SEC Chair Mary Schapiro was unable to provide the House Subcommittee on Capital Markets with a definitive answer to the cause of the May 6 market disruption, but pledged to release the information to the public as soon as it becomes available. In her May 11 testimony, Schapiro said preliminary findings do not point to a so-called fat finger error, in which an incorrect order is entered by mistake, or to hacker or terrorist activity.

CFTC Chair Gary Gensler also testified at the hearing. The SEC and the CFTC yesterday announced the formation of a joint committee to address emerging regulatory issues. The first item on the committee’s agenda will be a review of the market events of May 6. Schapiro advised the subcommittee members that the SEC and the CFTC are expected to provide joint preliminary findings to the committee about the May 6 market events on Monday.

The joint committee will help identify emerging risks and will assess the impact of potential risks on investors and market participants. The committee will also help further the SEC’s and the CFTC’s regulatory harmonization efforts. Among the committee members are former CFTC Chair Brooksley Born and Former SEC Chair David Ruder. Schapiro and Gensler will co-chair the committee.

In her written statement, Schapiro reported that the precipitous decline in stock prices closely followed the drop and recovery in the value of the E-mini S&P 500 future, which tracks the normal relationship between futures and stock prices for the broader market. Some reports have pointed to the E-mini as a factor in the market disruption, but Schapiro said in leading the market decline and recovery, the E-mini activity reflected basic market dynamics in which much of the price discovery for the broader market occurs in the futures markets.

In some instances, individual stocks experienced larger swings in their trading activity and were executed at what Schapiro called absurdly low prices. One stock opened above $40 but at one point traded at a penny before closing above $40. Schapiro said that officials from each of the equity markets worked out a common standard to cancel trades that were effected at prices that were sharply divergent from prevailing market prices.

The exchanges chose to cancel any trades that occurred between 2:40 p.m. and 3:00 p.m. at prices that were 60% away from the last trade at or before 2:40 p.m. Schapiro reported that transactions in 286 different equity securities were canceled. Several options exchanges also decided to cancel certain trades from the afternoon of May 6.

Schapiro said the extraordinary disruption in trading may have been the result of a confluence of events which, taken together, exacerbated what was already a down day in the markets and led to the extreme price drop and recovery. The SEC is not yet ready to draw that conclusion. She said of particular concern is why many individual stocks were affected much more than the broader market.

The market disruption has focused attention on the different exchange practices for dealing with major price movements and other unusual trading conditions. Schapiro said the SEC is looking at whether this disparity in practices can be addressed to promote more consistency in how orders are handled during rapid price changes without undermining the benefits of individual market practices.

Schapiro also noted that many of the securities that were subject to the trade cancellations were thinly-traded. For such illiquid securities, she said a large order or many orders could absorb all of the available liquidity across the market and break through many price levels to obtain an execution at any price.

The SEC is also reviewing a practice known as stub quoting which Schapiro described as a placeholder quote which is not expected to be reached. When a market order is seeking liquidity and the only liquidity available is a penny priced stub quote, the market order will execute against the stub quote. Human involvement likely would have prevented orders from being executed at that price, she said, but automated trading systems will follow coded logic.

The market events of May 6 added urgency to the SEC’s efforts which are already underway, including issues raised in its market structure concept release. Schapiro said the SEC will consider various types of time-out mechanisms to help maintain a fair and orderly market, including a mechanism for individual stocks. The SEC will also consider whether all trading venues in the national market system should be required to stop trading for a brief period of time on a stock-by-stock basis when prices move beyond normal trading patterns.