Human Error Said to be Source of Huge Market Selloff

(FOXBusiness)A fat-fingered trader may not have caused the 998-point drop in the stock market two weeks ago, but some type of human error appears to be the source, according to the preliminary findings of a government study into the massive market decline, FOX Business has learned.

The final report, to be published by the Securities and Exchange Commission, could be made public as early as today, FOX Business has learned, and it will lay out the causes of the market plunge that has renewed calls for a more coordinated market structure, along with increased regulation of the securities markets.

But according to people with knowledge of the study’s preliminary findings, there was some human error, or as one person with direct knowledge of the report told FOX Business, a “poorly handled order,” at the Chicago Mercantile Exchange, which touched off massive trading in the markets, particularly at the New York Stock Exchange.

At that point, specialists on the floor of the exchange stopped making markets in various stocks that began to trade lower on other exchanges that don’t slow down trading, as the NYSE does in times of stress.

According to people with knowledge of the preliminary findings, the entire market plunge lasted 17 minutes, but the last three minutes saw a massive amount of selling from retail brokers who sold stock on behalf of individual investors.

It’s unclear if these points will be made in the final report when it is publicly released, or in what form they will be disclosed.

An SEC spokesman declined to comment on the matter.

When the markets plunged two weeks ago, rumors circulated that a “fat fingered” trader at Citigroup (C: 3.88, 0, 0%) was responsible for the market plunge by typing in an order to sell billions instead of millions. Regulators quickly discounted that rumor and began to investigate the market decline.

Since then, market experts have been pointing to faulty computer programs at the NYSE as the cause and a lack of market integration.

For its part, CME Group (CME: 316.05, 0, 0%) said in a statement that it apologizes for delays in its messaging systems on May 6 that affected clearing firms. Its clearinghouse staff added systems to handle what it called increased message flow. It did not specifically mention any trader or firm.

Waddell is mystery trader in market plunge

(Reuters) – A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.

Waddell sold on May 6 a large order of e-mini contracts during a 20-minute span in which U.S. equities markets plunged, briefly wiping out nearly $1 trillion in market capital, the internal document from Chicago Mercantile Exchange parent CME Group Inc said.

The e-minis are one of the most liquid futures contracts in the world, providing holders exposure to the benchmark Standard & Poor's 500 Index. The contracts can act as a directional indicator for the underlying stock index.
Regulators and exchange officials quickly focused on Waddell's sale of 75,000 e-mini contracts, which the document said "superficially appeared to be anomalous activity."

Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, said in congressional testimony on Tuesday that it had found one sale was responsible for about 9 percent of the volume in e-minis during the sell-off in the U.S. markets.

Gensler said there was no suggestion that the trader, whom he did not identify, did anything wrong in only entering orders to sell. Gensler said data show that the trades appeared to be part of a bona fide hedging strategy.

It's unclear what impact the trading in the e-minis had on stock prices during the plunge, but regulators have scrutinized futures trading because the sharp decline in that market preceded the dive in the broader U.S. equities market.

The CME document shows that during the sell-off and subsequent rally, other active traders in e-minis included Jump Trading, Goldman Sachs Group Inc, Interactive Brokers Group Inc, JPMorgan Chase & Co and Citadel Group.

During the 20-minute period, 842,514 contracts in e-minis were traded while Waddell from 2 p.m. EDT to 3 p.m. traded its contracts, CME said. The CME document did not provide a break-out of Waddell's trading during the crucial 20 minutes.

Overland Park, Kansas-based Waddell declined to return calls seeking comment. But in a statement, the company said: "Like many market participants, Waddell & Reed was affected negatively by the market activity of May 6."

Waddell said in its statement that it often uses futures trading to "protect fund investors from downside risk," and on May 6 it executed several trading strategies including the use of index futures contracts as part of the normal operations of its flexible portfolio funds. The company advises and distributes the Ivy Funds, a family of mutual funds.

Waddell said it believes it was "among more than 250 firms" that traded e-minis during the market sell-off.

Waddell's shares were down almost 6 percent to $32.07 in afternoon trading.

The CFTC declined to comment.

A CME spokesman, who declined to comment on the document, said the Chicago-based futures exchange operator never discusses customer activity.

"We found no evidence of improper trading activity or erroneous trades by CME Globex customers," said CME spokesman Allan Schoenberg.

Trading in e-minis takes place entirely on the CME's Globex exchange. Hedge funds and high-speed trading firms often use the e-mini in an arbitrage strategy that seeks to capture the change in prices between the futures contract and the S&P 500.

Waddell's contracts were executed at Barclays Plc's Barclays Capital and later given up to Morgan Stanley, according to the document.

