Trading Analysis of October 27 and 28, 1997

A Report by the Division of Market Regulation
U.S. Securities and Exchange Commission

September 1998

Although the Commission has authorized publication of this report, it has expressed no view regarding the analyses, findings or conclusions therein.

Note: Graphs and tables appearing in attachments A through D are not available in this electronic version of the report.

Executive Summary

Immediately following October 27 and 28, Chairman Levitt requested that the Division of Market Regulation ("Division") reconstruct the days' events. The findings from this reconstruction are discussed in Part II of this report. The Division was also asked to determine the effects of circuit breakers on market price movements. The Commission's Office of Economic Analysis ("OEA") helped analyze the effects of the circuit breakers on the velocity of market price movements and the quality of market-making on October 27. The determinations regarding circuit breakers are discussed in Part III of this report. Finally, the Division analyzed the operational performance of the markets' automated trading, price-reporting, and clearance and settlement systems on October 27 and 28. In conjunction with the Division's analysis, the Commission's Office of Compliance Inspections and Examinations ("OCIE") inspected the systems performance of major full-service and online broker-dealers. The findings from these reviews are discussed in Part IV of this report.

Overall, the Division's trading reconstruction indicates that the steep market declines on October 27 and the morning of October 28 appear to have been a price correction along the lines of the 6.91% decline on October 13, 1989. On October 27, 1997, the selloff appears to have been prompted by concerns over the potential impact on U.S. corporate earnings of the growing market turmoil in Asia and the repercussions from the potential economic slowdown and deflationary pressures. The Asian market turmoil evidently caused a number of institutional and professional traders to attempt to reduce their equity exposure or increase their hedges in the U.S. markets, either directly through stock sales or indirectly through trades in futures. While various trading strategies and overall liquidity constraints in the stock and futures markets, as well as concerns over the potential early closure of the markets on October 27, may have contributed to the velocity of the price declines, no single factor emerged as the cause for the price volatility during this period. When the selloff reduced U.S. stock prices to attractive levels on the morning of October 28, broad-based buying developed to support a strong, albeit partial, bounce-back in share prices on then-record volumes.

The market decline on October 27 was not of a magnitude to offer a true test of how circuit breakers might operate during more severe declines. Nevertheless, the Division believes that the events on October 27 offered several critical insights into the need to change the circuit breaker procedures then in effect. The Division discussed these issues with the securities markets in the context of their revisions to the circuit breaker procedures which went into effect on April 15, 1998. In addition, the Division shared its analyses of the operation of the circuit breaker on October 27 with the staffs of the other agencies comprising the President's Working Group on Financial Markets ("Working Group"). The Division's findings regarding circuit breakers are discussed below and were reflected in the Working Group Staff Report on Circuit Breakers, issued on August 18, 1998.

First,	the circuit breaker thresholds needed to be raised significantly from those in place on October 27. When the 350-point trigger was reached on October 27, the DJIA was down only 4.54%, a level that had been reached on 11 previous days since 1945. Moreover, there was little evidence of the types of market liquidity constraints that would have justified cross-market halts. Circuit breaker halts should be reserved for an abrupt market decline of a magnitude that raises concerns that the exhaustion of market liquidity might result in uncoordinated, ad hoc market closures.
Second,	the trading dynamics on October 27 illustrated the need for circuit breakers to permit trading to resume whenever feasible for orderly market closings. The early market closure on October 27 does not appear to have been necessary. Moreover, investor concerns that the second circuit breaker would close the market may have accelerated the price declines in the last 24 minutes. Concerns over a likely premature market close may have resulted in a transfer of selling pressure to the futures markets (which offered faster executions in the limited time remaining), with stock prices quickly following futures down to the 550-point trigger level.
Third,	the events of October 27 reinforced the need for regulators to periodically re-examine circuit breaker procedures to ensure that they reflect both changing market levels and the increasing capacity of the markets to handle greater trading volumes and price volatility in an orderly manner. As markets continue to grow and change, the regulatory agencies and the self-regulatory organizations must monitor and revise circuit breakers and other protective measures to ensure that they continue to function as intended and achieve their goals with minimal market disruptions.

Overall, the Division's survey of the securities markets' systems performance on October 27 and 28 found that the operational capacity enhancements undertaken over the last ten years enabled the markets to accommodate the sharp increases in price volatility and trading volumes on these days with minimal delays and disruptions. While some small problems developed in stock and option quotation systems and Nasdaq, the Division found no indications of the types of large scale breakdowns in automated trading systems that had overwhelmed the markets in October 1987. In terms of broker-dealer systems, the staff found that the firms need to do more to evaluate, expand, and test their systems capacities for peak trading periods. In addition, the staff found that online brokerage firms need to do more to improve their customers' access through the Internet, to respond promptly to customer complaints, and to educate customers about the types of access problems that can develop during peak periods and access alternatives that are available under these circumstances.

Table of Contents

Part II – Findings From Trading Reconstruction

I.	Overview
II.	Specific Findings Regarding Types of Traders and Trading Strategies
	A. Largest Traders on October 27
	B. Trading by Mutual Funds
	C. Overall Program Trading
	D. Index Arbitrage
	E. Quantitative Program Trading Strategies
	F. "Risk" or "Blind Bid" Programs
	G. Dynamic Hedging
	H. Index Futures

Part III – Determinations Regarding Circuit Breakers

I	Background
	A. The October 1987 Market Break and the Adoption of Circuit Breakers in 1988
	B. Modifications to the Circuit Breakers in 1996 and 1997
II	Findings Regarding the Effects of Circuit Breakers on October 27, 1997
	A. The First Circuit Breaker was too Low
	B. Evidence is Mixed Whether the First Circuit Breaker had a "Magnet Effect"
	C. The 30-Minute Halt was Benign but of Little Utility
	D. Market Reopenings Appear to Have Been Orderly
	E. The Second Circuit Breaker May Have Had a Magnet Effect
	F. A Normal Close Should Have Been Permitted
	G. Most Firms Did Not Have Large Unexecuted Orders
	H. The Early Close Could Have Resulted in Severe Derivative-Related Losses
	I. Evidence is Mixed on Whether the Early Closure Harmed Foreign Markets
	J. Preopening Pricing on October 28 Was Viewed As Helpful
III.	Regulatory Initiatives Since October 27, 1997
IV.	Conclusions Regarding Cross-Market Trading Halts

Part IV – Determinations Regarding Operational Capacity

I.	Market Systems
	A. Trading and Clearance and Settlement Systems
	B. Exchange Quotations for Stocks and Options
	C. Nasdaq Systems
II.	Broker-Dealer Systems

Part V – The Division's Trading Reconstruction

I.	Market Context
	A. The Bull Market
	B. The Decline in Pacific Rim Markets
II.	October 27, 1997
	A. Foreign Market Declines and Pre-Opening Indications in the U.S.
	B. Market Declines in the Morning
	C. Market Declines to the First Circuit Breaker at 2:36 p.m.
	D. Market Declines to the Second Circuit Breaker at 3:30 p.m.
III.	October 28, 1997
	A. Foreign Market Declines and Pre-Opening Indications in the U.S.
	B. Initial Market Decline and Subsequent Rally

Part I: Introduction and Overview

October 27 was also the first time that the cross-market trading halt circuit breaker procedures had been used since their adoption in 1988. At 2:36 p.m. on October 27,² the DJIA had declined a total of 350 points from the previous trading session's closing value. This decline triggered a 30-minute halt on the stock, options, and index futures markets. After stock trading resumed at 3:06 p.m., prices fell rapidly to reach the 550-point circuit breaker level at 3:30 p.m., thereby ending trading 30 minutes prior to the normal stock market close.³

On Tuesday, October 28, market prices initially resumed their sharp decline. By 10:06 a.m. the DJIA had declined a total of 187.86 points (2.62%). The market subsequently rallied sharply, with the DJIA closing up 337.17 points (4.71%) at 7498.32⁴ on then-record share volumes of over a billion shares each on the NYSE and the Nasdaq Stock Market ("Nasdaq").⁵

Throughout these two days, the Commission staff monitored both U.S. and foreign market developments on a 24-hour basis. The staff consulted repeatedly with officials at the U.S. securities markets and clearing organizations to ensure that no systemic problems were arising from the sharp price swings and trading volume surges. Specialized teams of Commission staff also checked to determine if problems were developing in automated trading and price reporting systems, clearance and settlement operations, and market-making in the securities markets, as well as in the financial condition of key broker-dealers. We were also in contact with officials at the other agencies in the President's Working Group on Financial Markets: the Department of the Treasury, the Board of Governors of the Federal Reserve System ("Federal Reserve"), and the Commodity Futures Trading Commission ("CFTC").⁶ In addition, senior Commission staff consulted with international securities regulators to discuss conditions in other markets. Based on these preliminary reviews, the Commission staff determined that our markets had operated relatively well on October 27 and 28, and that, although some difficulties with automated systems were noted, systemic stress was not evident.

Immediately following these preliminary assessments, Chairman Levitt requested that the Division of Market Regulation ("Division") undertake a more thorough analysis of the markets on October 27 and 28. In particular, the Division was requested to conduct a reconstruction of trading on these days and to determine the effects of the circuit breaker procedures on market price movements. This review sought to determine how the circuit breaker procedures then in effect influenced trading decisions by key market participants on October 27. The Commission's Office of Economic Analysis ("OEA") helped analyze the effects of circuit breakers on the velocity of market price movements and the quality of market-making on October 27.⁷

In order to perform a timely reconstruction of trading on October 27 and 28, the Division reviewed trading and clearing records for the 30 stocks in the DJIA and the ten largest Nasdaq stocks in terms of capitalization (referred to collectively as the "sample stocks"). We then used a system referred to as the "electronic blue sheet" system⁸ to obtain information concerning how much customer and proprietary accounts purchased or sold the sample stocks on October 27 and 28 at the most active clearing firms. This trading information was analyzed to identify the largest buyers and sellers in the sample stocks. The information was then cross-checked against information supplied by the Depository Trust Company ("DTC") concerning its most active institutions in terms of net purchases and sales of the sample stocks. These analyses were supplemented by two additional sources of trading information. First, the detailed program trading reports submitted by NYSE member firms were analyzed for October 27 and 28.⁹ Second, reports provided by the CFTC staff concerning large traders in active stock index futures who were the largest net buyers and sellers in these contracts on October 27 and 28 were reviewed. Based on these trading reviews, the Division interviewed traders at the twelve most active broker-dealers and the three most active mutual fund complexes to discuss in detail how their order flow on October 27 and 28 was influenced by circuit breakers, systems problems, constraints in market liquidity, and other factors.

In addition to the trading reconstruction, the Division undertook an extensive survey of how well the securities markets' automated systems for trading, price-reporting, and clearance and settlement systems operated during the sharp market swings and heavy trading volumes experienced on October 27 and 28. The review analyzed the types of operational problems that developed during this period and whether increases in capacity or other systems enhancements are needed to respond to future market contingencies.

In conjunction with the Division's review, the Commission's Office of Compliance Inspections and Examinations ("OCIE") conducted a series of inspections of full-service and online broker-dealers' trading system capacity for October 27 and 28. These inspections included reviews of customer complaints, which included problems accessing online systems on these trade dates.

While the specific findings and recommendations from the Division's review and OCIE's inspections are non-public, a general overview of these reviews is provided in Part IV this report.

II – Findings From Trading Reconstruction

II. Specific Findings Regarding Types of Traders and Trading Strategies

A. Largest Traders on October 27

B. Trading by Mutual Funds

C. Overall Program Trading

D. Index Arbitrage

The relative reduction in index arbitrage trading on October 27, 1997, is consistent with longer term trends reflected in weekly program trading reports issued by the NYSE over the last few years. These reports indicate that the percentages of index arbitrage program trading have generally declined even as overall program trading has been increasing as a percentage of total NYSE volume.¹⁴ While the reduction in index arbitrage may be related to the strictures imposed by NYSE Rule 80A(c),¹⁵ this may also be a function of other factors, such as the recent increase in the non-arbitrage program trading strategies discussed below.

E. Quantitative Program Trading Strategies

The firms using quantitative program trading strategies indicated during our interviews that, while they were net sellers of stocks on the afternoon of October 27, they adhered to their models relatively closely and neither the magnitude of the market decline nor the approach of the circuit breaker thresholds caused them to increase the size or frequency of their sell programs. In other words, the likelihood that trading would be halted due to circuit breakers had not been factored into their quantitative models and could not be quickly formulated and inserted into their trading strategies on the afternoon of October 27.

F. "Risk" or "Blind Bid" Programs

The firms employing this strategy maintain that, because the precise makeups of the baskets to be traded are not disclosed by the funds, the firms do not attempt to buy or sell specific securities in anticipation of the later trades. Instead, the firms may buy or sell stock baskets that generally conform to the profiles identified by the funds in order to position the firms for the later trades. Although the firms using this strategy on the afternoon of October 27 were large net sellers of the sample stocks, the firms maintain that this strategy is designed to be "market neutral" because their sales in one portfolio are usually offset by purchases in another portfolio. The firms using these program trading strategies also indicated that, while they were net sellers of the sample stocks on the afternoon of October 27, neither the magnitude of the market decline nor the approach of the circuit breaker thresholds caused them to increase the size or frequency of their sell programs.

G. Dynamic Hedging

H. Index Futures

Part III – Determinations Regarding Circuit Breakers

Immediately following the October 1987 Market Break, the Presidential Task Force on Market Mechanisms was established with Nicholas F. Brady as Chairman. The report issued by the Task Force on January 8, 1988 ("Brady Report"), recommended a number of initiatives to address future periods of extreme market volatility, including the implementation of circuit breaker mechanisms coordinated across the markets for stocks, options, and stock index futures. The Brady Report noted that the market disorders of October 1987 "became, in effect, ad hoc circuit breakers, reflecting the natural limits to market liquidity." Accordingly, the Brady Report maintained that the October 1987 Market Break "demonstrates that it is far better to design and implement coherent, coordinated circuit breaker mechanisms in advance, than to be left at the mercy of the unavoidable circuit breakers of chaos and system failure."¹⁹

After the issuance of the Brady Report, the President's Working Group on Financial Markets ("Working Group") was formed with the mandate to determine the extent to which coordinated regulatory action was necessary to strengthen the nation's financial markets.²⁰ The May 1988 Interim Report ("Interim Report") of the Working Group recommended a number of initiatives to assist the markets in coping with future periods of extraordinary price swings and volume surges. These initiatives included expansion of the operational capacity of the markets, streamlining of clearance and settlement operations, and the adoption of circuit breakers that would provide coordinated trading halts and reopenings for large, rapid market declines that threaten to create panic conditions.

