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Business Law Newsletter

Stock and Commodity Exchange Volatility Controls

Stock exchanges such as the New York and American Stock Exchanges and trading facilities such as Nasdaq are considered self-regulatory organizations under federal securities laws. To reduce volatility, securities and commodities markets have adopted several mechanisms known as circuit breakers, the collar rule, and price limits.

Circuit breakers are percentages of decline during a single day in the Dow Jones Industrial Average of selected stocks on the New York Stock Exchange. The percentages are set according to New York Stock Exchange Rule 80B and are based on 10, 20, and 30 percent declines in point levels set each calendar year quarter. When a circuit breaker decline occurs, there is an across-the-markets halt in trading on securities and futures markets for a period of time depending on how much longer the market will be open that day.

For example, amendments to New York Stock Exchange Rule 80B approved by the Securities and Exchange Commission in 1998 provide that a 10 percent decline (1000 points in light of the Dow Jones Industrial Average in the last quarter of 2004) before 2:00 p.m. would result in a one hour halt to trading. A 10 percent or 1000 point decline between 2 and 2:30 p.m. would prompt a 30 minute halt to trading. A 10 percent decline after 2:30 p.m. would not result in a halt to trading.

If there is a 20 percent decline in the Dow Jones Industrial Average before 1:00 p.m., a two hour halt to trading is imposed. For a 20 percent decline between 1:00 and 2:00 p.m., a one-hour halt takes place. If a 20 percent decline occurs after 2:00 p.m., the market is closed for the remainder of the day. If a 30 percent decline in the Dow Jones Industrial Average occurs at any time during the trading day, the market will be closed for the remainder of the trading day.

New York Stock Exchange Rule 80A, approved by the Securities and Exchange Commission, sets out what is known as the "collar rule. " Under the collar rule, a move two percent up or down in the Dow Jones Industrial Average causes entry of program trading orders to buy or sell the 500 stocks in the Standard and Poor's Index with directions to have orders executed in a manner designed to stabilize share prices. Once the Dow Jones Industrial Average returns to within one percent of its previous closing value, the collar is removed.

Futures exchanges set price limits in order to lessen extreme changes in contract prices. Price limits do not cause halts in trading, but they do prevent trading at prices below pre-set limits in the decline of the price during the day. There are specific price limits set by exchanges for each stock index futures contract, but there are no price limits for stock index options, equity options, and stocks. While daily limits set ranges for the entire trading day, lesser intra-day limits are taken off at pre-set times during the trading day.