Two Managers. One Winner


Haves and Have-Nots Weigh In on the 60% Threshold; When Stop-Loss Fails

When officials at New York Stock Exchange parent NYSE Euronext (NYSE: NYX - News) and the Nasdaq Stock Market's owner Nasdaq OMX Group Inc. (NASDAQ: NDAQ - News) decided last week to cancel certain transactions made during Thursday's market tumult, they drew a sharp dividing line.

On one side stood investors allowed to cash in on the trade of a lifetime. On the other side were people who narrowly missed.

Now some are speaking out against the exchanges' decision, which they say was arbitrary and has served to undermine confidence in the markets.

"The whole thing is unfair," said Paul Schatz, president and CEO of Heritage Capital LLC in Woodbridge, Conn., who didn't trade during the frenzy last Thursday. "I don't know how you can arbitrarily play God with people's money."

Shortly after the Dow Jones Industrial Average (DJI: ^DJI - News) plunged nearly 1,000 points on May 6, the stock exchanges announced that any trades of securities that strayed more than 60% from the price at 2:40 p.m. would be canceled.

That 60% threshold separated Ian Naismith and Anthony Welch, co-portfolio managers at Currency Strategies Fund in Osprey, Fla.

The one-year-old, $25 million fund has been invested in Rydex S&P Equal Weight exchange-traded fund, which tracks the Standard & Poor's Equal Weight Index. When Messrs. Naismith and Welch watched the fund go from $40.73 at 2:40 p.m. to as low as $0.0001 around 2:45 p.m., they tried to scoop up the bargain-priced shares for their separate private client accounts.

As the ETF began to rebound, Mr. Welch quickly put in an order for 5,000 shares at $15 on the NYSE. "I was doing cartwheels" when the order went through, Mr. Welch said.

His co-manager, Mr. Naismith, was a little slower off the mark and put in an order for 5,000 shares at $32.

Mr. Naismith was the only one who profited. Because Mr. Welch's order breached the 60% threshold of around $24 a share, his order was canceled.

The Rydex ETF closed Thursday at $41.25. Mr. Naismith locked in a profit of $46,400. If Mr. Welch's trade hadn't been canceled, he would have earned $131,250.

The so-called flash crash "is the wave of the future until some kind of rule slows down the flow of trades coming in," Mr. Naismith said. "It's just a matter of time before it happens again."

Executives from Nasdaq and the NYSE testified before Congress on Tuesday. In written testimony, Larry Leibowitz, chief operating officer of NYSE Euronext, acknowledged that the 60% threshold was somewhat arbitrary.

"There should be clear rules that set thresholds and circumstances under which trades will be canceled or adjusted," Mr. Leibovitz said in his prepared remarks.

Eric Noll, executive vice president of Nasdaq, said the cancellation decision was the "the result of significant debate among the exchanges." There was brief debate about extending the cancellation period to 2:30, but the two exchanges ultimately agreed on 2:40, Mr. Noll said.

The stock exchanges have multiple systems in place to govern gyrations in share prices, and reserve the ability to cancel trades "when trade prices cease to reflect a true market," Mr. Noll said in his remarks. In 2003, for example, trades in the shares of Corinthian Colleges Inc. were canceled because of trader error.

Last Thursday's market breakdown has also put brokerage firms in the firing line of investors, who are upset that the middlemen failed to execute their trades as promised.Richard Wey, a former trader at the NYSE who is now an executive at money-management boutique Knollwood Capital in Saddle River, N.J., said he was watching with excitement as his bearish positions in ETFs and options rose in value on Thursday. He said he decided to get out of the positions and take profits at about 2:48 p.m., but wasn't able to log into his account with brokerage firm Interactive Brokers LLC.

About 30 seconds later, Mr. Wey said, as stocks remained under heavy pressure, he asked a colleague to enter the trade for him. Mr. Wey said the trades were made in time for him to book what he thought was a $150,000 profit. But when he got the trade confirmations, he found his fund's profit was only about $80,000.

Investors are free to appeal such price discrepancies with their brokerages. Mr. Wey said he appealed to Interactive. An Interactive Brokers spokesman said the firm can't comment on individual accounts for privacy reasons.

Meanwhile, some investors learned that so-called stop-loss orders didn't stop losses—they created them. A stop-loss order is an automatic computer trade made on a customer's behalf when a specific price threshold is breached. On Thursday, many investors who had stop-loss orders in place were sold out of positions when the market plummeted, thus locking in steep losses. Moments later, the markets rebounded.

Will Hepburn of Hepburn Capital Management LLC in Prescott, Ariz., said he prefers to enter stop-loss trades manually for his 85 separate accounts for high-net worth individuals and institutions. Because of the speed of the crash and the rebound, he didn't have time to enter trades.

"I dodged a bullet," he said.

—Aaron Lucchetti contributed to this article.

Write to Mary Pilon at

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