The U.S. Securities and Exchange Commission wants to know if anyone broke the law during the $1-trillion (U.S.) May 6 "flash crash."
SEC chairman Mary Schapiro vowed Thursday to "take appropriate action" if the agency's enforcement division uncovers violations of securities laws.
Among other things, investigators will look at whether market players met their obligation to get the best price for clients and whether stock exchanges later cancelled trades "fairly and consistently," Ms. Schapiro told the Senate banking committee.
But regulators conceded that the guilty party is just as likely to be a "dumb" algorithm, rather an individual or a company.
Regulators and stock market officials still don't know exactly why U.S. markets plunged nearly 10 per cent in a span of minutes that day, briefly turning a handful of blue-chip companies into penny stocks.
A preliminary investigation suggests a "severe temporary liquidity failure" was at the root of the incident, Ms. Schapiro said. The SEC has already ruled out a "fat finger" typing error, hackers or terrorists
What is clear is that the incident exposed serious flaws in today's fast-paced computer-driven markets, where billions of simultaneous trades are clocked in nanoseconds. The result is that the market moves faster than the human brain can process, let alone stop.
The problem, regulators acknowledge, is that algorithms can be, well, stupid.
"A lot of algorithms are really just rote, even dumb, really just doing what they've been programmed to do, repeatedly," said Gary Gensler, chairman of the Commodity Futures Trading Commission and a former Goldman Sachs executive.
Traders who used those programs to trade in stock index futures that day may have triggered "unintended" consequences when, for an instant, there was no liquidity in the market.
New rules are needed to ensure that preprogrammed trading doesn't "threaten fair and orderly markets," Mr. Gensler said.
"You can't stop technology, but I think we have to update our regulations," he told the hearing.
Mr. Gensler singled out an unnamed trader, who "sought to hedge its stock portfolio in the futures markets by selling a predetermined amount of futures through an executing broker's automated execution system."
News reports have identified the company as money manager Waddell & Reed Financial Inc.
The SEC and major exchanges have already proposed a rule to suspend stock trading when markets swing violently. The new "circuit breakers" would apply to all stocks in the Standard & Poor's 500 index under a six-month trial rollout planned for June.
Some Senators also complained about the arbitrary way that exchanges later cancelled trades made in the midst of the market mayhem.
"It's hard for me as someone who worked in the market for 31 years to understand how any trades can be broken arbitrarily by an exchange," said Kentucky Senator Jim Bunning, a former professional baseball player and broker. "Those are arbitrary rules and for someone who was left out of those arbitrary rules, in other words, didn't fit in the box, how do you think they feel?"
Regulators have been sifting through more than 19 billion trades as they piece together what happened May 6. They're also looking at links between automatic "stop-loss" orders and sudden declines in prices of stock index products such as E-mini S&P futures contracts.