CME said it spoke to representatives from both banks on May 6 and planned to speak to Waddell representatives the following day. The firm oversaw $74.2 billion in assets as of March 31.

Morgan Stanley told CME that it did not have concerns regarding Waddell's activity because it "would typically use equity index futures to hedge macro market risk associated with the substantial long exposure of its clients," the document said.

'QUITE A SHOCK TO THE MARKET'

Gensler said the contracts were sold between 2:32 p.m. and 2:51 p.m., the height of the meltdown.

The market for e-minis on May 6 fell more than 5 percent in a little more than 5 minutes starting at 2:40 p.m. -- the height of the crash, the document said. The e-minis began to recover before stock prices turned higher.

An order the size of the Waddell contract would be a big trade to execute on a normal day, said a trader whose firm is active in the S&P 500 futures market. About 50,000 contracts are typically traded in an hour, the trader said.

"To get rid of 75,000 contracts, that's a lot of trading even if the market is healthy," the trader said. "But when suddenly the market changes and there's not as many bids there to trade with, 75,000 is going to cause quite a shock to the market.

"That's an enormous position for anybody, whether it's a hedge or whether it's a trade. It's a big position, no doubt about it," the trader said.

This Day in Wall Street History 1837: Presentiment of a panic

On this day in 1837, an irate group of unemployed New Yorkers gathered to protest skyrocketing food and fuel prices, as well as the city's rapidly escalating rents.

The demonstration quickly degenerated into violence, as the workers turned their anger on a flour warehouse.

For the city, as well as the rest of the nation, the outburst was a strong indicator of the fiscal troubles that would bubble over later that year.

Come that May, a host of events -- including a wave of bank failures and a brewing recession -- both of which stemmed from President Andrew Jackson's decision to yank all federal deposits from the second Bank of the United States, signaled the onset of the Panic of 1837.

The panic hung over America for the next seven years, debilitating the nation's economy and triggering rampant unemployment.

Source: History.com

This Day in Wall Street History 1903: A rich man's panic

The Panic of 1903 reached its nadir -- the Dow dropped to a paltry 42.15 as the stocks of industrial companies plunged to single-digit lows.

Also known as the "Rich Man's Panic," the fiscal crisis dragged on for the rest of the year, taking a severe toll on banks, as well as many steel and iron producers.

Source: History.com

1873-1876 : The Panic of 1873

After the end of the Civil War, railroad construction in the United States had been booming. By 1873 railroad mileage had doubled itself since 1869, and this was a cause of rash speculation. Between 1866 and 1873, 35,000 miles of new track were laid across the country. Banks and other industries were putting their money in railroads. 

While business was expanding the currency was contracting. Paper money had depreciated, and the conditions foreboded a crash. So when the banking firm of Jay Cooke and Company, a firm heavily invested in railroad construction, closed its doors on September 18, 1873, a major economic panic swept the nation.

Jay Cooke firm handled most of the government loans during the war and was financing the planned Northern Pacific Railroad. The first transcontinental railroad had been completed in 1869 and entrepreneurs planned the Northern Pacific as the second. Cooke’s firm was the financial agent in this venture and poured money into it. Then on September 18, 1873, the company realized it had overextended itself and declared bankruptcy.

The collapse was disastrous for the nation’s economy. Other strong institutions tottered and thousands of people in every rank of life were stricken with absolute ruin. The blow was felt for years in impaired credit, pressure for payment of dues, the lowering of securities and general dread of even safe enterprises. Savings were exhausted and many banks went under. The New York Stock Exchange closed its doors for ten days. Credit dried up, foreclosures were common. Factories closed, costing thousands of worker’s their jobs. A startling 89 of the country’s 364 railroads crashed into bankruptcy. In two years, a total of 18,000 businesses failed and by 1876, unemployment in this country was at 14 percent.

The public tended to blame President Grant and Congress for mishandling the economy. The causes, however, were much broader. The postwar period was one of frantic, unregulated growth with the government playing no role in curbing abuses. The extreme overbuilding of the nation’s railroad system, more than any other single event, laid the groundwork of the Panic and the depression that followed. Recovery was not realized until 1878.

In the end, the Panic brought bitter antagonism between labor and the leaders of banking and manufacturing. Workers all over the country, in response to wage cuts and poor working conditions, struck and prevented trains from moving. President Rutherford B. Hayes was forced to send federal troops to more than a half a dozen states to stop the strikes. When it was over the fighting between strikers and troops left more than 100 people dead and many more injured. This tension between labor and manufacturing lasted for decades after.