According to the Interim Report, circuit breakers were designed to substitute planned trading halts for ad hoc, destabilizing market closings. Such ad hoc trading halts were manifest during the October 1987 Market Break through systems breakdowns, reduced liquidity, and concerns over trading because of fears of counter-party and clearing corporation failure.²¹ Thus, the Working Group recommended that all U.S. markets for stocks, options, and futures halt trading for one hour if the DJIA declined 250 points from its previous day's closing level and halt trading for two hours if the DJIA declined 400 points from its previous day's closing level.²² In addition, the Working Group anticipated quarterly reviews of the circuit breaker thresholds to determine whether changes in index levels necessitated changes to the triggers so that they continue to reflect percentage declines approximately equivalent to 12% and 20%.²³

Partly in response to the October 1987 Market Break and the recommendations of the Brady Report and the Working Group, the securities and stock index futures markets submitted proposals to the Commission and CFTC in 1988 to implement circuit breakers that would impose temporary trading halts following significant market declines. The circuit breaker rules for the securities and stock index futures markets were implemented on a pilot basis beginning in October 1988,²⁴ and have been extended on that basis each year since their adoption.

The circuit breakers approved in 1988 provided for a one-hour trading halt in all securities markets if the DJIA declined 250 points from its previous day's closing level and for a subsequent two-hour trading halt if the DJIA declined 400 points from its previous day's close. In addition, the original circuit breaker procedures allowed the markets to use abbreviated reopening procedures to permit trading to reopen before the scheduled closing. The abbreviated reopening procedures were also to be used to establish closing prices if the DJIA reached the 250-point trigger during the last hour, but before the last half-hour, of trading, or if the DJIA reached the 400-point trigger during the last two hours, but before the last hour, of trading.²⁵

In approving the original circuit breakers, the Commission and CFTC noted that the circuit breakers were not an attempt to prevent markets from reaching new price levels, but an effort by the securities and futures markets to arrive at a coordinated means to address potentially destabilizing market volatility along the lines of the historic decline of the October 1987 Market Break.²⁶ While concurring in the rationale of the Brady Report and the Interim Report regarding the purpose of circuit breakers, the Commission also believed that circuit breakers would help promote stability in the equity and equity-related markets by providing for increased information flows and enhanced opportunity to assess information during times of extreme market movements. The Commission believed that circuit breakers could provide market participants with an opportunity to re-establish an equilibrium between buying and selling interest and ensure that market participants had a reasonable opportunity to become aware of and respond to a dramatic market decline.²⁷

B. Modifications to the Circuit Breakers in 1996 and 1997

When these circuit breaker changes were approved in July 1996, the agencies reiterated their strong concern that the sharp rise in stock prices since 1988 had reduced the circuit breaker thresholds to levels that were too low. When the circuit breakers were adopted in 1988, the 250-point threshold represented a DJIA decline of 12% and the 400-point threshold represented a decline of 19%. By July 1996, the 250-point and 400-point triggers represented DJIA declines of 4.5% and 7%, respectively. Accordingly, in approving the shorter trading halts in July 1996, the Commission encouraged the markets to continue to evaluate the trigger levels for the trading halts to increase them to levels that reflected their original design.³⁰

Subsequently, when the agencies approved a six-month extension of the circuit breakers in October 1996,³¹ the Commission again urged the markets to reach a consensus on the size of increases in the trigger levels required to ensure that cross-market trading halts would be imposed only during market declines of historic proportions.³²

In response to the agencies' recommendations, the markets submitted proposals to increase the circuit breaker triggers to levels of 350 and 550 points in the DJIA.³³ In approving the 350/550 trigger levels through January 31, 1998, the Commission stated that the new trigger levels represented a substantial improvement over the existing 250/400 trigger levels. Nevertheless, the Commission noted that trigger levels should be amended to reflect an extraordinary decline under prevailing market conditions and that the Commission and CFTC would work with the markets to develop procedures for reevaluating the circuit breaker triggers on at least an annual basis.³⁴

II. Findings Regarding the Effects of Circuit Breakers on October 27, 1997

The following discussion is based on the Division's trading reconstruction and OEA's data for October 27, 1997, as well as on information compiled in interviews with the most active broker-dealers and mutual fund complexes.

A. The First Circuit Breaker Was Too Low

Traders indicated that, as the first circuit breaker trigger was being approached, overall trading and market operations appeared to be orderly. While a few firms indicated that pricing in stocks, options, and futures was becoming difficult because of price gapping³⁶ and price data transmission delays, most firms indicated that they were experiencing no significant problems along these lines prior to the 2:36 p.m. halt.³⁷ While some traders reported a reduction in market liquidity, there were no indications that liquidity problems might result in the types of ad hoc trading halts that circuit breakers were designed to address.

No firms reported panic selling by their institutional, retail or professional accounts.³⁸ Several firms indicated that their customer and proprietary accounts, particularly accounts that had been purchasers of stocks earlier in the day, pulled back from trading as the 350-point circuit breaker approached due to the uncertainties surrounding the first-ever triggering of the cross-market halt procedures. Only a few firms indicated that institutions increased somewhat the size and frequency of their outstanding sell orders in order to beat the pending halt.

B. Evidence Is Mixed Whether the First Circuit Breaker Had a "Magnet Effect"

First, the decline in the DJIA came within seven points of the 350-point trigger at 1:59 p.m., but prices then stabilized and recovered approximately 70 points by 2:10 p.m. Second, there is no clear pattern of an accelerating market decline from 2:10 p.m. to 2:36 p.m. as the DJIA reached the trigger point. As indicated in the graph at B-5, the Division found that the largest one-minute percentage decline in the DJIA during this period occurred around 2:16 p.m. The price decline abated for a few minutes shortly after 2:20 p.m. and again at 2:34 p.m. before the 350-point threshold was reached.

Second, although the OEA data indicate that the rate of decline in S&P 500 stocks accelerated as the first circuit breaker approached, with S&P 500 stocks declining at a rate of 0.03% per minute between 1:03 p.m. and 2:35 p.m. (compared 0.01% per minute between 9:30 a.m. and 1:03 p.m.), the rate of decline is not as dramatic as the rate of decline between 3:06 p.m. and 3:30 p.m., when S&P 500 stocks declined at a rate of 0.10% per minute.³⁹

Third, there was no appreciable increase in trading volume on the NYSE in the period immediately prior to the first circuit breaker.⁴⁰ If there had been a magnet effect, a surge in trading volume would have been expected as a function of investors rushing into the market in an attempt to trade before the circuit breaker could be implemented.

Overall, therefore, the Division believes that the evidence is mixed as to whether the 350-point circuit breaker had a magnet effect.

C. The 30-Minute Halt Was Benign but of Little Utility

In addition, most firms did not find the halt to be useful in assessing market conditions or in handling inquiries from institutional customers. In fact, the NYSE disseminated pre-opening indications in only a few stocks because most stocks had no sizeable order imbalances prior to the 3:06 p.m. reopening. Overall, it appears that the vast majority of firms simply had their trading staffs wait out the halt. Traders at a few firms were of the opinion that the halt may have somewhat exacerbated worries among professional and institutional traders. Most firms, however, found the halt to have been benign.

D. Market Reopenings Appear To Have Been Orderly

Firms generally experienced no significant difficulties in executing orders in listed or Nasdaq stocks immediately following the halt. Several firms, however, commented on the overall reduction in liquidity in the stock, options, and futures markets from 3:06 p.m. to 3:30 p.m. as buyers withdrew from the markets. In general, the rapid reopening of NYSE and Nasdaq stocks after the first circuit breaker was probably due to the fact that the first halt occurred after only a moderate decline while trading was still orderly.

E. The Second Circuit Breaker May Have Had a Magnet Effect

In addition, between 3:06 p.m. and 3:30 p.m., the price decline did not accelerate in a clear pattern. As indicated in the graph at B-6, the largest one-minute percentage declines in the DJIA during this period were experienced around 3:12 p.m. and 3:14 p.m. and again around 3:24 p.m. and 3:25 p.m. and the rate of decline abated somewhat in the intervening period and again just before the 550-point threshold was reached at 3:30 p.m. The absence of a clear pattern of an accelerating market decline from 3:06 p.m. to 3:30 p.m. again is not entirely consistent with a magnet effect for the second circuit breaker level.

Nevertheless, the velocity of the market decline and the OEA market-making statistics for the period immediately before the second circuit breaker halt indicate that it may have had some magnet effect.

During the period between the reopening of the markets at 3:06 p.m. and the triggering of the second circuit breaker at 3:30 p.m., the DJIA declined over 200 points. The OEA data indicate that the velocity of the price decline in S&P 500 stocks also increased significantly during this period, with S&P 500 stocks declining at a rate of 0.10% per minute (or 6% per hour) between 3:06 p.m. and 3:30 p.m., ten times more quickly than their decline at a rate of 0.01% per minute (or 0.6% per hour) between 9:30 a.m. and 1:03 p.m. The price decline for the period immediately before the second circuit breaker also is more rapid than the decline between 1:03 p.m. and 2:35 p.m., when S&P 500 stocks declined at a rate of 0.03% per minute (or 1.8% per hour).⁴²

The increase in quote spreads between 3:06 p.m. and 3:30 p.m. also suggests a possible magnet effect associated with the second circuit breaker. Between 3:06 p.m. and 3:30 p.m., mean relative spreads (the quoted dollar bid-ask spread divided by the spread mid-point) for S&P 500 stocks were approximately 46 basis points, a 47% increase over the mean relative spread of 31 basis points on October 23.⁴³

Effective quote spreads (calculated by doubling the difference between the trade price and the midpoint of the bid-ask spread), which reflect the cost of trades executed inside the quote spread, also increased throughout the day on October 27, but most significantly after the first circuit breaker. For S&P 500 stocks traded on the NYSE, the mean effective spread was 10.6 cents per share between 9:30 a.m. and 1:03 p.m., 12.9 cents per share between 1:03 p.m. and 2:35 p.m., and 18.1 cents per share between 3:06 p.m. and 3:30 p.m. Mean effective quote spreads for DJIA stocks also increased during these periods, rising from 10.4 cents per share during the first period, to 14 cents per share during the second period, to 23.4 cents per share during the third period.⁴⁴

Finally, the ratio of bid depth to ask depth exhibited a similar pattern. The median bid depth to ask depth ratio fell somewhat from the morning session to the first pre-halt period on October 27, then dropped substantially in the post-halt period.⁴⁵

Although the sharp increase in the rate of decline in the S&P 500 stocks between 3:06 p.m. and 3:30 p.m. is consistent with a magnet effect for the second circuit breaker, it is not possible to state definitively, on the basis of a single event, that the second circuit breaker produced a magnet effect. Given the increase in volatility prevailing at that time, it is impossible to place responsibility for the swiftness of the decline between 3:06 p.m. and 3:30 p.m. solely on the second circuit breaker.

F. A Normal Close Should Have Been Permitted

The OEA data for October 27 are consistent with the traders' observation that the early market closure was unnecessary. Although quote spreads widened throughout the day on October 27, other measures of market quality suggest that, overall, the markets were functioning in an orderly manner with sufficient liquidity on October 27.

For example, the number of transactions and shares traded at the bid before a downtick (i.e., a change in price downward) reflect the amount of liquidity at a bid quote and the markets' ability to absorb selling pressure. On October 27, data in both S&P 500 stocks and DJIA stocks reveal a fair amount of liquidity at each quote and suggest that the markets were able to function in an orderly manner. The OEA data in Attachment D do not indicate that there was chaotic pricing or destabilizing price moves in the late afternoon of October 27. Although certain measures, such as the ratio of bid depth to ask depth, quote spreads, and acceleration of price declines, show a deterioration after the first circuit breaker, they clearly do not indicate an impending systemic breakdown or failure to maintain an orderly market. Indeed, the decline in market measures may have been due not only to the increase in volatility, but also in part to the uncertainty caused by the prospect of a premature close of trading from the approach of the second circuit breaker.

G. Most Firms Did Not Have Large Unexecuted Orders

While the number of unexecuted orders when the markets closed at 3:30 p.m. apparently was not large at the firms interviewed by the Division, OCIE's inspections of broker-dealers found that there was confusion at firms as to how to properly execute pending customer orders and orders that were received after the markets closed on October 27. Most firms apparently executed these orders when the stock markets reopened on October 28. In order to address uncertainties if a future market decline results in a circuit breaker halt that closes the markets early, the Division has discussed its views in a staff legal bulletin which has been issued concurrently with the release of this report.⁴⁷ The bulletin reminds broker-dealers that customer orders received under these circumstances should be treated in the same manner as they would be when an SRO imposes a regulatory trading halt in a single security. Such security-specific regulatory halts occur virtually on a daily basis. If an issuer is about to release material corporate news during a trading session, the SRO that serves as the primary market for the issuer's securities would impose a regulatory trading halt (for "news pending") that is honored by all of the other SROs until the news is disseminated and the halt is lifted. Broker-dealers and the markets already know how to handle orders when an individual stock is halted under these circumstances, and the Division believes that there is no reason to adopt different practices for circuit breaker halts. Accordingly, the Division believes that, unless a customer indicates otherwise when submitting an order, orders that are pending when a circuit breaker is triggered, or that are received afterward, should be treated as "Good 'Till Cancelled" orders and held for execution at the reopening on the next trading session. Pending orders marked as "At-the-Close" orders (including "Market-at-Close" or "Limit-at-Close") should be treated as cancelled. In addition, no new orders relating to closing prices may be accepted.⁴⁸ The bulletin also indicates that, when circuit breakers have closed the markets, broker-dealers should make every reasonable effort to notify customers how their orders will be treated.⁴⁹

H. The Early Close Could Have Resulted in Severe Derivative-Related Losses

I. Evidence Is Mixed on Whether the Early Close Harmed Foreign Markets

Nevertheless, the Division recognizes that foreign markets have often fallen sharply immediately following previous U.S. market declines, such as those in October 1987,⁵³ October 1989,⁵⁴ and November 1991,⁵⁵ when circuit breakers were not employed. It may not be possible, therefore, to determine the precise extent to which the continuing market declines on foreign markets on October 28, 1997, were due to the early market closure on October 27 rather than the severity of the U.S. market decline itself or other factors related to the foreign markets' own trading dynamics. Nevertheless, the severity of the foreign market declines on the morning of October 28 appears to indicate that the early closure of the U.S. market on October 27 may have at least contributed to these declines

J. Preopening Pricing on October 28 Was Viewed As Helpful

III. Regulatory Initiatives Since October 27, 1997

As an interim measure, the markets adopted modest changes designed to reduce the likelihood that the 350/550-point trigger levels would preclude normal market closes. Specifically, the Commission and the CFTC approved changes effective through April 1998 which provided that the markets would not implement the 30-minute circuit breaker halt if the DJIA reached the 350-point trigger on or after 3:00 p.m. and would halt trading for only 30 minutes (rather than an hour) if the DJIA reached the 550-point threshold on or after 2:00 p.m. but before 3:00 p.m. If the DJIA reached the 550-point threshold on or after 3:00 p.m., the markets would have continued to use the one-hour halt, which would have ended the trading session early.⁵⁶

In discussions with the securities and stock index futures markets aimed at achieving a consensus on expanded circuit breaker levels, the Commission indicated its firm belief that the 10% and 20% circuit breakers should not close the markets prematurely during the trading day. In addition, at a U.S. Senate hearing on January 29, 1998, the Working Group agencies and most senators indicated a strong preference for the markets to remain open whenever possible and a disinclination for circuit breakers to close the markets for the day.

