Ex-Physicist Leading Inquiry Into Flash Crash
As a doctoral candidate in physics at Princeton two decades ago, Gregg E. Berman spent a year and a half in a laboratory searching through subatomic data for an elusive particle called the heavy neutrino.
Now, from his small office at the Securities and Exchange Commission here, the former physicist is busy completing a similarly painstaking task, supervising a team of more than 20 investigators who have spent the last five months scrutinizing reams of stock-trading data and hundreds of interview transcripts in an effort to figure out why stock prices went into free fall for 20 terrifying minutes on May 6.
Their long-awaited report on the so-called flash crash, in partnership with the Commodity Futures Trading Commission, is due to be published in the next two weeks.
Mr. Berman, 44, will not say exactly what will be in the report, but he says that it will not simply restate what regulators have already said — that markets were volatile because of worries over the debt crisis in Europe, causing some computerized trading programs to stop trading, and finally causing computers on other exchanges to misread the pullback as a rapid bidding down of stock prices.
Instead, he says, the report will zero in on a specific sequence of events that preceded the crash. He says it will tell a clear story about what happened in the markets on that stomach-churning day, beyond simply pointing a finger at the perils of the kind of high-speed computer trading that dominates today’s markets.
“The report will clearly demonstrate how market conditions and events prior to the flash crash led to the extreme price moves,” he said.
When pressed, he added, notably, that he had found no evidence of a deliberate attempt by anybody to disrupt markets.
The implications of the report are not merely academic. Ordinary investors, shaken by the brief stock plunge and the lack of an official explanation, have withdrawn money from stock mutual funds every week since the crash. Market analysts say investors want to be reassured about the integrity of the nation’s markets so they can be confident that a nose dive will not happen again.
The Berman report will not be the final word on the matter. Its findings will be used by a group of advisers to the S.E.C. and the commodity futures commission, which will make policy recommendations.
Still, some analysts question whether the report can deliver a simple answer that will satisfy everyone eager for reassurance.
“What everybody would love to hear from the S.E.C. is XYZ trader blew up the market and made a gazillion dollars and is now in jail,” said Larry Tabb, chief executive of the Tabb Group, a specialist on the markets. “The answer, I think, is much more complicated and nuanced and has to do with a lot of different things. I am not sure that everybody outside the industry is going to have the patience to understand that.”
Mr. Berman acknowledges that his team’s explanation will involve a number of things happening at once. It may strike many people as painfully complex, but that is an undeniable result of the byzantine nature of today’s disparate electronic markets and the many players who take part in them.
The report’s conclusions will involve “market participants doing very different things and for very, very different reasons,” he said.
Central to all of this is the fact that stock trading is no longer centralized but instead takes place on dozens of exchanges, all with varying policies and procedures. For example, the New York Stock Exchange has circuit breakers that prevent stocks from rising or falling so quickly that they disrupt the broader market.
Trading was slowed on several listings on that exchange on May 6, while other markets kept trading lower. That lack of coordination created confusion during the flash crash. Since then, the S.E.C. has extended circuit breakers for individual stocks across all markets.
In investigating the crash, Mr. Berman says he finds himself in a position similar to his physics work 20 years ago, when he was collecting huge amounts of data and comparing the competing views of many laboratories on a question dividing particle physics — whether the neutrino, one of the least known and most common elementary particles, actually had mass.
Today he finds himself in familiar territory, sifting through huge amounts of messy and disjointed data, and at the same time reading blogs and e-mails from a wide range of observers, each with a theory about what happened on May 6.
Despite his formal training as a physicist, Mr. Berman is no stranger to stock markets. After academia, he spent 16 years on Wall Street, first devising algorithmic trading strategies for hedge funds, then working for RiskMetrics Group, where he created software and dispensed risk-management advice to asset managers, banks and hedge funds.
Having worked with hedge funds and high-frequency traders, Mr. Berman came to his current job a year ago with practical market knowledge and a familiarity with the world of stock trading. Several prominent market players say they found Mr. Berman’s rare combination of experiences refreshing — and reassuring.
“He had a sense that actions in markets provoke reactions and they are done for reasons, benign or not benign,” said Frank Hatheway, chief economist at Nasdaq, one of the exchanges that provided data for the inquiry.
Even though Mr. Berman’s Wall Street background was paramount, S.E.C. officials said his measured communication skills were also important. They have helped him in the complex task of coordinating the commission’s cross-divisional flash crash investigation team and presenting a clear narrative about what happened.
“He can analyze the data in a way that tells a story,” said Robert W. Cook, Mr. Berman’s boss and the director of the S.E.C.’s trading and markets division.
The investigation has had two prongs. One strategy has been to collect all kinds of market data from May 6 and analyze it for patterns.
“They must be completely awash with data on their spreadsheets, a trove of data,” said Lawrence Leibowitz, chief operating officer of NYSE Euronext, another exchange that provided information for the investigation. “We sent them over raw data with analysis on top of it.”
The second line of investigation has involved “many dozens” of interviews with people involved in the markets on May 6, including market makers, the exchanges, high-frequency traders, banks and fund managers, to ask what they did on May 6 and why.
More than one interviewee was surprised to find Mr. Berman and 10 more S.E.C. officials on one conference call to discuss the crash — their number was a sign of how badly the commission, after a few difficult years, wants to get this investigation right.
“Many market participants told us, ‘We’re not quite sure what happened over all, but this is what my firm saw and the actions we took,’ ” Mr. Berman said. “It was like ‘C.S.I.’ We wanted to interview everyone around.”
Mr. Berman said the level of detail gleaned from his investigation will help provide the explanation for what occurred on May 6, even if it may not delivery the simple answer that many people would like.
“This level of fact proved to be very, very telling,” he said. “We started to build up a complete picture.”