficient and less liquid markets. It is also important to note that automated trading or algorithmic trading has 

its origins in Europe. Accordingly, efforts to place limits or impose regulatory burdens on HFTs in the United States may encourage HFTs to shift the trading they 

currently conduct in the United States to Europe and other foreign jurisdictions that 

are already well-equipped to handle additional growth in both equities and futures. 

As noted above, CME Globex employs many risk management policies and procedures which assist in the mitigation of risk associated with any type of electronic 

trading, including that of HFTs. In addition, the CME Group Exchanges are 

proactive in monitoring the trading activity of HFT entities. In sum, CME believes 

that HFTs play an important role in the markets, particularly when such activities 

are engaged in with the types of risk management procedures detailed in the previous 

section. 

VI. Recommendations 

As noted previously, CME has endeavored to extensively examine the activity in 

our markets on May 6, 2010. Upon review of the activity, to this point, we believe 

that there are potential changes which would improve the functioning of the markets during times of severe stress. 

Throughout this process we have worked closely with our regulator, the CFTC, 

as well as with other regulators not only to identify the causes of significant volatility on May 6, but also to assist in providing thoughts and recommendations for 

market improvement. Of course, as we continue to study the events further, we 

would be happy to contribute our further thoughts and recommendations. 

• Circuit breakers, including circuit breakers for individual stocks such as that 

implemented by the NYSE, must be harmonized across markets. As we stated 

above, we believe that consistency and transparency across markets benefits the 

market by providing clarity in times of market stress. In reviewing the trading 

activity of May 6, we believe that the lack of consistency and coordination 

across markets exacerbated the decline in price of certain individual stocks. The 

NYSE exercised its Liquidity Replenishment Rule (i.e., its individual stock ‘‘cir-
101 

cuit breaker’’ rule) to slow down its markets; Orders were then directed to other 

less liquid electronic trading venues which had no such rule. 

• Stop Price Logic functionality should be adopted across markets, on a product 

by product basis, to prevent cascading downward market movements. As evidenced by the trading activity on May 6, we believe that our Stop Price Logic 

functionality provided the opportunity to source needed liquidity at a crucial 

time and contributed to allowing the market to gain its equilibrium. 

• The current circuit breaker levels of 10, 20 and 30 percent, the duration of the 

halt and the time of day at which such triggers are applicable, should be reevaluated in light of current market conditions to determine whether any 

changes are warranted. A comprehensive, coordinated and quantitative review 

of the market wide circuit breaker levels and duration of pause should be undertaken across all market centers and trading venues supporting equity based 

products, including cash equities, single name and index options, single stock 

futures, index futures and options on index futures and total return swaps and 

structured products. Any effort should be examined and coordinated across markets and the input of all market operators should be sought. 
102 
103 
104 
105 
106 
107 
108 

RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER 

FROM MARY L. SCHAPIRO 

Q.1. In your testimony, Chairman Schapiro, you described the 

events of May 6 as ‘‘a 20-minute period during the afternoon of 

May 6’’ in which ‘‘the U.S. financial markets failed to live up to 

their essential price discovery function.’’ As a result, you have announced that the SEC is focused on taking steps ‘‘to reduce the 

likelihood of a recurrence of that day.’’ 

If it is the case that the ‘‘flash crash’’ was the result of high volume players pulling out of the market, removing a dramatic 

amount of liquidity, how will the changes the SEC intends to implement protect against that? 

A.1. On September 30, 2010, the staffs of the SEC and CFTC released a report on the findings regarding the market events of May 

6. As highlighted in that report, one of the key lessons learned 

from the events of May 6 is that many market participants employ 

their own versions of a trading pause—either generally or in particular products—based on different combinations of market signals. While the withdrawal of a single participant may not significantly impact the entire market, a liquidity crisis can develop if 

many market participants withdraw at the same time. This, in 

turn, can lead to the breakdown of a fair and orderly price-discovery process, and in the extreme case trades can be executed at 

stub-quotes used by market makers to fulfill their continuous twosided quoting obligations. 

In response to this phenomenon, and to curtail the possibility 

that a similar liquidity crisis can result in circumstances of such 

extreme price volatility, the SEC staff worked with the exchanges 

and FINRA to promptly implement a circuit breaker pilot program 

for trading in individual securities. The circuit breakers pause 

trading across the U.S. markets in a security for 5 minutes if that 

security has experienced a 10 percent price change over the preceding 5 minutes. On June 10, the SEC approved the application 

of the circuit breakers to securities included in the S&P 500 Index, 

and on September 10, the SEC approved an expansion of the program to securities included in the Russell 1000 Index and certain 

ETFs. The circuit breaker program is in effect on a pilot basis 

through December 10, 2010. 

A further observation from May 6 is that market participants’ 

uncertainty about when trades will be broken can affect their trading strategies and willingness to provide liquidity. In fact, in the 

staff interviews many participants expressed concern that, on May 

6, the exchanges and FINRA only broke trades that were more 

than 60 percent away from the applicable reference price, and did 

so using a process that was not transparent. 

To provide market participants more certainty as to which trades 

will be broken and allow them to better manage their risks, the 

SEC staff worked with the exchanges and FINRA to clarify the 

process for breaking erroneous trades using more objective standards. On September 10, the SEC approved the new trade break 

procedures, which like the circuit breaker program, is in effect on 

a pilot basis through December 10, 2010. 
109 

Going forward, SEC staff will evaluate the operation of the circuit breaker program and the new procedures for breaking erroneous trades during the pilot period. As part of its review, SEC 

staff intends to assess whether the current circuit breaker approach could be improved by adopting or incorporating other mechanisms, such as a limit up/limit down procedure that would directly 

prevent trades outside of specified parameters, while allowing trading to continue within those parameters. Such a procedure could 

prevent many anomalous trades from ever occurring, as well as 

limit the disruptive effect of those that do occur, and may work 

well in tandem with a trading pause mechanism that would accommodate more fundamental price moves.