In response to Congress's and the agencies' concerns, the securities and futures markets submitted proposals to revise their circuit breaker procedures. The Commission and the CFTC approved the revised procedures in April 1998.⁵⁷ The circuit breakers adopted by the securities exchanges establish trading halts following one-day declines in the DJIA of 10%, 20%, and 30%. The NYSE will calculate the trigger levels at the beginning of each calendar quarter, using the average closing value of the DJIA for the previous month to establish specific point values for the quarter. Under the securities exchanges' revised circuit breaker procedures, trading will halt for one hour if the DJIA declines 10% prior to 2:00 p.m., and for one-half hour if the DJIA declines 10% between 2:00 p.m. and 2:30 p.m. If the DJIA declines by 10% at or after 2:30 p.m., trading will not halt at the 10% level. If the DJIA declines 20% prior to 1:00 p.m., trading will halt for two hours; trading will halt for one hour if the DJIA declines 20% between 1:00 p.m. and 2:00 p.m., and trading will halt for the remainder of the day if a 20% decline occurs at or after 2:00 p.m. If the DJIA declines 30% at any time, trading will halt for the remainder of the day.

The futures exchanges trading stock index futures have adopted substantially identical circuit breaker procedures. However, the Chicago Mercantile Exchange ("CME") has adopted a daily price limit for the S&P 500 futures that will permit a maximum daily downward price movement of 20%, while the securities exchanges' circuit breaker procedures will permit trading in the range of 20% to 30% down prior to 2:00 p.m. In addition, the CME's variation margin settlement values will be based on the 20% limit price, rather than on a price derived from the closing index value. While noting the disparities in the markets' procedures and urging the CME to reconsider its 20% cap on variation margin, the regulators, in approving the revised procedures, concluded that the markets' rules are substantially identical for purposes of the effectiveness of the circuit breaker rules.⁵⁸

In adopting the securities markets' revised circuit breaker procedures, the Commission noted that the amended trigger levels reflect the type of severe one-day market declines that circuit breakers were intended to address. The Commission concluded that the revised trigger levels are consistent with the intended design and function of the circuit breakers, and that they should not cause premature or unnecessary trading halts. In addition, the Commission found that the revised circuit breaker procedures sufficiently address the need for the markets to remain open or to reopen during the trading day to permit an orderly market close.⁵⁹

IV. Conclusions Regarding Cross-Market Trading Halts

First, the circuit breaker thresholds needed to be raised significantly from those in place on October 27. When the 350-point trigger was reached on October 27, the DJIA was down only 4.54%, a level that had been reached on 11 previous days since 1945. Moreover, there was little evidence of the types of market liquidity constraints that would have justified cross-market halts. Circuit breaker halts should be reserved for an abrupt market decline of a magnitude that raises concerns that the exhaustion of market liquidity might result in uncoordinated, ad hoc market closures.

Second, the trading dynamics on October 27 illustrated the need for circuit breakers to permit trading to resume whenever feasible for orderly market closings. The early market closure on October 27 does not appear to have been necessary. Moreover, investor concerns that the second circuit breaker would close the market may have accelerated the price declines in the last 24 minutes. Concerns over a likely premature market close may have resulted in a transfer of selling pressure to the futures markets (which offered faster executions in the limited time remaining), with stock prices quickly following futures down to the 550-point trigger level. In addition, although the harm to investors and markets from the early closure on October 27 may be difficult to quantify, our review highlighted the types of losses that could result if circuit breakers prevent day-end unwindings of highly leveraged derivative positions. While the derivative losses on October 27 appear to have been isolated and manageable, losses could have been many times worse if unwindings had been precluded on dates when more exchange-traded and OTC derivatives expire.⁶⁰

Third, the events of October 27 reinforced the need for regulators to periodically re-examine circuit breaker procedures to ensure that they reflect both changing market levels and the increasing capacity of the markets to handle greater trading volumes and price volatility in an orderly manner. As markets continue to grow and change, the regulatory agencies and the self-regulatory organizations must monitor and revise circuit breakers and other protective measures to ensure that they continue to function as intended and achieve their goals with minimal market disruptions.

IV – Determinations Regarding Operational Capacity

Nevertheless, the Division noted that a number of alternative trading systems, known as electronic communication networks ("ECNs"), had their systems capacity severely strained during the sharp price swings and heavy trading volumes on October 27 and 28. Several ECNs experienced system outages and one significant ECN withdrew its quotes from Nasdaq because of lack of capacity. Similarly, a major interdealer broker in non-exempt securities experienced serious capacity problems in processing the large number of transactions on these days and had to close down temporarily.

B. Exchange Quotations for Stocks and Options

C. Nasdaq Systems

II. Broker-Dealer Systems

Overall, the broker-dealers did not have adequate excess capacity to handle peak periods on October 28. As a result, full-service broker-dealers experienced at least some trading system problems on October 28, which interfered with timely executions of customer orders. In addition, while several online broker-dealers executed record numbers of customer orders on October 28, some firms experienced limited degradation in their Internet access systems, which prevented certain customers from accessing their online accounts in a timely manner. While several firms offered price adjustments to customers who received delayed executions, more efforts can be made by broker-dealers to address these problems.

The Division has sought to address the need for improvements in these areas as part of its staff legal bulletin that has been issued concurrently with this report.⁶⁵ In particular, the firms should make greater efforts to meet the guidelines set forth in the Commission's automation review policy statements. Broker-dealers should recognize the importance of having adequate capacity to handle high volume or high volatility trading days, and to conduct capacity planning on a regular basis.⁶⁶ Broker-dealers should also consider other appropriate measures to minimize potential capacity problems, including developing back-up technology systems and developing procedures for handing system problems. Online broker-dealers might consider additional steps, such as enhancing their internal capacity and their links to the Internet, prioritizing customer access at peak times (such as limiting some general price inquiries in order to facilitate executions of customer orders), educating their customers about Internet access issues, and providing customers with alternative means to place orders when Internet access is slow or unavailable.⁶⁷ Broker-dealers should also use every reasonable effort to notify customers about operational difficulties.⁶⁸

Part V – The Division's Trading Reconstruction

A. The Bull Market

Much of the gain in share prices was accompanied by generally declining interest rates, particularly since late 1994. For example, while yields for the benchmark 30-year Treasury bonds fluctuated throughout this period, bond yields generally declined from a high of 8.166% on November 7, 1994, to around 6.3% on July 31, 1997, with the yield edging up to 6.481% as the DJIA peaked on August 6.⁷³ This environment of relatively low interest rates, coupled with indications of continuing low inflation and rising corporate earnings, was cited by many market commentators as justifying stock price valuations that were high by some traditional valuation measures.⁷⁴ For example, by September 1997, the dividend yield on the S&P 500 stocks had reached a then-historic low of 1.63%, well below the yield of 2.83% in July 1987 as stock prices were peaking before the October 1987 Market Break.⁷⁵ Similarly, the price/earnings ratio for S&P 500 stocks reached a peak of 24.00 in September 1997, exceeding the 22.33 ratio in August 1987.⁷⁶ Nevertheless, even as share prices pulled back slightly for several weeks following the August 6 high, many investors and market commentators continued to view the favorable interest rate, inflation, and corporate earnings environment as justifying further share price gains.

The continued optimism for stock prices was also apparently fueled by the historic increase in investor interest in equity mutual funds since the late 1980s. According to the Investment Company Institute, the asset values of equity funds had soared from $76 billion in January 1984 to over $2.39 trillion in September 1997, an increase of 3,030%.⁷⁷ Strong investor interest in equity funds evidently continued even after short-term stock price declines, such as the 247.37 point (3.11%) decline in the DJIA on August 15, 1997.⁷⁸ The high level of interest in U.S. stocks was also reflected in the increasing share volume levels on the NYSE and Nasdaq. The NYSE average daily share volume grew from less than 200 million shares in 1991 to over 500 million shares by October 1997. During the same period, Nasdaq average daily share volumes rose to over 600 million shares.⁷⁹ Volume levels on the NYSE and Nasdaq remained strong in 1997 through October.⁸⁰

Nevertheless, a number of market commentators expressed increased concern in the late Summer and early Fall of 1997 that high stock valuations made the market vulnerable to a sharp pull-back in prices if one or more factors arose, such as a changed interest rate outlook by the Federal Reserve, signs of incipient inflation, disappointing corporate earnings or unexpected world events such as a war or other international crisis.⁸¹ These concerns were particularly strong as the ten-year anniversary of the October 1987 Market Break approached.⁸²

B. The Decline in Pacific Rim Markets

This pattern remained in place through much of 1997, when U.S. share prices continued to rise despite mounting losses on some of the smaller Southeast Asian markets. For example, the stock market in Thailand, as measured by the Bangkok SET Index, had a year-to-date decline of more than 44% by June 19, 1997. U.S. stock prices continued to rise during this period.⁸⁵ This relationship was maintained even through July and August 1997 as the currency crisis in Thailand accelerated.⁸⁶ Similarly, U.S. stock prices showed little reaction as currency volatility contributed to declines in other small Southeast Asian markets, such as Indonesia and Malaysia, which experienced year-to-date percentage losses in their stock markets that reached almost 23% and 35%, respectively, by late August 1997.⁸⁷ In fact, prices for broad U.S. indexes, such as the S&P 500 index, established new closing highs on October 7, 1997, despite the sharp declines in the smaller Asian stock markets over the preceding months.

Anxieties over possible "contagion" effects began to be reflected in stock markets worldwide, however, when the currency and share price instability appeared to spread to other Pacific Rim markets, such as the much larger Hong Kong market, in the week of October 20, 1997. On the three trading sessions on Monday, October 20, to Wednesday, October 22, Hong Kong share prices declined 14.43% in reaction to concerns over the ability of the Hong Kong Dollar to remain "pegged" to the U.S. Dollar. Despite the severity of this three-day decline in Hong Kong, however, the reaction in other markets began to build only slowly.⁸⁸

This situation began to change when short-term interest rates in Hong Kong were raised sharply on Thursday, October 23, in order to support the Hong Kong Dollar, and the decline in share prices in Hong Kong accelerated. When the Hong Kong Hang Seng Index plunged 1,211.47 points (10.41%) to close at 10,426.30 on October 23, the Tokyo Nikkei closed down 536.06 points (3.03%) at 17,151.55, the London FTSE closed down 157.30 points (3.06%) at 4,991.50, and the DJIA declined 186.88 points (2.33%) to close at 7,847.77. Comparable price declines were experienced on other markets worldwide.⁸⁹

On Friday, October 24, the Hang Seng Index rallied 718.04 points (6.89%) to close at 11,144,34, and the Nikkei closed up 212.19 points (1.24%) at 17,363.74, while the FTSE declined only 21.30 points (0.43%) to close at 4970.20.⁹⁰ U.S. stock prices initially rallied on the morning of October 24, with the DJIA rising almost 92 points at its intra-day high. Continuing worries over the effects of the Asian turmoil on the U.S. bull market, however, resulted in a further decline in U.S. share prices throughout the afternoon. As a result, the DJIA closed down 132.36 points (1.69%) at 7,715.41. By the end of the trading session on October 24, it was also becoming clear to investors that the market turmoil was taking a severe toll on other emerging markets, such as stock markets in Latin America, several of which had been outperforming U.S. markets for much of the year.⁹¹ For example, in Brazil, the Sao Paulo Bovespa Index closed down 2.97% on October 24, while the Argentine Merval Index fell 4.17% and the Mexican I.P.C. All-Share Index fell 2.74%.

The expansion of the market turmoil beyond small Southeast Asian markets to larger Pacific Rim markets and emerging markets in Latin America during the week of October 20 evidently raised serious concerns among institutional and professional traders that economic slowdowns and even deflationary pressures in these markets could adversely affect U.S. corporate earnings. Moreover, if earnings projections were adjusted downward significantly, these investors evidently had reservations that the historically high U.S. stock valuations at that time were likely to be surpassed or even sustained in the short term.⁹² As a result, by Monday, October 27, some institutional and professional traders were prepared to reduce their equity exposure in the U.S. or at least to increase their equity hedges significantly, either directly through stock sales or indirectly through trades in stock index futures.

