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NYSE Makes Rules on the Fly?

Recs

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May 29, 2013 – Comments (2)

Board: Macro Economics

Author: yodaorange

We recently passed the third anniversary of the May 6, 2010 flash crash. You recall when all Hades broke loose. Many stocks, options and futures were affected. Luckily investors that were not watching in real time largely missed the fireworks. As quickly as prices fell, they then rose back to their starting point. All of this occurred in about 30 minutes. One of the lessons learned by individual investors was how rapidly the market could both decline and rise. The Dow was changing at a rate of about 2,000 points per hour. In percentage terms, it was about 10% per hour. There have been many years when the Dow moved less than 10% for the whole year. (Yes, there might have been larger interim moves.)

After the flash crash, the regulators and exchanges got together and implemented a new rule. All trades that were more than 30% “away from the market” were arbitrarily cancelled, aka “busted.” It was just like they never occurred. There were several issues that collapsed to a 1 cent share price during the flash crash. There were a few issues that rose to $99,999 per share. All of these trades were erased and you will NOT see them if you download historical data. If you had a trade that was changed by 29.9%, it was deemed “good” and allowed to stand.

Understand that “busted” trades have been around forever. Someone gets a few numbers backwards or they add an extra digit. In those cases of “clearly erroneous” trades, you are able to cancel the trade after the fact. Both the buyer and seller are NOT given an option. One side was always the big winner while the other side was the big loser.

Under the radar to most investors, “mini” flash crashes have continued to occur. These are typically on one or two stocks at a time, which is why they go largely unnoticed. We see a version of mini flash crashes on REIT preferreds fairly often. In some cases, the trades stand and in other cases they are busted.

Last week on May 23rd, there were flash crashes on two issues: American Electric Power (AEP) and NextEra Energy (NEE). AEP has been around forever with a market cap of about $25 billion. It averages about 2.5 million shares per day. Certainly this would NOT be a likely candidate for a flash crash caused by relative illiquidity.

Unfortunately for AEP, something went wrong at the 9:30 am stock market open on Thursday. AEP closed at 48.50 on Wednesday. It traded as low as 22.28 in the first minute of trading. This is a 54% drop not based on any kind of fundamental business issue.

The NYSE honchos got together and decided that the trades did NOT fall under the “Clearly Erroneous Execution” rule and they let them stand, i.e. they were NOT busted. This is similar to what the NYSE ruled when Knight trading had a slight software problem and did uncontrollable buying at any price. The NYSE must have determined that these trades were NOT caused by a misplaced number, a typo or something of that ilk. Maybe they were caused by an algorithm running on a computer that had a logic fault. In any event, the trades stand as valid. So far so good.

The problem comes after the fact. It seems that the same NYSE honchos that decided to let the trades stand, decided to PERMANENTLY STRIKE THEM FROM THE RECORD! All trades are reported on a system called the “Consolidated Tape” regardless of which exchange a trade was done one. The NYSE instructed the CTA to NOT include these low trades in the high and low statistics that are kept and reported. Go look at your data source for that day. I am willing to bet that it does NOT show the low trades on AEP. I checked five different sources and the reported “low” of the day was in the range of 46.07 to 47.87. Nowhere did I see the 22.28 trades listed.

BOTTOM LINES:

1) The NYSE has the power to make up rules on the fly and get by with them. How can they possibly rationalize letting the low trades stand, but “erasing” the data? If the trades stand, REPORT the data like it actually occurred. Maybe the NYSE Mensa group was having a separate meeting that day and could not rule on this issue.

2) Some poor investor(s) got killed on these trades. The investor sold AEP shares for 22.28 when the going price was ~ 48.00. Unfortunately, it means you have to use “limit” orders even on a huge market cap, highly liquid issue like AEP. Yes, it is STUPID that you have to do this, but apparently that is what it is going to take to protect yourself.

3) The exchanges and regulators have made progress in preventing flash crashes like this one, but have a long way to go. Yoda’s opinion is that we will continue to see more of the same. It would not be surprising to see a much larger flash crash that affects many issues.

4) One of the ironies is that the “circuit breakers” that are supposed to prevent trades like this are TURNED OFF between 9:30 and 9:45, when this mishap occurred. You better hope your flash crash occurs when the circuit breakers are turned on. . .


CNBC (Gulp!) has the best write-up I have seen so far. [1]

Thanks,

Yodaorange


[1] CNBC NYSE Lets Volatile Trades Stand But Cuts Them From Tape
http://www.cnbc.com/id/100763193

2 Comments – Post Your Own

#1) On May 29, 2013 at 1:59 PM, L0RDZ (82.47) wrote:

I thought  it  was  horrible  that  they   decided  to let  the  trades stand but  yet  failed  to  recognize  them  on   the  tape..   Sort  of  almost akin  to  police acknowledging that  someone  was  indeed raped  or   killed but  failing to   detain  arrest   and  or  prosecute  the  perpetrator.

Just  look  the  other way  and  attempt to erase it  from  the  record books.

Sadly  those  who  are  in   possesion of   the  exchanges seem to be able  to  make up  whatever  rules  they  wanna  and  with  the exchanges  now  being  for  profit  entities...  its  like  casinos  where  they beat  the  hell  out  of  anyone  who  doesn't  have  back up of  gangs  and  is   being   a   little  lucky at  say  the  tables.

I  had  a  messed  up thing  happen   to  me   where  I  had  a  limit  order  to  sell  and   cancelled it  and  had  the  market  close  and  suddenly within   5 minutes  of   the  market  close  the  powers  that  be  decided  after  the  facts  that my sale  of  100  shares  of  BHP   mysteriously  got   executed  after  the  close  of  the market  around  4:02  pm  !!!

When  I  questioned  my  scottrade  broker and  spoke of  my  displeasure  as  the  stock  was   trading up  and  would and could  have  been sold by  me  the next day  for a greater  amount,  they  told  me  that  things  get  crazy  at  the  end of   the day  and  that  it  was  normal  and nothing  illegal  or  improper  happened...

But  as  they  are  in  control  what  could I do ?    I  had  confirmation my  sell  was  closed  in fact  I  decided  to  close  it  just  to  make  sure  rather  than  have   the  close of the  market  close it for me...

It  seems  these  guys  just  make  things up as they go  along...

Integrity  is  for  sale  these days.

 

SIncerely,

 

Lordz

 

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#2) On May 29, 2013 at 9:04 PM, chris293 (81.42) wrote:

     You have to know what is going on in dealing with stocks as an investor.  This goes along with the old standard, 'buyer beware' I think should also be considered with 'seller beware'.  Even the bible has a parable that tells of how people are responsible for enriching themselves so they in turn can enrich others, and this is from one who does not believe in the superstitious claim of some people but I believe in the SEC to be honest with the full faith of most if not all shareholders.

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