Monday, May 24, 2010

Senator Bunning's Office Responds

I received an email on Thursday from Senator Jim Bunning's legislative director, William Henderson.  Unfortunately, it was sent to my secondary account, and I didn't notice it until this evening when I returned home from a weekend trip.  I feel it's only fair to post Mr. Henderson's email in full, as it is a response/clarification/enhancement to the post I wrote last week titled "Emergency Powers."  And oh, Mr. Henderson - if you ever want to contact me, drop me a comment on my blog.  It's a much quicker way to get in touch with me, and I'm happy to provide further input on the policies you guys are looking at.

Without further ado:

KD, I enjoy the blog and am a regular reader. It has been helpful as we have been working on the financial reform bill and, most recently, the stock plunge hearing today.

I wanted to clarify what Sen. Bunning's comments regarding emergency powers at the hearing today. His point was that the SEC and the exchanges have identified some changes they think should be made (the new trading curbs) but those changes are not yet in place and able to be used because the SEC's rule approval process takes a couple weeks. He was inviting Schapiro to ask for the ability to make such changes faster if she thinks that is appropriate. That is what he meant by emergency powers.

Regarding market orders, he agrees with you. I'll paste an exchange that started with Eric Noll of NASDAQ and Larry Leibowitz of NYSE Euronext on breaking trades and ended with a bit on market orders.

Finally, he said at the beginning of the hearing that he was glad to see the curbs are for moves in either direction, and not just down.

Hopefully this will allay your concerns a bit.


Mr. Henderson also included the exchange to which he was referring:


    It's all right. Thank you.

    Mr. Noll, I'm 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?

    I -- I share much of your concerns, 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 and, quite frankly, lasted many hours trying to decide what the appropriate decision was fair.

    So we were trying to balance the need and requirement 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 wasn't functioning as it should function.

    So in the absence of any clearly erroneous trade, we looked at the DK of what we would call price discovery and the provision 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-by- stock circuit-breakers that we're putting into place will prevent a reoccurrence of this kind of situation.

    Looking back, we all have 20/20.

    I think that's true. So we -- we -- we believe that we'd 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 -- what those events are and how they will be triggered.

    Anybody else like to jump in? Go ahead.

    Sure. 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...

    I was there.

    ... the CEO at the time or the 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 abhorrent (ph) conditions are -- are -- are just not orderly markets, in my mind. It's not the way we should do our business.

    I think, in this case, the big challenge wasn't we had institutional investors who made a mistake. You know what? You're 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 stocks...

    But -- but I'm sorry, sir. Sophisticated -- even if they're not sophisticated, anybody that puts a market order in knows exactly what's going to happen to a market order.

    So I would agree with you that their broker probably does -- and maybe the answer is the broker should have stood up (ph) for that trade -- I would submit to you that a lot of the public does not. And I'll tell you...

    A lot of the public doesn't know that if you put a market order in, it's executed?

    They think, maybe it'll go -- it'll go -- you know, I'll be...


    Rather than a limit order?

    Well, they don't realize that, when I trade Accenture, it's going to be down 99 percent when they get now.

    I agree with that.

    And -- and...


    But if you put a market order in, that's your execution.

    You're absolutely right in that regard. And I think we have to make sure that it just can't 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 don't 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."

It's good to see that Bunning understands exactly what a market order is, and I agree with Larry Leibowitz that the retail public does NOT understand exactly what a market order is, and that reform is needed to either educate the public so that there is no whining and there are no "victims" after the fact, or to simply protect Joe Retail from himself by preventing him from entering market orders.



getyourselfconnected said...

Once again it seems KD should be Emperor of the new Galactic Republic....

Sorry, Star Wars reference.

common sense in the halls of government? Say it aint so!

Kid Dynamite said...

i'm a little surprised Bunning is so unrepentant in his opinion of what Retail should know, but i don't disagree with it, I'm just surprised to hear it from a politician. It's good.... I was home this weekend for my mom's birthday and my brother in-law's graduation. My parents' friends are what I would consider the upper tier of financially educated people: they have stock portfolios, they have masters degrees, they don't default on their debt: yet they have ZERO idea about how markets work, and most of them would have trouble executing a stock order themselves.

it's amazing. it's horrifying.

