Investigators seeking an explanation for the brief stock market panic last week said Sunday that they were focusing increasingly on how a controlled slowdown in trading on the New York Stock Exchange, meant to bring about stability, instead set off uncontrolled selling on electronic exchanges.
It was an unintended consequence of a system built to place a circuit breaker on stocks in sharp decline. In theory, trades slow down so that sellers can find buyers the old-fashioned way, by hand, one by one. The electronic exchanges did not slow down in tandem, causing problems, according to two officials familiar with the investigation.
That could mean that the computers first flooded the market with sell orders that could not be matched with buyers. Then, just as quickly, many of these networks withdrew from trading. The combined effect might have set off a chain reaction that sent shares of many companies spiraling during the 15-minute frenzy.
After a weekend of analysis, many specialists at the major exchanges no longer believe that a single large sell trade in one stock, like that of Procter & Gamble , was the trigger, according to the people familiar with the investigation. Instead, they suspect that a mismatch in rules between the older New York Stock Exchange and younger electronic exchanges set off a frightening sequence of events.
It is not known exactly what caused the initial sell-off in the blue chips, but investigators say the earliest sign of trouble they have found was a sudden drop in the value of a futures contract on the Chicago Mercantile Exchange, based on the Standard & Poor’s 500-stock index. That pushed down a broad array of stocks in that index, all of them traded on the New York Exchange and other major exchanges, and sent many stocks on the New York Exchange into slow mode.
Ever since computerized trading became dominant in the nation’s stock markets in recent years, market experts have been warning that the lack of consistent rules among exchanges and the increasing complexity and speed of computer trading systems could destabilize markets. This appears to have happened last Thursday, when stock prices plunged and the Dow Jones industrial average fell roughly 600 points in a few minutes.
Officials of the Securities and Exchange Commission and the heads of the four main exchanges are to meet Monday in Washington to discuss applying circuit breakers across all exchanges. Today, only the New York Exchange applies circuit breakers on individual stocks. A Congressional hearing on the episode is scheduled for Tuesday.
Investigators say the rule on halting trading was created for a time when one exchange accounted for the vast proportion of stock trading. But over the last half decade the Big Board’s share of the market has dropped sharply — in part because of regulatory changes to encourage new competitors — while ever larger volumes of stocks are traded on electronic exchanges without circuit breaker rules.
Investigators are now focusing on the events of last Thursday, when several hundred stocks on the Big Board, including five major stocks that make up the Dow — Accenture , Procter & Gamble, 3M and two others — went into slow mode.
This decision forced a switch to slow-motion trading as traders on the floor tried to arrest the decline by manually seeking out bidders. But that did not work, because trading shifted immediately to broader markets controlled by computers, where the plunge continued.
Regulators and the exchanges continued over the weekend to review the tapes from the millions of trades made last Thursday. The investigations are looking at what effect the decision to halt trading in these stocks in New York had on broader market confidence — and on algorithms used by computerized traders.
The scale of the shutdown on may have been a new phenomenon for these computer systems. They may also have been programmed to shut down in such a cataclysmic moment of stress, which would have had a further cascading effect in withdrawing bidders from the market and putting further intense downward pressure on prices.
In Washington on Sunday there were cross-party calls to fix the system and criticism that regulators had still not fully identified the cause of the sell-off, even as markets, still jittery over Europe’s debt crisis and last week’s plunge, were due to open Monday. (Asian markets were up in early trading Monday, after European leaders authorized billions in new loans to the Continent’s debt-riddled nations.)
Senator Christopher J. Dodd, the Connecticut Democrat who is chairman of the Banking Committee, said on “Face the Nation” on CBS that he believed market regulators should consider new “marketwide circuit breakers” to deal with the kind of market break that occurred on Thursday.
“This is an issue that raises systemic risk,” Mr. Dodd said, adding that he had called for hearings on the matter.
What regulators need
Mr. Dodd also criticized the S.E.C. “Clearly the S.E.C., the Securities and Exchange Commission, needs to act,” he said. “They need to step up very quickly and let us know what happened here and what steps need to be taken.”
Senator Richard C. Shelby of Alabama, the ranking Republican member of the banking committee, said on the same program that he believed “the technology has gotten ahead of the regulators.” Instead, he added, “the regulators have got to get ahead of the technology. That is going to be a big challenge down the road. Otherwise, we could have more of this.”
The Homeland Security Department said Sunday that there was no evidence that a computer attack had started the stock spiral.
In the talks on Monday, Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, will meet with senior officials from the New York Stock Exchange, Nasdaq, BATS Exchange and Direct Edge.
Not one of the regulatory agencies has said anything more about the possible cause of Thursday’s market break since a statement on Friday afternoon identified disparate trading conventions and rules as a possible cause and said the review was continuing.
The lack of coordination among exchanges has been one part of the investigation and is considered by regulators to be more of a magnifying event than the trigger of the market’s sudden swoon, according to another person close to the investigation.
As trading has been dispersed among a dozen electronic exchanges, the S.E.C. and other market regulators have maintained no centralized database of stock trades, order sizes or prices. That has made it more difficult for regulators to piece together what exactly happened on Thursday.
The S.E.C. has been warned in recent months by market participants, publicly traded companies and other regulatory agencies that the lack of coordination between trading platforms, as well as the expansion of high-speed trading in alternative markets, has furthered systemic risk, encouraged regulatory arbitrage and increased opportunities for market manipulation.
The staff of the Financial Industry Regulatory Authority wrote to the S.E.C. in April that “no single regulator has a full picture of all trading activities in the U.S. equity markets.”