II. October 27, 1997

A. Foreign Market Declines and Pre-Opening Indications in the U.S.

On Monday, October 27, the Hong Kong Hang Seng Index declined 646.14 points (5.80%) to close at 10,498.20, thereby reversing much of Friday's gain. While the reaction to this renewed decline in Hong Kong was moderate in Tokyo, where the Nikkei closed down only 325.38 points (1.87%) at 17,038.36, the overnight share price declines in other markets were more severe.⁹³ By around 9:00 a.m. on October 27, the decline in European stock markets was already widespread. While the London FTSE was trading down a moderate 1.53%, the Frankfurt Dax had closed down 4.24% (after-hours trading on the Frankfurt IBIS Dax was showing that index down 2.71%), and the Paris CAC was trading down 3.09%.⁹⁴

Nevertheless, the pre-opening indications in the U.S. markets remained fairly moderate on the morning of October 27. The December S&P 500 futures contract on the Chicago Mercantile Exchange's Globex automated trading system had traded as low as down 14.00 points (1.48%) at 930.00 around 7:55 a.m. The futures, however, ended the after-hours trading session at 9:00 a.m. down only 10.25 points (1.09%) at 933.75, which forecast a decline in the DJIA of approximately 80-to-100 points at the 9:30 a.m. opening of the NYSE.⁹⁵

When the S&P 500 futures began their regular floor trading session at 9:15 a.m.,⁹⁶ prices actually improved somewhat from the levels set earlier on the Globex automated trading system. While the futures had ended the Globex session at 9:00 a.m. down 10.25 points, floor trading began with the futures down only 8.00 points (0.85%) at 936.00. Futures prices fluctuated in approximately a 2 1/2 point range as the 9:30 a.m. opening for the stock market approached. As of 9:30 a.m., the S&P 500 futures were down 7.00 points (0.74%) at 937.00, which forecast a decline in the DJIA of 50-to-70 points.⁹⁷

B. Market Declines in the Morning

Therefore, even at the low point for the DJIA on the morning of October 27, the decline in the index was not particularly severe in percentage terms. On an intra-day basis, the 2.37% decline in the DJIA at 11:30 a.m. on October 27 had been exceeded on six previous trading sessions in 1997 alone.¹⁰⁶ Similarly, the CFTC staff reports that the 15-point price limit in the S&P 500 futures, which was triggered at 11:14 a.m. on October 27, had been reached on 15 prior trading sessions in 1997.

The relatively moderate nature of the market decline on the morning of October 27 is also reflected in the price velocity statistics compiled by OEA. These statistics show that the rate of decline in the S&P 500 index was only 0.01% per minute in the interval from 9:30 a.m. to 1:03 p.m. on October 27, compared to a rate of 0.007% per minute for the same period on October 23.¹⁰⁷ This pattern is also reflected in the quotation and market-making statistics developed by OEA. While OEA calculated that the quote percent spreads for NYSE and Nasdaq stocks from 9:30 a.m. to 1:03 p.m. on October 27 were somewhat wider than those during a comparable period on the control date of October 23, 1997, the October 27 morning spreads were significantly narrower than those evident during the late afternoon.¹⁰⁸ The NASD staff reported comparable quote spread statistics for Nasdaq stocks. Specifically, the NASD staff calculated that, while Nasdaq spreads were 11% higher than normal on the morning of October 27, they were significantly narrower than in the afternoon, when Nasdaq spreads were running 17% to 19% above normal. The OEA statistics for the "effective spreads" for NYSE stocks on the morning of October 27 also generally followed this pattern.¹⁰⁹

In another measure of liquidity, OEA found that the "bid down tick" trades and volumes for NYSE stocks on the morning of October 27 were generally somewhat greater than those during a comparable period on the October 23 control date.¹¹⁰ On the other hand, OEA found that the average bid and ask depths (greater depths, in general, indicate greater liquidity) were somewhat less in key NYSE stocks on the morning of October 27 as opposed to those on the morning of October 23.¹¹¹

In terms of NYSE specialist activity, OEA found that specialist trading patterns on October 23 and 27 were similar. On both days, specialists in aggregate were slight net sellers of DJIA stocks from 9:30 a.m. to 1:03 p.m. and slight net buyers of stocks in the S&P 500 index.¹¹² In view of the up and down spikes in share prices throughout the morning and early afternoon on October 27, it is not surprising that specialist buying and selling during this period were more or less evenly matched.

It appears that the stock market decline on the morning of October 27 was accompanied by only moderately heavy trading volume. The Division found that 75.4 million shares traded on the NYSE by 10:00 a.m., which was only 6.38% higher than the first-half hour average for the previous week. Even by 10:30 a.m., total NYSE volume was only 140.1 million shares, which was only 7.21% above the first-hour average for the prior week, and well below the first-hour volume then-record of 279 million shares set on December 15, 1995. For the morning as a whole, NYSE share volume totalled only 318.1 million shares, a level only 15.41% above the prior week's average.¹¹³

Overall, the relatively moderate price declines and trading volume levels on the morning of October 27 are consistent with the indications of order flows that were provided to the Division in interviews with the most active trading firms and mutual fund complexes. Most of the traders indicated in their interviews that there were no signs of panic selling by institutional or proprietary accounts in the morning despite the severity of the price declines in foreign markets overnight. The frequent periods throughout the morning in which U.S. share prices stabilized temporarily and even staged partial recoveries are also consistent with reports from traders that a number of institutional accounts took advantage of some of the morning's price declines to step in and buy stocks that appeared oversold. This is also confirmed by the indications that the strongest relative increases in NYSE share volume on the morning of October 27 (when compared to trading levels in the prior week) occurred as stock prices staged a partial recovery from 11:30 a.m. to 12:00 p.m.

The Division found that the levels of program trading on the morning of October 27 were also more or less normal. The graphs at B-12 and B-13 indicate that, while there were repeated surges in program selling throughout the trading session on October 27, most of the program buying appears to have been concentrated in the morning and early afternoon.¹¹⁴ As a result, many of the periods in the morning when share prices stabilized and managed partial recoveries coincided with periods when program buying outpaced program selling. For example, while sell orders accounted for 69% of all program orders when share prices fell sharply in the first ten minutes of trading,¹¹⁵ this situation was quickly reversed as share prices recovered. Buy orders accounted for 89% of program orders from 9:40 to 9:50 a.m. and 92% of program orders from 9:50 to 10:00 a.m. This pattern was particularly pronounced when share prices began their strongest recovery in the morning between 11:30 a.m. and 11:40 a.m., when 95% of all program trading orders were on the buy-side.¹¹⁶ The statistics compiled by OEA that provide an account type breakdown for NYSE volume in S&P 500 index stocks also reflect the slight preponderance of buy-side activity by program trading firms during this interval.¹¹⁷

C. Market Declines to the First Circuit Breaker at 2:36 p.m.

Although by 1:59 p.m. the decline in the DJIA had come within seven points of the 350-point trigger for the first circuit breaker halt, prices rebounded approximately 70 points by 2:10 p.m., leaving the DJIA down 273.33 points (3.54%). A similar partial price recovery was experienced in the S&P 500 index, which reduced its decline to 34.69 points (3.68%) at 2:10 p.m. Nasdaq stocks also followed this trend to reduce their decline to 84.82 points (5.14%) by 2:11 p.m.

Share prices thereafter resumed their decline. The DJIA was down 327.84 points (4.25%) at 2:20 p.m. The DJIA recouped over 20 points in the next few minutes, and fell once again to reach minus 354.36 points (4.59%) at 2:36 p.m., thereby triggering the first circuit breaker trading halt. At that point, the S&P 500 index was down 43.63 points (4.63%) and the Nasdaq composite index was down 92.86 points (5.62%).¹¹⁹ The S&P 500 futures had hit their 45-point price limit at 2:35 p.m., which resulted in a trading halt in the futures when the first circuit breaker was implemented.¹²⁰

Between 2:00 p.m. and 2:30 p.m., share volume continued to be strong, with 60.5 million shares trading on the NYSE, which represented an increase of 74.25% above the prior week's average for this period. Nevertheless, there was no appreciable increase in volume on the NYSE immediately prior to the circuit breaker triggering. Specifically, the NYSE reported that 17.7 million shares traded from 2:30 p.m. to 2:36 p.m., compared to 18.4 million shares traded during the previous ten minutes.

The statistics developed by OEA highlight the increase in the velocity of the stock market decline in the period leading up to the first circuit breaker triggering at 2:36 p.m. Specifically, OEA calculated that the rate of the price decline in the S&P 500 index increased from 0.01% per minute in the interval from 9:30 a.m. to 1:03 p.m. to a rate of 0.03% per minute from 1:03 p.m. to 2:35 p.m.¹²¹

Quote spreads widened as the market decline accelerated. The quote spreads for NYSE and Nasdaq stocks from 1:03 p.m. to 2:35 p.m. on October 27 were significantly wider than those during a comparable period on the control date of October 23. Moreover, the quote spreads had widened from those evident earlier on October 27.¹²² Similar patterns were found for the effective spreads for NYSE stocks from 1:03 p.m. to 2:35 p.m. on October 27.¹²³

Nevertheless, the markets were still functioning in an orderly manner with sufficient liquidity and operational capacity. For example, OEA found that the statistics for "bid down tick" trades and volumes for S&P 500 index and DJIA stocks generally showed slightly more depth in the interval from 1:03 p.m. to 2:35 p.m. on October 27 in comparison with the statistics for the earlier part of the day.¹²⁴ In terms of NYSE specialist activity, OEA found that specialists in aggregate had increased their net buying in both DJIA and S&P 500 index stocks as the share price declines accelerated.¹²⁵ The price declines were increasing in velocity, but prices were not gapping or exhibiting poor continuity.

The price trends found by the Division and OEA for the period leading up to the first circuit breaker halt are generally consistent with the indications of order flows that were provided to the Division in interviews with the most active trading firms and mutual fund complexes. In particular, the rebounds in share prices around 2:00 p.m. and again around 2:20 p.m. are consistent with reports from traders that a number of institutional accounts continued to take advantage of the price declines in the early afternoon to step in and buy stocks that appeared oversold. The trading volumes and the market depth statistics for this period, however, are somewhat stronger than the market conditions indicated by the traders in their interviews. As discussed above, while a few traders acknowledged that some customers increased their selling as the market decline worsened, many traders claimed that selling by their institutional and proprietary accounts abated somewhat as the circuit breaker threshold was approached. Moreover, a number of traders observed that, while trading was orderly, there were already some signs of a general deterioration in market liquidity and depth as the price declines approached the first circuit breaker trigger point.

The Division found that program selling reached significant levels during several periods of the sharpest market declines from 1:50 p.m. to 2:36 p.m.¹²⁶ For example, 98% of the program trading from 1:50 p.m. to 2:00 p.m. was on the sell-side, with the 6.47 million shares of program selling representing 21.53% of total NYSE volume and 34% of NYSE volume in S&P 500 stocks. Similarly, 97% of the program trading from 2:30 p.m. to 2:36 p.m. was on the sell-side, with the 4.74 million shares of program selling representing 26.79% of total NYSE volume and 40.20% of NYSE volume in S&P 500 stocks. Nevertheless, there were also periods during the market declines after 2:00 p.m. in which program trading was negligible. For example, program selling accounted for only 5.47% of total NYSE volume and 9.02% of NYSE volume in S&P 500 stocks from 2:20 p.m. to 2:30 p.m. In addition, while the statistics developed by OEA concerning program trading in the interval from 1:03 p.m. to 2:35 p.m. show an increase in program sell volume in the S&P 500 stocks (in comparison with program selling in the earlier part of the day), the percentage of share volume from program selling remained a moderate 18.6%.¹²⁷ Overall, therefore, it appears that, while program selling may have contributed to the velocity of the stock market declines at some key periods, this type of selling was insufficient to explain the magnitude of the market declines leading to the first circuit breaker triggering at 2:36 p.m.

Our trading analysis also indicates that most of the program selling that was effected during the market declines leading to the circuit breaker triggering did not involve classic index arbitrage. From 1:50 p.m. to 2:36 p.m., index arbitrage was reported to constitute only 7.93% of total program selling. Another 31.51% of program selling, however, was for quantitative program trading strategies that had some elements of arbitrage timing of futures trading. Nevertheless, 60.56% of program selling during this period was reported to have no arbitrage elements. As discussed earlier, this non-arbitrage program selling was reported to have been effected for a variety of trading strategies, including quantitative and risk strategies, as well as some isolated programs designed to dynamically hedge index positions maintained by firm proprietary accounts.¹²⁸ In interviews with the most active program trading firms, their traders indicated that their quantitative and risk strategies were not particularly influenced by the severity of the market declines after 1:50 p.m. or the likelihood that the first circuit breaker trading halt would be implemented. Instead, most program traders indicated that they employed much the same types of strategies as they had during the more moderate market declines in the morning. In addition, the traders claimed that they did not have to significantly increase the size or frequency of their programs as the DJIA approached the 350-point circuit breaker level.

D. Market Declines to the Second Circuit Breaker at 3:30 p.m.

When trading resumed in the stock market at 3:06 p.m., it appears that the market reopening was handled relatively smoothly. The vast majority of stocks on the NYSE and Nasdaq reopened quickly with few significant "gaps" between their prices before and after the halts. For example, the DJIA traded in about a seven-point range from 3:06 p.m. to 3:09 p.m. as stocks reopened. As discussed above, virtually all of the firms that were interviewed by the Division viewed the market reopenings after the first circuit breaker halt to have been surprisingly orderly. Moreover, OEA's statistics found that over 82% of the S&P 500 stocks on the NYSE had reopened by 3:10 p.m. and that over 93% of the DJIA stocks had reopened by that time.¹³⁰

By 3:07 p.m., trading had resumed in stocks representing over 50% of the capitalization of the S&P 500 index, thereby permitting trading to resume in the index futures. At around 3:10 p.m., however, S&P 500 futures fell rapidly in price, falling 15 points in eight minutes. The futures reached their 70-point price limit by 3:25 p.m.¹³¹ Stock prices quickly followed the futures lower, with the DJIA reaching the 550-point circuit breaker trigger at 3:30 p.m., thereby ending the regular trading sessions for U.S. stock, options, and index futures markets.¹³² After all last-sale prices were reported, the DJIA ended the day down 554.26 points (7.18%) at 7,161.15. The S&P 500 index closed down 64.65 points (6.87%) at 876.99. The Nasdaq composite index closed down 115.83 points (7.02%) at 1,535.09.¹³³

Trading volumes remained strong from 3:06 p.m. to 3:30 p.m., with 80.1 million shares trading on the NYSE, representing an increase of 74.81% from the previous week's average for this period.¹³⁴ Even with the abbreviated trading hours on October 27, daily share volume set a new record on the NYSE and volume on Nasdaq was the then-fourth heaviest on record. Nevertheless, even these trading volumes on October 27 were only moderately larger than recent trading levels. For example, while the October 27 daily volume on the NYSE totalled 685.5 million shares, representing a 33% increase over the year-to-date average, this was only a 14% increase from the average for the previous week and only a 2% increase from share volume on the previous trading session of Friday, October 24. Similarly, while the 906.4 million shares traded on Nasdaq on October 27 represented a 42% increase over the year-to-date average and a 13% increase from the share volume average for the previous week, Nasdaq volume on October 27 was actually 2% less than on October 24.¹³⁵

