“False Profits”

Statement before the Third Meeting of the CFTC-SEC Joint Advisory Committee on Emerging Regulatory Issues

Commissioner Bart Chilton

August 11, 2010

All too often some look for an easy explanation of what took place in a disastrous circumstance. Ever since 1997 when Sebastian Junger’s Perfect Storm was released, that phrase has been used to explain calamitous circumstances. Hurricane Katrina’s impact on New Orleans was a perfect storm, and some suggest that the May 6th flash crash was a perfect storm. I don’t rule out that there were anomalous market circumstances that may have led to the flash crash. There could be a collection of culprits. We understand that there was great uncertainty about European financial conditions. There was a “flight to quality.” Investors were moving money to gold and government bonds, for example. But, as I have said, computer trading added to the volatility and that without this technology, the number of trades simply would not have occurred. The downward spiral of nearly 1,000 points would not have taken place, nor would the rapid rebound to a loss of 348 points have occurred.

There may in fact be an over-reliance on computer systems and high-frequency trading. Nevertheless, we should not accept that those were merely part of a collection of culprits and let it go at that. This matter is too important. We certainly need to continue to look deeper. Today is another effort in that regard.

One area that deserves additional attention is the matter of price feeds or price quotes. These feeds come in two forms: there is the general feed—the consolidated feed—that is offered to anyone. This feed is made available, for example, to myriad portals through which a trader might want to trade with an exchange, such as the New York Stock Exchange (NYSE). There are also premium feeds available directly from the exchanges. On May 6, during the 20 or so minutes in question, it appears that the consolidated feed that many portals were using was delayed from the real time quotes. At times, this delay amounted to more than 20 seconds. While 20 seconds may not seem like a lot to many folks, when markets are volatile, 20 seconds is a significant amount of time.

What this delay means is that, hypothetically, at the same real time, there could be two different price quotes: the real time NYSE price quote feed that had most stocks falling rapidly and the delayed consolidated price quote feed where the prices had not yet fully reflected the downward movement. Therefore, an algorithmic computer program, which would use high-frequency or flash trading and is written to sense price differences, could submit buy and sell orders to arbitrage between the two prices. The algo program could buy at the lower price from the NYSE feed and immediately sell on another exchange portal using the delayed consolidated price quote feed. This could be done is large quantities, repeatedly. Here is what we know: there was a delay between the premium and the consolidated price quote feeds. What we do not know yet is if some algorithmic trading took advantage of that situation.

We had our Technology Advisory Committee in this room last month and I asked the experts if this type of thing was possible or if it was just a conspiracy theory. Four of the panelists assured me that this could take place. In fact, they even acknowledged that some algorithmic programs were geared to not only take advantage of market circumstances, but could be used to instigate certain market conditions in order to then initiate their own program of buying or selling.

Therefore, I urge the staffs of the CFTC and the SEC to not leave this and any other stones unturned as they continue to investigate the flash crash. Did algo price pirates seek false profits on May 6th? Inquiring minds want to know.

Thank you.

Last Updated: August 11, 2010