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Eleventh Hour Limit Up Limit Down Anti-Volatility Proposal Change (LULD)

31

May, 2012

 

US Stock Exchanges have just changed their proposal to the SEC for the Limit Up Limit Down (LULD) safety mechanism that is supposed to take the place of the SEC’s Single Stock Circuit Breakers (SSCBs).

What do we have in place now? Currently we have SSCBs in place that are designed to safeguard equity markets. These SSCBs halt trading when the price of a stock/ETF moves 10% within 5 minutes.

What was the original LULD proposed? You can read the SEC’s May 25th 2011 proposal here. In essence, LULD would create 15-second “limit states” when a stock deviates from calculated reference points a certain percentage. Trading in these “limit states” would be restricted with regard to price, but not halted; trades wouldn’t be allowed to take place more than a specified percentage above or below the average price over the preceding five-minute period. If prices don’t move away from the specified limits within 15 seconds, the listing market would declare a trading pause of five minutes.

In our note to you from June 27th, 2011 we pointed out some serious flaws in the proposed LULD mechanism. Of course, we were concerned that the safety mechanism that would limit trading in wild times was being proposed by stock exchanges that have a financial interest to not limit such trading. We were also concerned with:

1)      The needless complexity of the rule,

2)      Why the limit state would last only 15 seconds,

3)      That the slower SIP would be used to calculate the trading bands, as opposed to the faster speeds that HFTs operate.

We wrote the SEC with our concerns in this comment letter. The SEC has not passed this proposal, and has delayed implementing it 3 times,

What is changing in the new LULD proposal? Flexibility for the stock exchanges. The proposal would give the market that lists a security the discretion to declare a trading pause during a “straddle state” when a stock “deviates from normal trading characteristics”. It would not be automatic. The April 2011 proposal didn’t include this flexibility. So in the eleventh hour, the stock exchanges change the LULD proposal, which already would allow for much more trading than circuit breakers, by making the trading pauses at the discretion of the exchanges, which have a financial interest in allowing continuous trading. Makes sense?

Why have the exchanges who wrote LULD put this last minute change in? Has everyone had time to digest this last minute change, which again would give the exchanges discretion to halt and limit trading? What is the exchanges’ track record with providing for continuous trading? How did the exchanges handle continuous trading in recent IPOs? Do you trust them?

The SEC is expected to rule today. Let’s watch the SEC today to see what they decide. We will all quickly see whether our regulators care more about protecting investors and giving bringing back confidence, or helping HFT firms and the exchanges who arm them.

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