The statistics developed by OEA show the increase in the velocity of the stock market decline in the period leading up to the early close at 3:30 p.m. Specifically, the rate of the price decline in the S&P 500 index increased from 0.01% per minute in the interval from 9:30 a.m. to 1:03 p.m. to a rate of 0.03% per minute from 1:03 p.m. to 2:35 p.m., and the rate of decline increased even further, to 0.10%, in the interval from 3:05 p.m. to 3:30 p.m.¹³⁶

Quote spreads widened as the market decline accelerated. The quote spreads for NYSE and Nasdaq stocks from 3:05 p.m. to 3:30 p.m. on October 27 were significantly wider than those during a comparable period on the control date of October 23. The quote spreads had also widened from those evident in the intervals earlier on October 27.¹³⁷ The statistics developed by the NASD staff are comparable. Nasdaq spreads widened from 11% above normal prior to the first circuit breaker halt to levels 17% to 19% above normal for the interval 3:05 p.m. to 3:30 p.m. The statistics for the effective spreads for NYSE stocks from 3:05 p.m. to 3:30 p.m. on October 27 follow the same pattern.¹³⁸

The OEA statistics on market liquidity and depth during this period, however, are mixed. For example, OEA found that the statistics for "bid down tick" trades and volumes for S&P 500 index and DJIA stocks generally showed significantly more depth in the interval from 3:05 p.m. to 3:30 p.m. on October 27 in comparison with the statistics for the earlier part of the day or those for the late afternoon on the October 23 control date.¹³⁹ On the other hand, OEA's calculations regarding the average bid and ask depths in NYSE stocks from 3:05 p.m. to 3:30 p.m. on October 27 show that, overall, the increases in the ask sizes outpaced the increases in bid sizes in S&P 500 index and DJIA stocks during this period.¹⁴⁰

In terms of NYSE specialist activity, OEA found that specialists in aggregate continued to increase their net buying in both DJIA and S&P 500 index stocks as the share price declines accelerated.¹⁴¹ The NASD staff reported that, in the final 24 minutes of trading on October 27, Nasdaq market makers bought $1.39 billion of stock and sold $1.31 billion. In the aggregate, market makers supported the market by buying $78 million dollars worth of stock from investors.

The price trends leading up to the 3:30 p.m. circuit breaker halt are generally consistent with the information provided to the Division in interviews with the most active trading firms and mutual fund complexes. Firms indicated that the market reopenings after 3:06 p.m. appeared to have been handled relatively well. The plunge in futures prices shortly thereafter, however, had a strong "billboard" effect, signalling that stock prices would quickly fall to the next circuit breaker level. Several traders indicated that this billboard effect caused institutional accounts that had been purchasers on price dips earlier in the day to hold back further buy orders until prices stabilized at lower levels. As discussed above, while a few traders acknowledged that some customers increased their selling as the market decline worsened, most traders claimed that selling by their institutional and proprietary accounts abated somewhat as each circuit breaker threshold approached. The trading volumes throughout this period, however, were somewhat heavier than indicated by the traders in their interviews. Nevertheless, the overall volume levels during this period, while strong, were not of a magnitude to indicate panic selling by institutional or proprietary accounts.

Program selling reached significant levels during several periods of the sharpest market declines from 3:06 p.m. to 3:30 p.m. For example, 94% of the program trading from 3:10 p.m. to 3:20 p.m. was on the sell-side, as was 75% of the program trading from 3:20 p.m. to 3:30 p.m. This activity, however, represented somewhat smaller percentages of total trading volumes during these periods than it had prior to the first circuit breaker at 2:36 p.m.¹⁴² In fact, the 6.24 million shares of program selling from 3:10 p.m. to 3:20 p.m. represented only 18.38% of total NYSE volume and 29.16% of NYSE volume in S&P 500 stocks. The 5.63 million shares of program selling from 3:20 p.m. to 3:30 p.m. represented only 12.31% of total NYSE volume and 18.92% of NYSE volume in S&P 500 stocks. Overall, therefore, it appears that program selling may have contributed only moderately to the velocity of the stock market declines leading to the second circuit breaker triggering at 3:30 p.m.

As in the period preceding the first circuit breaker, it appears that the majority of program selling from 3:06 p.m. to 3:30 p.m. involved non-arbitrage strategies. During this period, index arbitrage was reported to constitute 10.97% of total program selling. Another 33.74% involved quantitative program trading strategies that had some elements of arbitrage timing of futures trading. Nevertheless, 55.29% of program selling during this period was reported to have no arbitrage elements. This non-arbitrage program selling was reported to have been effected for a variety of trading strategies, including quantitative and risk strategies as well as some dynamic hedging. At least one active firm, however, indicated that it shifted all of its remaining dynamic hedging from stocks to index futures after 3:07 p.m. because these transactions were deemed more economical. It is possible, therefore, that a transfer of selling to futures, where selling could be effected more quickly in the limited time remaining in the trading session, may have contributed to the plunge in futures prices during this period.

III. October 28, 1997

A. Foreign Market Declines and Pre-Opening Indications in the U.S.

The pre-opening indications in the U.S. markets remained extremely negative on the morning of October 28. The S&P 500 futures had begun trading on the Globex automated trading system at 7:00 p.m. on October 27. Most of the night and into the morning of October 28, they traded down the 15-point price limit on Globex, which represented a further decline of 1.72% from the October 27 regular-session settlement price. While there were brief price rises around 6:00 a.m. and 8:00 a.m., the S&P futures were again down 15 points when the Globex session ended at 9:00 a.m. This forecasted a further decline in the DJIA of approximately 120-to-150 points at the 9:30 a.m. opening of the NYSE.¹⁴⁵

When the S&P 500 futures began their regular floor trading session at 9:15 a.m., they immediately traded down 15 points. This limit remained in effect until 9:25 a.m. At this point the CME instituted a two-minute trading halt in the futures. When trading resumed at 9:27 a.m., futures prices plunged. At 9:30 a.m., the S&P 500 futures were trading down 26.00 points (2.97%), at 848.00. This forecasted a decline in the DJIA of 200-to-260 points.¹⁴⁶

B. Initial Market Decline and Subsequent Rally

The velocity statistics compiled by OEA also highlight the dramatic price turnaround on the morning of October 28. Specifically, the S&P 500 index declined at a rate of 0.05% per minute from 9:30 a.m. to 10:07 a.m. The index then gained at a rate of 0.11% per minute from 10:07 to 10:45 a.m.¹⁵² It appears that the somewhat slower rate of change in the index from 9:30 to 10:07 a.m. is a function of the time required to open S&P 500 stocks on the NYSE. For example, by 9:40 a.m., only 46% of the NYSE stocks in the index had opened, compared to 76% by the same time on the control date of October 23. It was not until 10:25 a.m. that 100% of the NYSE stocks in the S&P 500 index were open for trading on October 28, compared with 10:11 a.m. on October 23.¹⁵³ Similarly, it was 10:06 a.m. on October 28 before all 30 of the DJIA stocks were open, compared with 9:57 a.m. on October 23.¹⁵⁴

The somewhat longer than normal period required to open NYSE stocks on the morning of October 28 appears to have been due to the large influx of orders prior to the opening. While the trading volumes on the NYSE and Nasdaq were extremely heavy throughout the day, the volume surges were particularly strong during the morning turnaround in share prices. For example, 127.3 million shares traded on the NYSE by 10:00 a.m., a level that was 79.60% above the first half hour average for the previous week. By 10:30 a.m., total NYSE volume was 267.8 million shares, which was 104.93% above the first-hour average for the prior week, and only slightly less than the then-record first-hour volume of 279 million shares on December 15, 1995. NYSE volume levels remained well above the prior week averages throughout the day, and the October 28 total NYSE volume was a then-record 1.2 billion shares.¹⁵⁵ Share volume on Nasdaq also set a new daily record at 1.4 billion shares.

Despite the sharp price swings and historic trading volumes on October 28, our interviews with the most active broker-dealers and mutual fund complexes indicate that most traders were extremely complimentary of the markets' capacity to process their order flows on that day. While some traders noted price gapping and some price reporting delays, particularly for Nasdaq securities in the afternoon, traders by-in-large found the markets to have been orderly and systems problems minor. Many traders drew sharp contrasts between the orderly operation of the markets on October 28 with the systems overloads that were evident in the October 1987 Market Break.

These observations were confirmed by the extensive surveys conducted by the Division. As discussed above, the Division found that, while some minor problems were encountered during October 28, there were no indications of the types of massive queuing problems and transmission failures for order-entry, order-routing, and trade-reporting systems on the exchanges that had overwhelmed the markets in October 1987. Similarly, while some minor delays were experienced in transmissions of clearance and settlement records on October 28, there were no problems that threatened to overload the operational capacity of these systems.

The Division did find, however, that the large number of quotation changes on October 28 did at times exceed the maximum capacity of the CQS high-speed transmission lines for stock quotations. This resulted in some queuing problems that delayed quote updates for investors. Similar delays developed in the quote updates for the vast number of options series handled by OPRA. Both CQS and OPRA staffs indicate that these problems developed in older transmission lines, which are being phased out in favor of new, higher-capacity lines. The Division will continue to work closely with the CQS and OPRA staffs to expedite the phase-in of the new transmission lines.

The Division also found that, while the capacity enhancements undertaken by Nasdaq since 1987 permitted its trading systems to handle the demands of October 28, this was accomplished only by employing load shedding procedures to discontinue non-critical functions such as the SelectNet BroadCast. The SelectNet Broadcast system was shut down during peak volume periods from 10:54 a.m. until 2:30 p.m. on October 28. The Division also found that there were some quote delays in Nasdaq stocks on October 28. Nasdaq, however, attributed such delays to capacity limitations and slow application program interfaces at member-firms or market-data vendors. The Division also found that significant trade-reporting problems that developed around 3:17 p.m. on October 28 prevented the dissemination of historical trade information on volume and sale prices through Nasdaq and the calculation of indexes. This problem also resulted in a delay of six to seven hours in Nasdaq sending data files for overnight processing by SIAC and NSCC. The Division is working with Nasdaq to address these areas.

The OCIE inspections found that all full-service broker-dealers that were reviewed experienced at least some system problems on October 28 which interfered with timely executions of customer orders. In addition, while several online broker-dealers executed record numbers of customer orders on October 28, some firms experienced limited degradation in their Internet access systems which prevented certain customers from accessing their online accounts in a timely manner. As discussed above, OCIE recommended to the Commission that a number of initiatives be undertaken by broker-dealers to address these problems.

The Division's trading reconstruction confirmed the broad based buying that resulted in the strong price rebound and then-record trading levels on October 28. Institutional and professional trading strategies involving program trading appear to have played a relatively small role in the day's sharp price swings. Levels of program selling remained small, even during the initial price decline at the market opening. Specifically, while program selling accounted for 65.55% of all program trading from 9:30 to 9:50 a.m., sell-side program orders represented only 14.06% of total NYSE volume during this period and only 23.61% of NYSE volume in S&P 500 stocks. For the day as a whole, sell programs accounted for 56.50% of all program trading, but represented only 9.11% of total NYSE volume and 14.98% of NYSE total volume in S&P 500 stocks. Buy programs were heaviest in the afternoon, when they accounted for 61.49% of all program trading and 69.62% of program volume entered as market-on-close ("MOC") orders. Nevertheless, for the day as a whole, buy programs represented only 7.02% of total NYSE volume and 11.53% of NYSE volume in S&P 500 stocks.¹⁵⁶

As indicated above, program selling slightly outpaced program buying on October 28. This appears to have been a function of the relative pricing of futures and underlying stocks on that day. While S&P 500 futures prices led stock prices through much of October 28, significant futures premiums to theoretical values were evident only sporadically. Surprisingly, futures actually traded at slight discounts to theoretical values for much of the day even after share prices began to rally.¹⁵⁷ As a result, program selling did not abate significantly until the late afternoon. It also appears that the continuing futures discounts for much of the day resulted in index arbitrage accounting for a much larger portion of program selling on October 28 than had been the case on October 27. For example, index arbitrage represented 46.15% of all program selling on October 28, and quantitative program trading strategies with arbitrage aspects in related futures trading accounted for an additional 14.19% On the buy-side, in contrast, index arbitrage represented only 2.22% of program volume, with quantitative program trading strategies with arbitrage aspects in related futures trades accounting only for an additional 23.38% of program volume.

Overall, therefore, the limited roles played by program trading and futures pricing in the strong price rally on October 28, coupled with the then-record trading volumes experienced on that day, appear to be consistent with the widespread view that the bounce-back in share prices reflected broad-based buying by institutional and retail investors.

