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Subject:  SEC lays an egg on Flash Crash Date:  10/3/2010  1:32 AM
Author:  yodaorange Number:  340959 of 485085

Yesterday (10/1/10) the SEC and the CFTC issued their report on the 5/6/10 Flash Crash. It is 104 pages with lots of pretty multicolor charts that illustrate various aspects of the crash. After reading the report over, I started to write up the most essential points and post them. After further reflection, I decided that the SEC report and my summary of it were almost totally misguided.

Link to the SEC report:

Factually, the SEC report is quite good and comprehensive in explaining various aspects of the crash. For the small minority of investors in America that enjoy learning about nitty-gritty details of what occurred that day, it is a worthwhile read. Exactly how many investors fit into that category? Let’s make an estimate. Let’s assume that 100 investors read the METAR board postings on a regular basis and would take the time to read the full 104 page report. How many non-METARites do you know that would be interested enough to read the report? I don’t see many hands. There are approximately 114 million US households. Let’s assume that half of them either have stock accounts, 401K accounts or some other interest in US equity markets. That gives us 57 million investors that “care” how US equities perform. (Yes, for purposes of simplification, I am assuming there is only one interested investor per household.)

Out of the 57 million investors, how many METAR like investors are there that will read the SEC flash crash report? Let’s be incredibly generous and say 1 million. I actually think it is closer to zero, but let’s assume it is 1 million. That leaves us with 56 million US investors that will only see news headlines on the SEC Flash Crash report.

My original summary was intended for the 100 METARites which I decided was the wrong approach. This new summary is intended for the 56 million non-METARites. Here goes:

1) The SEC totally, 100% missed the most important points to highlight to the masses. Most likely they did this on purpose to try and convince the masses that all is well or will be well with US equity markets. I do NOT think the SEC is so incompetent that they actually believe this to be true, but they have to put a positive spin on it. And no, it is NOT a Democrat or Republican issue. Chris Cox under Bush is the same as Mary Schapiro under Obama in this regard.

2) The SEC lays primary blame for the flash crash on Waddell-Reed placing orders to sell short 75,000 e-mini SP500 contracts. The contracts have a nominal value of $4.1 billion which is supposed to impress the naïve that it is a large number. In fact, on a typical day about 2 MILLION of these contracts change hands. So the 75,000 represent about 3.75% of average trading. Does anybody believe that an incremental change of 3.75% volume should crash the US equity markets? I don’t think so. Similar trades to this likely have been done hundreds of times before without causing a flash crash.

3) Waddell-Reed is basically a widows and orphans mutual fund manager that was trying to hedge an $81 billion equity position. So it is not like they were some wild eyed speculator using 100 to 1 leverage or doing naked shorting. What they were doing was 100% legal, 100% moral, 100% rational and probably prudent.

4) The SEC report should have come out directly and said they every single firm and exchange they investigated was acting legally, morally and rationally in their own self interest. The SEC did not directly say it, but the implication to the public is that Waddell-Reed is somehow the bad guy in the flash crash. ABSOLUTELY NOT TRUE. In fact, what the SEC should have said to the public was that there were NO bad actors involved at all. The markets were working 100% like people intended them to work. Nothing irrational about them at all.

5) Th