Anonymous said...

> He was inviting Schapiro to ask
> for the ability to make such
> changes faster if she thinks
> that is appropriate. That is
> what he meant by emergency
> powers.

I watched the entire testimony, and while I generally thought that Senator Bunning's questions and comments were excellent, this is the sole area where I took exception.

The desire to move rapidly here is understandable, however not getting this right is potentially a destabilizing event of itself. The rules involved have not yet been well thought out, and the software implementation is non-trivial with tremendous downside risk if botched.

I wrote one of the 4 (yes - 4!) comment letters that the SEC has received on the stock circuit breaker proposal, and I hope Senator Bunning will give it a read if his staff is reading these blog comments:

The other 3 comments can be found here:

Normally the SEC has comment periods where the SEC website is setup to make it easy to find the filings and review/post comments. This however was done as SRO filings by each of the exchanges, burying somewhat the comments. I fear however it is a fait accompli, as the SROs all listed June 7th for their go live date with a test subset of symbols, which means that all exchanges with listed securities are actively at work on this.

The market may be too volatile right now, however I really believe that there is a material risk that the circuit breaker changes being rushed into our securities markets could compound matters.


Anonymous said...


I think something's up with blogger. Very slow to post, and a disconnect between the comment count (3 here prior to this one, 2 on main page after full page re-load).


Transor Z said...

KD, IMO all of this is a granular study of Rule of Law. I loved Paul Kedrosky's take on May 6th as a glimpse at the "trapdoor to hell." Peter's point in his SEC letter re: latency is interesting. It's never pretty when fps goes below 29 and things start to get very coarse-grained.

You just want to say to these people: "Pardon me, but your ad hoc is showing!"

The darker side is that executive power tends to expand in times like this.

Daniel said...

"they have stock portfolios, they have masters degrees, they don't default on their debt: yet they have ZERO idea about how markets work, and most of them would have trouble executing a stock order themselves."

This is why I have such trouble with people that advocate an hour a day/week like Cramer and some other folks. If you are going to be involved with equities you have to invest significant time. This is in addition to the fact that I believe equities are unsuitable for the vast majority of people from a risk standpoint. Like I said in an earlier post, I really don't have a solution. Market orders are a tool. I rarely use a MO (very narrow spread, need to execute immediately) but sometimes I will use. I don't want that choice taken away from my toolbox because the vast majority don't understand what they are doing.

Kid Dynamite said...

daniel - if market orders were banned, that would not remove a single tool from your trading toolbox. if you want to sell at market, you'd just enter "sell 100 XYZ @ .01"... same exact functionality. it doesn't harm you.

Daniel said...

Let me think about this. If MO's are banned then there would be the bid, ask and some number between the spread. As options for execution. You would have to place your order at the bid, ask or limit between the spread. Ok, I see that. If I want instant execution then I place a limit at the bid or ask. The only problem is the delay prior to execution if it moves from that bid or ask within the time I place the order. Whereas with MO you will get filled. The trade off is not getting filled and deciding to chase or getting filled at a price that is undesirable. I think.

Kid Dynamite said...

"If I want instant execution then I place a limit at the bid or ask."

no daniel - you place a limit that's THROUGH the bid/ask. above the best ask, or below the best bid.

let's take a step back.. if GE is trading $16.00 - $16.01, instead of selling at "market" you can say "sell at $15" or " sell at $14" or, if you really really meant that you'd hit any and all bids, you could say "Sell at 1c"

all three limits would result in "sweeping" the order book - hitting all bids down to your limit. in all likelihood, you'd probably end up selling GE at $16 or $15.99, but in times of extreme dislocation and illiquidity, like May 6th, you wouldn't accidentally sell GE down to 1c unless you wanted to and had specifically stipulated that as your limit.