1	The 7.18% correction on October 27, 1997, was the largest one-day decline in the DJIA since the 8.04% decline on October 26, 1987. Attachment A includes a number of background charts and graphs showing historical market trends. A chart of the 25 largest one-day percentage declines in the DJIA since 1915 is provided at A-1. A graph illustrating these percentage declines is provided at A-2. Similar charts and graphs for one-day percentage declines in the DJIA since 1945 are provided at A-3 and A-4, respectively.
2	All times are Eastern. Initial reports indicated that the first circuit breaker was triggered at 2:35 p.m. on October 27. The New York Stock Exchange ("NYSE") subsequently reported to the Commission that the NYSE's systems indicated a trigger time of 2:35:50 p.m. and that, accordingly, the official time for the resumption of trading on the NYSE following the 30-minute circuit breaker halt was 3:06 p.m.
3	The 550-point circuit breaker normally would have lasted one hour. Because there was less than an hour before the normal market close, however, trading did not resume in the U.S. stock, options, and index futures markets during the remainder of the October 27 trading session.
4	A price graph for the DJIA on October 27 and 28 is provided at A-5. More detailed graphs for October 27 and 28 are provided in Attachments B & C, respectively.
5	NYSE volume on October 28 was reported as 1.2 billion shares and Nasdaq volume was 1.4 billion shares. Graphs showing historical average daily share volumes on the NYSE and Nasdaq are provided at A-15 to A-17.
6	Our consultations also extended to a number of other agencies, including the Federal Reserve Bank of New York.
7	Tables and graphs based on the OEA statistics are provided in Attachment D.
8	This system is referred to as the "electronic blue sheet" system because it replaced the blue paper questionnaires that formerly were sent by the Commission's Division of Enforcement to compile account information for inquiries or investigations into possibly illegal trading practices.
9	Since 1988, the NYSE has required its member firms to submit Daily Program Trading Reports ("DPTRs") that provide detailed, program-by-program breakdowns of activities in the firms' proprietary and customer accounts. These detailed reports are confidential, and are used by the NYSE and the Commission for surveillance and other regulatory reviews. The NYSE uses summary information from the DPTRs, however, to produce weekly public reports on program trading activities of member firms.
10	On Friday, October 13, 1989, the DJIA declined 190.58 points (6.91%) to close at 2,569.26. The vast majority of this decline occurred in the last 90 minutes of trading on heavy trading volume. The decline initially continued on Monday, October 16, with the DJIA falling 63.16 points (2.46%) in the first 40 minutes of trading before rallying to close up 88.12 points (3.43%) for the day. The NYSE trading volume on October 16 was the fourth heaviest on record at that time. No circuit breaker trading halts were used on either October 13 or 16, 1989. See generally Division, Trading Analysis of October 13 and 16, 1989 (May 1990).
11	For purposes of identifying the largest traders in the sample stocks during our review period, we focused on those entities that take positions, and not entities that act as intermediaries for other investors. In addition, we excluded those broker-dealer average price accounts that usually act as conduits for multiple customer and proprietary accounts.
12	Program selling accounted for 20% to 36% of total NYSE volume and 30% to 50% of NYSE volume in S&P 500 stocks during some periods in the afternoon market decline on October 13, 1989. See Division, Trading Analysis of October 13 and 16, 1989 (May 1990) at Table 13-A.
13	See id.
14	The NYSE public reports on program trading indicate that overall program trading in 1997 averaged around 17% of total NYSE volume, up from 13% in 1996. Index arbitrage, however, in 1997 averaged around 21% of total program trading, down from 30% in 1996. Graphs showing 1996-1997 weekly figures for program trading as percentages of total NYSE volume and for index arbitrage as percentages of total program trading are provided at A-18 and A-19, respectively.
15	If the DJIA moves up or down 50 points from the previous closing value, NYSE Rule 80A(c) (the "collar rule") requires program orders to buy or sell stocks as part of index arbitrage strategies be entered with directions to have the order executions effected in a manner that stabilizes share prices.
16	See, e.g., Ip, By the Numbers; Trading Vast Volumes, Stock Firm Consults Only Its "Black Box," Wall St. J., Dec. 16, 1997, at A1.
17	See, e.g., Ip, Blind Bids Become Popular in Big Trades, Wall St. J., Aug. 14, 1997, at C1.
18	See Division, Trading Analysis of October 13 and 16, 1989 (May 1990), at 29-30.
19	See Report of the Presidential Task Force on Market Mechanisms (January 1988) at 66.
20	The Working Group, established in March 1988, consists of the Secretary of the Treasury and the Chairmen of the SEC, CFTC, and the Board of Governors of the Federal Reserve System.
21	See Interim Report of the Working Group on Financial Markets (May 1988) at 5. The Brady Report also noted that the October 1987 Market Break produced its own circuit breakers: the clogging of the NYSE's order processing systems; ad hoc trading halts in individual stocks, options, and stock index futures; jammed communications systems; and some less than responsive specialists and market makers throughout the markets. See Brady Report at 66.
22	See Interim Report at 4
23	See Interim Report at Appendix A.
24	See Securities Exchange Act Release Nos. 26198 (Oct. 19, 1988), 53 FR 41637 (Oct. 24, 1988) (Amex, CBOE, NASD, and NYSE) ("1988 Approval Order"); 26218 (Oct. 26, 1988), 53 FR 44137 (Nov. 1, 1988) (CHX); 26357 (Dec. 14, 1988), 53 FR 51182 (Dec. 20, 1988) (BSE); 26368 (Dec. 16, 1988), 53 FR 51942 (Dec. 23, 1988) (PSE); 26386 (Dec. 22, 1988), 53 FR 52904 (Dec. 29, 1988) (PHLX); and 26440 (Jan. 10, 1989), 54 FR 1830 (Jan. 17, 1989) (CSE).
25	See id.
26	Id.
27	Id.
28	See Securities Exchange Act Release Nos. 37457 (July 19, 1996), 61 FR 39176 (July 26, 1996) (NYSE) ("1996 Approval Order"); 37458 (July 19, 1996), 61 FR 39167 (July 26, 1996) (Amex); and 37459 (July 19, 1996), 61 FR 39176 (July 26, 1996) (BSE, CBOE, CHX, and PHLX).
29	See 1996 Approval Order, supra, at 9.
30	Id. at 8-9.
31	See Securities Exchange Act Release No. 37890 (Oct. 29, 1996), 61 FR 56983 (Nov. 5, 1996) (Amex, NYSE, and PHLX).
32	Id.
33	See Securities Exchange Act Release No. 38221 (Jan. 31, 1997) 62 FR 5871 (NYSE, Amex, CBOE, CHX, BSE, and PHLX) ("1997 Approval Order").
34	Id.
35	A chart of the 25 largest percentage declines since 1945 is provided at A-3.
36	By price "gapping," traders are referring to instances in which prices for a security or futures contract are updating with substantial moves up or down between the price reports.
37	The indications in the Division's interviews of price-reporting delays on the afternoon of October 27 were primarily from traders of Nasdaq stocks. Nevertheless, several of the Nasdaq traders interviewed indicated that they experienced no significant price-reporting delays or other systems problems on October 27. As discussed above, the Division found that, while most market systems handled the price volatility and trading volumes well on those days, some information systems did experience reporting delays on October 27. The Division believes, however, that these reporting delays were not of a magnitude to justify the cross-market circuit breaker trading halt at 2:36 p.m. on October 27.
38	A few traders indicated in interviews that the sharpness of the price decline in the afternoon of October 27 must have been caused by some panic selling. Even traders attributing the decline to panic selling, however, cited no first-hand knowledge along these lines. Moreover, no traders described panic selling by any of the customer or proprietary accounts that they managed.
39	The charts and graphs produced by OEA are provided in Attachment D. The rates of change of S&P 500 stock prices for several intervals on October 27 are shown in the graph provided as Exhibit 1 and the chart provided as Exhibit 3.
40	The OEA graph showing intra-day trading volume on the NYSE on October 27 and 28 is provided as Exhibit 4 in Attachment D.
41	A chart showing the opening of S&P 500 stocks on October 27 and 28 is provided as Exhibit 5 in Attachment D, while a similar chart for DJIA stocks is provided as Exhibit 6.
42	The data regarding the rates of change of S&P 500 stock prices for several intervals on October 27 are reflected in the graph provided as Exhibit 1 and the chart provided as Exhibit 3 in Attachment D.
43	The data regarding the quote spreads on NYSE issues during several intervals on October 23 and 27 are reflected in the chart provided as Exhibit 7 in Attachment D. A similar chart for Nasdaq issues is provided as Exhibit 8. In order to assess the impact of circuit breakers on October 27, OEA compared trading on October 27 to trading on a control day, October 23. OEA selected October 23 as the control day because it was relatively close in time to October 27 and because trading on October 23 displayed price trends similar to those of October 27, though of a lesser magnitude. The use of October 23 minimized changes in the characteristics of the sample (e.g., stock prices, trading activity, and volatility) that affect liquidity measures.
44	The data regarding the effective bid-ask spreads on NYSE issues during several intervals on October 23 and 27 are reflected in the chart provided as Exhibit 9 in Attachment D. Spreads typically exhibit an intra-day pattern characterized by wider spreads at the beginning and end of the day and narrower spreads in the middle of the day. Spreads on the control day, October 23, follow this pattern. Specifically, on October 23, the mean effective quote spread for S&P 500 stocks was 11.5 cents per share from 9:30 a.m. to 1:03 p.m., 8.9 cents per share from 1:03 p.m. to 2:35 p.m., and 9.7 cents per share from 3:06 p.m. to 3:30 p.m. The mean effective quote spreads for the DJIA shares during these three periods was 9.8 cents per share, 8.3 cents per share, and 9.2 cents per share. See Exhibit 9.
45	The data regarding average bid and ask depths in NYSE issues during several intervals on October 23 and 27 are reflected in the chart provided as Exhibit 11 in Attachment D.
46	As discussed above, the Division's review of systems operations found that, while most market systems handled the price volatility and trading volumes well, some information systems did experience reporting delays on October 27. The Division believes, however, that these reporting delays were not of a magnitude to justify the early market close at 3:30 p.m.
47	Staff Legal Bulletin No. 8 (MR).
48	See id.
49	See id. at 3-4. Ideally, broker-dealers should be prepared to receive telephone calls and other direct communications from customers to inform them of how pending or new orders would be handled. The Division recognizes, however, that direct communications might not always be feasible under those conditions. But at a minimum, broker-dealers (both online and full-service) that maintain a web page should promptly post a notice stating that circuit breaker halts have closed the markets and explaining how pending or new orders will be handled. The Division believes that the SROs should also promptly provide notification of the circuit breaker halts to the financial media. Finally, the Division believes that broker-dealers that handle orders through the Internet should have mechanisms in place so that, when a customer attempts to transmit an order after the triggering of a circuit breaker, an electronic response will indicate that the markets are closed and explain how orders will be handled. See id.
50	A flex option is an exchange-traded option in which the buyer and seller are given the flexibility to determine some contract features (such as expiration date) that are different from standardized features on other exchange-traded options.
51	Market commentators have also cited the early market closure in the U.S. on October 27 as a contributing factor in the sharp declines in international markets overnight. See, e.g., Norris, Stocks Rally on Record Volume as Small Investors Take Lead; Wall Street Sets the Tone; Its Curbs Heighten The Impact Overseas, N.Y. Times, Oct. 29, 1997, at A1.
52	On October 28, in Tokyo, the Nikkei 225 Share Index ("Nikkei") closed down 725.67 points (4.26%) at 16,312.69; and, in Hong Kong, the Hang Seng Index closed down 1,438.31 points (13.70%) at 9,059.89. In London, the Financial Times - Stock Exchange 100 Share Index ("FTSE") fell as much as 457.90 points (9.46%) before following U.S. share prices higher later on October 28 to close down only 85.30 points (1.76%) at 4755.40.
53	The 22.61% decline in U.S. share prices on October 19, 1987, was followed by a decline of 14.90% in Tokyo on October 20. The Hong Kong Stock Exchange was unable to open until October 26, when it closed down 33.33% from its October 19 value. In London, the FTSE fell as much as 14.82% on October 20 and closed down 12.22%.
54	After the 6.91% decline in U.S. share prices on Friday, October 13, 1989, Tokyo and Hong Kong stocks closed down 1.84% and 6.49%, respectively, on Monday, October 16. In London, share prices fell as much as 9.15% on October 16 before closing down 3.16%.
55	After the 3.93% decline in U.S. share prices on Friday, November 15, 1991, Tokyo and Hong Kong stocks closed down 2.90% and 1.71%, respectively, on Monday, November 18. In London, share prices fell as much as 2.47% on November 18 before closing down 1.71%.
56	See Securities Exchange Act Release No. 39582 (Jan. 26, 1998), 63 FR 5408 (Feb. 2, 1998) (NYSE, Amex, BSE, CHX, and PHLX) ("January 1998 Approval Order").
57	See Securities Exchange Act Release No. 39846 (April 9, 1998), 63 FR 18477 (April 15, 1998) (NYSE, Amex, BSE, CHX, NASD, and PHLX) ("April 1998 Approval Order").
58	See id. Subsequent to the adoption of the revised circuit breaker rules, the CME and the Options Clearing Corporation ("OCC") held discussions on how cross-margining of index futures and options would be treated if stocks ended the day with price declines substantially greater than the 20% maximum price limit set by the CME. Under these circumstances, the CME would provide OCC with a theoretical value for each of the appropriate index futures contracts and OCC could use these values for cross-margining purposes. In this regard, OCC has filed a rule-change proposal with the Commission that would make explicit OCC's flexibility in handling cross-margining of index futures and options under these circumstances. See File No. SR-OCC-98-06 (submitted on June 9, 1998).
59	See April 1998 Approval Order, at 14.
60	The Division recognizes that there might be extremely rare circumstances where the magnitude of a market decline is so overwhelming that the markets, as a practical matter, cannot continue to function. In this circumstance, the markets might effect a de facto halt for the day if a circuit breaker did not cause a close for the day. For this reason, the securities markets have determined to close for the day if the DJIA declines 30% during the course of the trading session.
61	"Queuing" refers to situations in which multiple electronic messages (quotes, orders, trade reports, etc.) are sent through a system and, due to capacity limitations, temporary backlogs in the message transmissions develop.
62	SelectNet is a service that allows Nasdaq subscribers to send or broadcast orders in Nasdaq securities to market makers; market makers in Nasdaq securities can send or broadcast orders to Nasdaq subscribers.
