Regulators search for clues to market plunge

NEW YORK - Regulators and Wall Street officials went through millions of trades one by one on Friday and cancelled thousands as they sought to explain a record plunge in the stock market, undo damage and keep it from happening again.

It wasn't clear how long the laborious process would take or if it would even solve the mystery behind Thursday's harrowing trading session that saw the Dow Jones industrial average fall hundreds of points and then recover, all in a matter of minutes.

The chaotic slide - some stocks briefly fell to near zero - brought back memories of the darkest days of the financial crisis.

The Securities and Exchange Commission and the Commodity Futures Trading Commission were investigating but on the day after, there were more questions than answers:

- Did a single trader mistakenly punch in the wrong number of shares when making a sell order, maybe mistyping "billion" instead of "million" and setting off a market-wide panic that at one point pulled the Dow down almost 1,000 points?

- Did high-speed computerised trading systems that are supposed to make markets work smoothly go haywire, sending stocks into a nosedive?

- Most important to anyone with money in the stock market: Could it happen again?

Maybe the scariest part was that no one could unravel what happened. That left executives at the major stock exchanges pointing fingers at each other, and the public wondering if the hidden world of high-frequency, computerised trading that fed the panic posed a threat to their 401(k)s.

"It could be awhile before they figure it out because they have to sift through everything trade by trade," said San Diego State University finance professor Dan Seiver, who has followed the markets for 52 years. "And humans are a lot slower than machines."

Market officials worked to cancel thousands of "clearly erroneous" trades made during the plunge.

New York Stock Exchange Euronext CEO Duncan Niederauer told CNBC that his exchange canceled 4,000 trades.

At Direct Edge, the third-largest US exchange, employees worked through the night reviewing some of the 10 million trades made on Thursday and found 2,000 that had to be cancelled, said chief executive William O'Brien.

BATS Global Markets, one of the largest US trading networks, had to cancel 540 trades.

Nasdaq declined to give a number.

The turbulence continued on Friday. Amid anxiety about the unexplained plunge and the growing debt crisis in Europe, the Dow was down as much as 280 points and up briefly before closing down almost 139.

Thursday's trading was enough to stir fear among even the most seasoned market veterans.

The Dow had already fallen nearly 400 points by around 2:40 p.m. EDT. Yet the damage only got worse. The Dow tumbled 600 points in seven minutes, giving it a record one-day loss of 998.50, or 9.2 per cent. Minutes later, the index inexplicably turned up again, erasing most of the losses.

Among the hardest hit: Procter & Gamble and 3M, whose stocks are among the highest priced of the 30 stocks in the Dow industrials average. Their big drops took the Dow down sharply because it is price-weighted - a $1 drop has the same impact whether the price started at $100 or $2.

On Thursday, at 2:42 p.m., P&G was trading at $61.73. Within seven minutes, it fell 36 per cent. That drop alone accounted for 169 of the nearly 500 points that the Dow lost during the same time.

Similarly, 3M shares, which fell 17 per cent from $83.38, took another 109 points off the Dow.

How did it happen? Speculation on trading floors initially centred on a computerised sell-off possibly caused by a typographical error. One theory was that a trader trying to sell millions of shares accidentally sold billions, a move that would have triggered a wave of automatic selling.

The SEC is poring through trading data containing millions of transactions to try to identify what might have caused the disruption, according to two people familiar with the matter.

The two major markets, the New York Stock Exchange and Nasdaq, were also examining audits of completed trades, according to the people, who spoke on condition of anonymity because the investigation is ongoing.

At Nasdaq, Thursday's plunge set off MarketWatch, an internal system that alerts regulators to trading problems. Regulators are still sifting through the day's trading data for irregularities.

A Nasdaq spokesman declined to comment on when the investigation will be completed.

NYSE spokesman Raymond Pellecchia said the Big Board is working with regulators but declined to comment further.

BATS CEO Joe Ratterman said SEC officials called him at his Kansas City, Missouri, office late Thursday and again Friday seeking information on what might have gone wrong.

Ratterman said the SEC has called a meeting of all exchanges on Monday in Washington.

The SEC declined to comment.

On Capitol Hill Friday, Sens. Ted Kaufman and Mark Warner called for the SEC and the Commodity Futures Trading Commission to conduct a thorough study of high-frequency trading and other tools that move markets in milliseconds.

"We saw a living, breathing, real-time example today of the potential catastrophe that takes place if we don't have an ability to make sure we adequately use this technology," Warner said late Thursday.

"Right now, there is no way to know what is happening in this marketplace," Kaufman said.

One theory was that high-frequency traders pulled out of the market completely during the drop, which might have sent the markets even lower because there were only sellers and no buyers.

But Jeff Wecker, chief executive of Lime Brokerage, which caters to more than 100 high-frequency trading firms, said his clients traded more - not less - during the steepest drop.

"They're the reason the market rebounded as rapidly as it did," he said.

- AP