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"Flash crash" panel calls for market overhaul

By Roberta Rampton and Jonathan Spicer

WASHINGTON/NEW YORK (Reuters) - Regulators should stem the growing tide of anonymous stock-trading and consider imposing fees on high-frequency traders, said a panel of experts advising how to avoid another "flash crash."

The panel's 14 recommendations for U.S. securities and futures regulators contained far-reaching ideas to overhaul the high-speed electronic market.

Yet many of the ideas issued on Friday called only for "consideration" or "further study" -- potentially raising more questions as the first anniversary of the May 6 flash crash nears.

"I don't think it's possible to prevent another one from happening," said Adam Sarhan, chief executive of Sarhan Capital in New York.

U.S. regulators were cautious about some of the boldest recommendations, including new fee structures to encourage liquidity and discourage high numbers of order cancellations.

"I do not know where we as a commission would come down on fees," Securities and Exchange Commission Chairman Mary Schapiro told reporters after meeting with the panel.

The unprecedented May 6, 2010, market crash sent the Dow Jones industrial average down some 700 points before rebounding, all in a matter of minutes. It rattled investors, exposed flaws in the structure of markets, and set regulators on a mission to fix the system and restore confidence.

Since then, individual stocks have experienced what some refer to as "mini" crashes, where shares unexpectedly move on a sudden burst of volume, absent of any news.

Prominent technology shares including Apple Inc and Cisco Systems Inc. have been halted after breaking through thresholds that automatically halt trading.

On September 27, shares of Progress Energy Inc were halted after plunging suddenly to $4.57 a share from $44.57 a share in a fraction of a second.

The eight-member panel suggested the SEC consider forcing the banks, hedge funds and others that facilitate stock-trading away from the public exchanges to give investors a better price by a minimum amount.

It also said stock pauses and limit-up/limit-down price bands would help reduce investor fears about how markets react in times of uncertainty.

"What market regulation now has to do is limit uncertainty," said Maureen O'Hara, professor of finance at Cornell University and member of the flash crash panel. "You limit uncertainty by limiting the amount of movement a price can have before it falls off the map."

The changes would require the SEC and fellow regulator, the Commodity Futures Trading Commission, to take on a massive amount of work at a time when the agencies are straining to carry out the Dodd-Frank financial reform law.

"Many market participants spent north of $1 billion a year on technology, and we as an agency only spent $31 million last year, and this year ... are actually cutting that back," CFTC Chairman Gary Gensler told reporters.

MERGER ADDS NEW WRINKLE

Some of the recommendations, such as expanding and modifying the "circuit breaker" trading pauses, had been anticipated and mostly endorsed by traders and exchanges such as NYSE Euronext and Nasdaq OMX Group.

The exchanges at the center of the breakdown, however, added a new wrinkle to the debate when in the last week they set off a new wave of planned global mergers, including the takeover of Big Board parent by Germany's Deutsche Boerse.

The mergers highlight the increasingly interconnected global marketplace, where drops in one region can rapidly trigger plunges elsewhere.

REGULATORS VS TECHNOLOGY

The panel wants regulators to consider a so-called "trade at" order routing rule -- something that would hurt the growing ranks of "dark pools" where trading is done anonymously.

Some 33 percent of U.S. stock-trading takes place away from exchanges, up from 20 percent four years ago, through "internalizers" such as market-maker Knight Capital Group Inc, Goldman Sachs, and hedge fund Citadel.

A "trade at" rule, which Schapiro on Friday expressed support for, would generally prohibit any of the dozens of U.S. venues and wholesale market makers from executing an incoming order unless they were already publicly displaying the best bid or offer in that particular stock.

Another idea would see regulators adjust trading fees so that firms providing liquidity get rebates to help stabilize markets during stressful times.

These types of adjustments could revamp the flow of tens of trillions of dollars annually in the markets -- and could take years of hearings and deliberation to settle.

"Trading systems are complicated ecosystems, and when you make what appear to be minor changes that can have big effects on the market -- the commissions will have to be very careful," said James Overdahl, a former chief economist for both regulators, and a vice-president at NERA Economic Consulting.

ALGO TRADERS NOT DEMONIZED

Following the flash crash, some lawmakers called for a crackdown on traders who use algorithms to execute complex trading strategies across markets.

But the panel's report focused on structure and liquidity issues, and did not blame high-frequency trading, said Overdahl, who is also an advisor to the Futures Industry Association's Principal Traders Group, which includes some of the largest high-frequency traders in the market.

"I did not hear a lot of inflammatory discussion that you heard immediately after the flash crash," he said.

The CFTC is due to consider new guidance next Thursday for traders on a new ban on disruptive trading practices.

(Reporting by Sarah N. Lynch, Jonathan Spicer and Roberta Rampton, with additional reporting by Ryan Vlastelica; Editing by Steve Orlofsky, Dave Zimmerman and Tim Dobbyn)

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