63	See Securities Exchange Act Release No. 27445 (Nov. 16, 1989), 54 FR 48703 (Nov. 24, 1989) ("ARP I"); Securities Exchange Act Release No. 29185 (May 9, 1991), 56 FR 22490 (May 15, 1991) ("ARP II"). ARP I states that SROs should: (1) establish current and future capacity estimates; (2) conduct capacity tests periodically; and (3) obtain annual independent assessments of whether the affected systems can perform adequately in light of estimated capacity levels and possible threats to the systems. In ARP II, the Commission expressed its belief that the SROs should obtain independent reviews of general controls and risks in place in the SROs' automated trading and information dissemination systems to determine the need for further reviews of, or enhancements to, those controls. In addition, the Commission asked the SROs to provide notices of significant additions, deletions, or other changes to their automated systems on an annual and on an as-needed basis. Finally, the Commission stated that the SROs should provide Commission staff with real-time notifications of unusual events such as significant outages involving automated systems. Pursuant to ARP I & II, the Commission conducts regular oversight reviews of the SROs to ensure their adherence to the guidelines.
64	See ARP I, supra, 54 FR at 48706 n.17; ARP II, supra, 56 FR at 22493 n.15.
65	Staff Legal Bulletin No. 8 (MR), supra, at 4-6.
66	See id. at 4. As of October 28, 1997, most of the broker-dealers covered by the inspections had excess operational capacity of approximately twice normal trading volume, although some firms indicated that capacity problems at peak periods could be handled by load shedding of non-critical functions.
67	See id. at 5-6.
68	See id. at 6.
69	See, e.g., McGee, Industrials Dive 554.26 Points, or 7.18%; 'Correction' Is the First In Bull Run, Wall St. J., Oct. 28, 1997, at C1.
70	See, e.g., McGee, Bull Market Turns 15 as Landscape Is Changing, Wall St. J., Aug. 12, 1997, at C1. See also Barboza, Bull Market's Glitter May Be Blinding Investors, N.Y. Times, Oct. 22, 1997, at D1.
71	A graph showing year-end closing values for the DJIA since 1980 is provided at A-6. A graph showing daily closing values for the DJIA since 1986 (to October 31, 1997) is provided at A-7.
72	See Barboza, Bull Market's Glitter May Be Blinding Investors, N.Y. Times, Oct. 22, 1997, at D1. The record of three-year gains of over 20% was set on December 31, 1997, when the DJIA closed with an annual gain of 22.64%.
73	Graphs showing the relationship between DJIA prices and bond yields from 1994 to October 1997 are provided at A-8. Similar graphs for January-October 1997, and October 1997 are provided at A-9 and A-10, respectively.
74	See, e.g., McGee, Ten Years After the 1987 Market Peak and Crash; Today's Market Is Different, but So Are Risks, Wall St. J., Aug. 25, 1997, at C1; McGee, Bull Market Turns 15 as Landscape Is Changing, Wall St. J., Aug. 12, 1997, at C1.
75	A graph showing the dividend yield for the S&P 500 index from January 1987 to September 1997 is provided at A-11. As discussed below, prices for the DJIA peaked on August 25 for 1987.
76	A graph showing the price/earnings ratios for the S&P 500 index from January 1987 to September 1997 is provided at A-12. As this graph indicates, however, an even higher price/earnings ratio of 25.71 was set in May 1992.
77	A graph showing the growth in total assets of funds since 1984, including a breakdown of assets in money market instruments, bond or income funds, and equity funds, is provided at A-13. A graph focusing on the surge in assets in equity funds during this period is provided at A-14.
78	Id.
79	Yearly figures for average daily share volumes on the NYSE and Nasdaq from 1986 to 1997 are reflected in the graph at A-15.
80	Daily share volumes on the NYSE and Nasdaq for 1997 are reflected in the graph at A-16. Daily share volumes for October 1997 are reflected in the graph at A-17.
81	See, e.g., McGee, Ten Years After the 1987 Market Peak and Crash; Today's Market Is Different, but So Are Risks, Wall St. J., Aug. 25, 1997, at C1.
82	See, e.g., Norris, A Decade and a Bull Ride Later, Complacency Reigns, N.Y. Times, Oct. 19, 1997, at 1.
83	A graph showing the decline in the Nikkei from December 1989 to October 1997 is provided at A-20. A graph comparing the percentage losses in the Nikkei and the percentage gains in the DJIA during this period is provided at A-21.
84	This is illustrated by the graph at A-21.
85	A graph comparing the year-to-date percentage declines in the Bangkok Set Index with the percentage gains in the DJIA through October 1997 is provided at A-25.
86	Id.
87	A graph comparing the year-to-date percentage declines in the Indonesian Jakarta Composite Index with the percentage gains in the DJIA through October 1997 is provided at A-26. A graph comparing the year-to-date percentage declines in the Malaysian Kuala Lumpur Composite Index with the percentage gains in the DJIA through October 1997 is provided at A-27.
88	While some Pacific Rim and European stock markets declined in conjunction with the 4.63% decline in Hong Kong on Monday, October 20, other international markets appeared to be little affected. For example, while the South Korean Composite Index declined 3.26%, the Tokyo Nikkei closed down only 1.05%, the London FTSE declined 1.14%, the Frankfurt DAX closed down 0.51%, and the Paris CAC closed down 0.38%. The reaction in non-European markets was even more subdued, with the DJIA closing up 0.95% in the U.S., the Toronto 300 Composite Index closing up 0.55% in Canada, and stock markets in Brazil, Argentina, and Mexico closing up 1.73%, 2.65%, and 0.70%, respectively. Similarly, while Hong Kong share prices declined another 4.38% on Tuesday, October 21, South Korean stocks closed up 0.21%, the Nikkei closed down only 0.49%, and share prices in London, Frankfurt, and Paris rose 0.29%, 2.44%, and 1.47%, respectively. In the U.S., the DJIA gained 1.75%, and markets in Canada, Brazil, Argentina, and Mexico rose 0.87%, 2.46%, 1.69%, and 1.07%, respectively. In addition, most markets moved higher or were down only moderately following the 6.17% decline in Hong Kong on Wednesday, October 22. In Asia, the Nikkei closed up 2.77% and South Korean stocks rose 6.08%. In Europe, the FTSE declined 1.48%, the DAX closed up 0.77%, and the CAC declined 1.06%. In the U.S., the DJIA closed down only 0.32%, while Canadian shares rose 0.37%, Brazilian stocks declined 0.46%, Argentine stocks gained 0.58%, and Mexican shares declined 1.31%
89	For example, while the South Korean stock market gained 0.46% on October 23, the Frankfurt DAX closed down 4.66% and the Paris CAC fell 3.42%. Similarly, while Canadian stocks declined only 1.26%, share prices in Brazil, Argentina, and Mexico plunged 8.15%, 4.88%, and 4.54%, respectively. See Hong Kong Stock Drop Spreads World-Wide: Calian, Friedland & Webb, 'Global Shock' Linked to Crisis in Currencies; McGee, Industrials Fall 186.88 Points; Bonds Rocket, Wall St. J., Oct. 24, 1997, at C1.
90	South Korean share prices, however, declined 5.49% on Friday, October 24, and fell another 3.93% on Saturday, October 25. The Frankfurt DAX closed up 1.85%, the Paris CAC declined 0.27%, and Canadian shares declined 0.57% on October 24.
91	The graph at A-28 compares the performance of the Brazilian Bovespa Stock Index with the DJIA for 1997, while the graphs at A-29 and A-30 provide the same types of comparisons for the Argentine Merval Index and the Mexican I.P.C. All-Share Index, respectively.
92	See McGee, Asian Stocks' Meltdown Prompts Worry Over Possible Impact on U.S. Bull Market, Wall St. J., Oct. 27, 1997, at C1; Fuerbringer, Wall Street Fails to Build on Rally Seen in Hong Kong; Dow Sinks Again, By 132; U.S. Rebound Fizzles on Fears of Deepening Asia Turmoil - Thai Crisis Deepens, N.Y. Times, Oct. 25, 1997, at 1.
93	For example, the South Korean Composite Index, which had declined 5.49% on Friday and 3.93% on Saturday, fell an additional 3.28% to close at a five-year low on Monday. This decline was due to the continuing currency and stock market volatility in general and to the fall in the Korean Won in particular. The Australian All Ordinaries Index closed down 3.29% on October 27.
94	Intra-day prices for foreign and U.S. markets are based on information supplied by market-data vendors used by the Division's MarketWatch program, such as Reuters, Bloomberg, and Bridge Information Systems.
95	A graph showing the price movements in the S&P 500 futures on Globex on the morning of October 27 is provided at B-9. In addition, Bloomberg indicates that prices in U.S. Treasury securities were only moderately higher, particularly in the long end of the yield curve. For example, as of 9:00 a.m., the yield-equivalent on 3-month Treasury bills was 5.07%, reflecting a decline of 5.31 basis points. This decline in yield reflected higher prices in the bills, perhaps because the short-term bills were being used by investors as a "safe haven" from the continuing turmoil in worldwide stock and currency markets. The 30-year Treasury bonds, however, were up only 11/32 point, bringing the yield down 2.56 basis points to 6.25% The U.S. Dollar was trading down 0.28 Yen at 121.65 and down 0.018 Deutsche Marks at 1.759 as of 9:00 a.m.
96	The CME moved the opening of floor trading in the S&P 500 futures from 9:30 a.m. to 9:15 a.m. on October 6, 1997, and the end of the Globex trading session was moved from 9:15 a.m. to 9:00 a.m. on the same date. The CME returned to a 9:30 a.m. opening time for floor trading and a 9:15 a.m. end time for Globex on November 17, 1997.
97	According to Bloomberg, the price gains in Treasury securities had abated slightly by 9:30 a.m., but the yield-equivalent for the 3-month bills was still down 4.23 basis points and the 30-year bonds were up 7/32 point in price to yield 6.25% The U.S. Dollar was trading down 0.38 Yen at 121.55 and down 0.016 Deutsche Marks at 1.761 as of 9:30 a.m.
98	Price graphs for the DJIA on October 27 are provided at B-1 and B-3; a price graph for the NYSE Composite Index appears at B-7; and a price graph for the Nasdaq Composite Index is provided at B-8. As indicated in this last graph, while Nasdaq securities experienced somewhat sharper price declines than the DJIA on the morning of October 27, there appears to have been a generally similar pattern of intra-day price declines.
99	The 50-point threshold in the DJIA for NYSE Rule 80A(c), which limits index arbitrage program trading, initially was triggered at 9:36 a.m.
100	Pursuant to NYSE Rule 80A(c), the limitations on index arbitrage programs were removed at 10:14 a.m. when the DJIA recovered to within 25 points of the previous closing value. Price graphs for the DJIA on October 27 are provided at B-1 and B-3. DJIA price graphs for the morning of October 27 are provided at B-14 and B-15.
101	The provisions of NYSE Rule 80A were triggered for a second time when the DJIA reached the 50-point threshold at 10:21 a.m.
102	The NYSE "Side Car" provisions were triggered at 11:00 a.m., when the S&P 500 futures were down 12 points from the previous day's settlement price. Under these provisions, all automated program trading orders for S&P 500 stocks on the NYSE were routed to special electronic files for a period of five minutes. During this period, NYSE specialists in these stocks could review any order imbalances in these files that might indicate that a halt in specific stocks was warranted due to a temporary imbalance of buy and sell interest. No such halts resulted from the NYSE Side Car procedures on October 27.
103	Even as stock and index futures prices were reaching their morning lows at 11:30 a.m., U.S. bond and currency markets were evidencing only moderate reactions. According to Bloomberg, the benchmark 30-year Treasury bonds were up only 14/32 point to yield 6.24%, a decrease of only 3.26 basis points. Even in the two-year Treasury notes, which were showing the greatest reaction at that time, the yield had declined a moderate 7.85 basis points. Bloomberg also indicated that the U.S. Dollar was trading down moderately against major currencies: down 0.20 Yen at 121.73 and down 0.018 Deutsche Marks at 1.759.
104	The graph at B-8 shows that, while the magnitude of the price decline in Nasdaq stocks on the morning of October 27 was greater than the decline in DJIA stocks, the intra-day price movements in Nasdaq issues were generally similar.
105	Bloomberg also indicates that, between 11:30 a.m. and 12:00 p.m., bond prices had declined as stock prices staged a partial recovery. As of 12:00 p.m., the 30-year Treasury bonds were down 2/32 point to raise their yield to 6.28%, and the two-year Treasury notes were yielding 5.70%, reducing their yield decline to 4.35 basis points. The U.S. Dollar had also reduced its declines against major currencies, trading down 0.10 Yen at 121.83 and down 0.013 Deutsche Marks at 1.764.
106	Intra-day declines in the DJIA reached 3.13% on March 27, 1997; 2.64% on March 31, 1997; 2.48% on June 23, 1997; 2.56% on August 8, 1997; 3.11% on August 15, 1997; and 2.85% on October 23, 1997. While the declines in the Nasdaq Composite Index on the morning of October 27 were somewhat more severe in percentage terms, with the decline reaching 3.55% by 11:32 a.m., the Nasdaq staff indicates that this percentage decline was not unprecedented. For example, the Nasdaq Composite Index had declined 3.59% intra-day on May 30, 1997.
107	The rate of change of the S&P 500 index on October 27 is reflected in the graph provided as Exhibit 1 in Attachment D. A chart summarizing this information is provided as Exhibit 3 in Attachment D.
108	The quoted and percent bid-ask spreads in NYSE issues (S&P 500 stocks, DJIA stocks, and non-S&P 500 stocks) for intervals on October 23 and 27 are shown in a chart provided as Exhibit 7 in Attachment D. A similar chart for Nasdaq stocks is provided as Exhibit 8 in Attachment D.
109	The effective spread is calculated by doubling the difference between the trade price and midpoint of the bid-ask spread. If all trades were executed on either the quoted bid or ask price, then the effective spread would precisely equal the quoted spread. But, in general, some fraction of trades occurs at prices inside the quote spread. The effective spread captures this effect. Effective spreads, therefore, are indicative of realized trading costs. Exhibit 9 in Attachment D reports the effective spread of trades executed in each of the three time periods on October 23 and 27.
110	The number of transactions and shares traded at the bid before a downtick reflects the amount of liquidity at the bid quote. If prices fall rapidly through successive bid quotes with few trades occurring at these quotes, market depth and liquidity are poor. A chart showing OEA's compilation of bid down tick trades and volumes for NYSE stocks during three intervals on October 23 and 27 is provided as Exhibit 10 in Attachment D.
111	This was true for bid depth and ask depth for S&P 500 stocks and DJIA stocks. For non-S&P 500 stocks, the bid depth was slightly less, but the ask depth was slightly greater, on the morning of October 27 than on the morning of October 23. These relationships held constant for both the mean and median of the bid/ask depths. A chart of OEA's statistics is provided as Exhibit 11 in Attachment D.
112	This determination is reflected in the ratios of specialist buy to sell volume appearing in the chart provided as Exhibit 12 in Attachment D. A ratio greater than one indicates specialists were net purchasers; a ratio less than one indicates that specialists were net sellers. The OEA compilation found that, for DJIA stocks, the ratios were 0.93 from 9:30 a.m. to 1:03 p.m. on October 23 and 0.97 for the same period on October 27. For S&P 500 stocks, the ratios were 1.04 on October 23 and 1.08 on October 27. The net buy-side activity by specialists in the S&P 500 index stocks during this period also is reflected in the chart showing the distribution of share volume by account type provided as Exhibit 13 in Attachment D.
113	A graph comparing NYSE share volume in 30-minute intervals on October 27 with averages for the previous week is provided at B-4.
114	The graphs at B-12 show prices in the DJIA for the entire trading session on October 27 and the levels of sell-side program trading order flow (in one-minute intervals using order entry times on NYSE program trading reports) throughout the session. The graphs at B-13 compare DJIA price movements throughout the day with buy-side program trading order flow. The graphs at B-14 and B-15 show the same type of information for program sell orders and program buy orders, respectively, for the morning of October 27. The graphs at B-16 and B-17 provide the same types of program trading order flow on the morning of October 27, but compare this with price movements in S&P 500 futures and stocks during this time.
115	The NYSE program trading reports indicate that, prior to 9:40 a.m., a total of 11.66 million shares of program trading orders had been submitted to the NYSE. Out of this 11.66 million shares, 8 million were on the sell-side, accounting for 31% of total NYSE volume during this period and 52% of NYSE volume in S&P 500 stocks. Nevertheless, 3.58 million shares of buy program orders also had accumulated by 9:40 a.m., accounting for 14% of total NYSE volume and 23% of NYSE volume in S&P 500 stocks in the first ten minutes of trading.
116	The NYSE program trading reports indicate that, from 11:30 to 11:40 a.m., a total of 5.3 million shares of program trading orders were executed on the NYSE. Out of this 5.3 million shares, 5 million were on the buy-side, accounting for 20% of total NYSE volume during this period and 31% of NYSE volume in S&P 500 stocks. Only 281,264 shares of sell program orders were executed, accounting for 1% of total NYSE volume and 1.75% of NYSE volume in S&P 500 stocks during this period.
117	The net buy-side activity by program trading firms in the S&P 500 index stocks during this period is reflected in the chart showing the distribution of share volume by account type provided as Exhibit 13 in Attachment D.
118	Bloomberg indicates that bond prices had resumed their gains as stock prices declined. By 2:00 p.m., the 30-year Treasury bonds were up 7/32 point to lower their yield 1.56 basis points to 6.26%. The price gains/yield declines were strongest in the two-year Treasury notes, with their yields falling 10.45 basis points. The U.S. Dollar was trading unchanged against the Yen at 121.93 and down 0.020 Deutsche Marks at 1.758.
119	Nasdaq prices continued to fluctuate over the next few minutes as late trade reports continued to be calculated into the Nasdaq composite index.
120	Bloomberg indicates that, at 2:35 p.m., the 30-year Treasury bonds were up 8/32 point to yield 6.25%, a decline of 1.96 basis points for the day. The yield in the two-year Treasury notes continued to be down 10.45 basis points. The U.S. Dollar was trading up 0.18 Yen at 122.10 and down 0.018 Deutsche Marks at 1.759.
121	The rate of change of the S&P 500 index on October 27 is reflected in the graph provided as Exhibit 1 in Attachment D. A chart summarizing this information is provided as Exhibit 3 in Attachment D.
122	The quoted and percent bid-ask spreads in NYSE issues (S&P 500 stocks, DJIA stocks, and non-S&P 500 stocks) for intervals on October 23 and 27 are shown in a chart provided as Exhibit 7 in Attachment D. A similar chart for Nasdaq stocks is provided as Exhibit 8 in Attachment D.
123	As discussed above, the effective spread is calculated by doubling the difference between the trade price and midpoint of the bid-ask spread. If all trades were executed on either the quoted bid or ask price, then the effective spread would precisely equal the quoted spread. But, in general, some fraction of trades occur at prices inside the quote spread. The effective spread captures this effect. Effective spreads, therefore, are indicative of realized trading costs. Exhibit 9 in Attachment D reports the effective spread of trades executed in each of the three time periods on October 23 and 27.
124	As discussed above, the number of transactions and shares traded at the bid before a downtick reflects the amount of liquidity at the bid quote. If prices fall rapidly through successive bid quotes with few trades occurring at these quotes, market depth and liquidity are poor. A chart showing OEA's compilation of bid down tick trades and volumes for NYSE stocks during three intervals on October 23 and 27 is provided as Exhibit 10 in Attachment D. A chart of OEA's statistics on average bid and ask depths in NYSE stocks is provided as Exhibit 11 in Attachment D.
125	This determination is reflected in the ratios of specialist buy to sell volume appearing in the chart provided as Exhibit 12 in Attachment D. As discussed above, a ratio greater than one indicates specialists were net purchasers; a ratio less than one indicates that specialists were net sellers. The OEA compilation found that, for DJIA stocks, the ratio was 1.07 for the interval from 1:03 to 2:35 p.m. on October 27, and for S&P 500 stocks, the ratio was 1.13. The increased net buy-side activity by specialists in the S&P 500 index stocks during this period also is reflected in the chart showing the distribution of share volume by account type provided as Exhibit 13 in Attachment D.
126	The graphs at B-18 show levels of program selling during the decline in the DJIA on the afternoon of October 27. The graphs at B-19 provide the same information for program buying. The graph at B-20 illustrates both program buying and selling at one-minute intervals from 1:40 p.m. to 2:36 p.m. The graphs at B-21 place the same information in the context of price movements in S&P 500 futures and stocks during this period.
127	The net sell-side activity by program trading firms in the S&P 500 index stocks during this period is reflected in the chart showing the distribution of share volume by account type provided as Exhibit 13 in Attachment D.
128	As discussed above, several of the most active program trading firms maintain index "books" that include positions not only in exchange-traded index options and futures, but also in conventional or OTC index options.
129	The circuit breaker trading halt did not extend to the OTC markets in Treasury securities or currencies. For example, by 3:00 p.m., the price gains/yield declines in Treasury securities had increased somewhat since 2:36 p.m. Bloomberg reports that, as of 3:00 p.m., the 30-year Treasury bonds were up 13/32 point to yield 6.24%, representing a daily decline of 3.06 basis points. In the two-year Treasury notes, the yield decline had extended to a total of 13.85 basis points. The U.S. Dollar was trading mixed: up 0.22 Yen at 122.15 and down 0.021 Deutsche Marks at 1.757.
130	A chart showing the opening of S&P 500 stocks on October 27 and 28 is provided as Exhibit 5 in Attachment D, while a similar chart for DJIA stocks is provided as Exhibit 6.
131	The price declines in S&P 500 futures and stocks from 3:06 to 3:30 p.m. are indicated in the graph in the upper portion of B-23.
132	As discussed above, the 550-point circuit breaker normally would have lasted one hour. Because there was less than an hour before the normal market close, however, trading did not resume in the U.S. stock, options, and index futures markets during the remainder of the October 27 trading session.
133	The price gains/yield declines in Treasury securities had increased substantially since 3:00 p.m. Bloomberg reports that, as of 3:30 p.m., the 30-year Treasury bonds were up 1 25/32 points to yield 6.14%, representing a daily decline of 13.06 basis points. The yield decline in the two-year Treasury notes had extended to a total of 24.25 basis points and the yield in the three-year Treasury notes had extended even further for a total of 25.52 basis points. The U.S. Dollar was down 0.10 Yen at 121.82 and down 0.028 Deutsche Marks at 1.750.
134	The spike in NYSE share volume from 3:06 to 3:30 p.m. on October 27 is shown in the graph at B-4. This surge in volume also is reflected in OEA's graph of intra-day volume (in 15-minute intervals) for October 27 and 28, provided as Exhibit 4 in Attachment D.
135	The Division recognizes that the reduced trading hours on October 27 somewhat skew comparisons of that day's trading volume levels with levels during previous trading sessions that did not experience cross-market trading halts.
136	The rate of change of the S&P 500 index on October 27 is reflected in the graph provided as Exhibit 1 in Attachment D. A chart summarizing this information is provided as Exhibit 3 in Attachment D.
137	The quoted and percent bid-ask spreads in NYSE issues (S&P 500 stocks, DJIA stocks, and non-S&P 500 stocks) for intervals on October 23 and 27 are shown in a chart provided as Exhibit 7 in Attachment D. A similar chart for Nasdaq stocks is provided as Exhibit 8 in Attachment D.
138	As discussed above, the effective spread is calculated by doubling the difference between the trade price and midpoint of the bid-ask spread. If all trades were executed on either the quoted bid or ask price, then the effective spread would precisely equal the quoted spread. But, in general, some fraction of trades occur at prices inside the quote spread. The effective spread captures this effect. Effective spreads, therefore, are indicative of realized trading costs. Exhibit 9 in Attachment D reports the effective spread of trades executed in each of the three time periods on October 23 and 27.
139	As discussed above, the number of transactions and shares traded at the bid before a downtick reflects the amount of liquidity at the bid quote. If prices fall rapidly through successive bid quotes with few trades occurring at these quotes, market depth and liquidity are poor. A chart showing OEA's compilation of bid down tick trades and volumes for NYSE stocks during three intervals on October 23 and 27 is provided as Exhibit 10 in Attachment D.
140	A chart of OEA's statistics on average bid and ask depths in NYSE stocks is provided as Exhibit 11 in Attachment D.
141	This determination is reflected in the ratios of specialist buy to sell volume appearing in the chart provided as Exhibit 12 in Attachment D. As discussed above, a ratio greater than one indicates specialists were net purchasers; a ratio less than one indicates that specialists were net sellers. The OEA compilation found that, for DJIA stocks, the ratio was 2.06 for the interval from 3:05 to 3:30 p.m. on October 27, and for S&P 500 stocks, the ratio was 2.00. The increased net buy-side activity by specialists in the S&P 500 index stocks during this period also is reflected in the chart showing the distribution of share volume by account type provided as Exhibit 13 in Attachment D.
142	The graph at B-22 illustrates program buy and sell order flow in one-minute intervals from 2:45 to 3:40 p.m., and the graphs at B-23 place the same information in the context of price movements in S&P 500 futures and stocks during this period.
143	The South Korean Composite Index, which had declined 5.49% on October 24, 3.93% on October 25, and 3.28% on October 27, fell an additional 6.63% on October 28. Australian stocks declined 7.18% and the New Zealand stock market (which had been closed for a holiday on Monday, October 27) declined 12.46% on October 28.
144	Intra-day prices for foreign and U.S. markets are based on information supplied by market-data vendors used by the Division's MarketWatch program, such as Reuters, Bloomberg, and Bridge Information Systems.
145	A graph showing the price movements in the S&P 500 futures on Globex on the morning of October 28 is provided at C-7. Bloomberg indicates that prices in U.S. Treasury securities were relatively little changed from the levels reached at the end of October 27. For example, as of 9:00 a.m. on October 28, the yield-equivalent on 3-month Treasury bills was 5.00%, reflecting a decline of only 3.17 basis points. The 30-year Treasury bonds, however, were down 6/32 point, bringing the yield up 1.31 basis points to 6.14%. The U.S. Dollar was trading down 2.76 Yen at 119.30 and down 0.032 Deutsche Marks at 1.718 as of 9:00 a.m.
146	According to Bloomberg, the prices in Treasury securities had risen significantly by 9:30 a.m. The yield-equivalent for the 3-month bills was down a total of 8.37 basis points and the 30-year bonds were up 13/32 point in price to yield 6.10%, representing a total decline of 2.99 basis points from the previous day. The U.S. Dollar was trading down 3.29 Yen at 118.70 and down 0.039 Deutsche Marks at 1.711 as of 9:30 a.m.
147	Price graphs for the DJIA on October 28 are provided at C-1 and C-3. Price graphs for the NYSE Composite Index and the Nasdaq Composite Index appear at C-5 and C-6, respectively. As indicated in this last graph, Nasdaq securities experienced an even sharper price turnaround than the DJIA on the morning of October 28.
148	Because the S&P 500 futures were trading down more than 12 points at the 9:30 a.m. opening, the NYSE Side-Car procedures were in effect for the first five minutes of trading. The 50-point threshold in the DJIA for NYSE Rule 80A(c), which limits index arbitrage program trading, was triggered on the down-side at 9:41 a.m. Price graphs for the DJIA on October 28 are provided at C-1 and C-3. A DJIA price graph for the morning of October 28 is provided at C-2. Rather surprisingly, Bloomberg indicates that the price rises in Treasury securities already had largely abated by the time stock prices reached their nadir. By 10:15 a.m., the yield-equivalent for the 3-month bills was down only 0.07 basis point and the 30-year bonds were down 9/32 point in price to yield 6.15%, representing a total gain of 2.02 basis points from the previous day. The U.S. Dollar was trading down 3.15 Yen at 118.90 and down 0.036 Deutsche Marks at 1.714.
149	Pursuant to NYSE Rule 80A, the limitations on index arbitrage program trading were removed at 10:20 a.m. when the DJIA recovered to within 25 points of the previous closing value.
150	NYSE Rule 80A(c) was implemented on the up-side at that time and remained in effect for the remainder of the day.
151	The turnaround in Nasdaq share prices is shown in the graph at C-6. By the end of the day, Bloomberg indicates that prices in Treasury securities had fallen sharply as the need for a safe haven from the stock market abated. By 4:35 p.m., the yield-equivalent for the 3-month bills was up an extraordinary 21.78 basis points at 5.25% and the 30-year bonds were down two full points in price to yield 6.28%, representing a total gain of 14.54 basis points from the previous day. The U.S. Dollar had stabilized only slightly lower against major currencies, and was trading down only 1.50 Yen at 120.53 and down only 0.007 Deutsche Marks at 1.743.
152	A graph showing the price swings in the S&P 500 index on October 28 is provided as Exhibit 2 in Attachment D. A chart showing OEA's calculations of the rates of price changes in the S&P 500 index during various intervals on October 27 and 28 is provided as Exhibit 3 in Attachment D.
153	Timing statistics compiled by OEA for the opening of NYSE stocks in the S&P 500 index on October 23, 27, and 28, 1997 are shown in the chart provided as Exhibit 5 in Attachment D.
154	Timing statistics for the opening of DJIA stocks on October 23, 27, and 28, 1997 are shown in the chart provided as Exhibit 6 in Attachment D.
155	A graph comparing NYSE share volume in 30-minute intervals on October 28 with averages for the previous week is provided at C-4. The NYSE volume surges on the morning of October 28 also are reflected in the graph produced by OEA, which is provided as Exhibit 4 in Attachment D.
156	The graphs at C-10 show levels of program selling during the price swings in the DJIA on October 28. The graphs at C-11 provide the same information for program buying. The graphs at C-12 show program buying and selling in the context of price movements in the S&P 500 futures and stocks from 9:15 a.m. to 10:45 a.m. The graphs at C-13 provide the same information from 9:45 a.m. to 10:15 a.m.
157	Prices for S&P 500 futures and stocks for October 28 are shown in the line graph in the upper portion of C-8, and premiums/discounts to theoretical values are shown in the bar graph in the lower portion of that page. Similar graphs for the morning of October 28 are provided at C-9.

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