Don’t Get Short Circuited By a Trading Halts

As an investor, you’ve likely grown accustomed to dealing with periods of volatility.  However, the pandemic and other recent events have created even higher levels of uncertainty for market participants, especially in early 2020.

Statistics show just how much more:  the March 2020 “Coronavirus Crash[1]” broke all previous volatility records, when the S&P 500 dropped over 34% in a little over a month.  During that time, the wild market movements created other aberrations, including the price of crude oil futures dipping temporarily into negative territory.

Volatile markets don’t just stress people; they also stress technical platforms.  That March time period put systems to the test as the market reacted to the rise of Covid-19 and its resulting body blows to world economies:

• Volatility overwhelmed technology at times at Robinhood, a newer broker-dealer, resulting in many customers losing account access.
• The increased volatility led to shorter-term outages at established broker-dealers.
• System-wide “circuit breakers” were invoked repeatedly to halt all trading for fixed periods on the major exchanges.

If the entire exchange, or your broker, shuts down at a time you need to make a trade, your account could be put at risk.  That’s why it is important to understand these issues so you can protect yourself in today’s often hyperactive trading environment.

What are Exchange Circuit Breakers?

First, it is essential to understand system-wide circuit breakers[2].  These are mechanisms designed to kick in across all US markets and exchanges when volatility spikes.

Previously these circuit breakers were rarely triggered.  However, in March 2020, these kicked in repeatedly, halting trading for 15 minutes at a time.

When is Trading Halted by the NYSE?

In the case of a 7% or 13% decline, trading is halted for 15 minutes.  If a 20% decline were to occur, trading would be paused for the remainder of the trading day.

Unfortunately, there’s nothing we can do about exchange circuit breakers.   They are put in place to help prevent marketwide panics from getting worse.  These instances don’t usually cause an individual investor harm, as all other investors are restricted from trading simultaneously.

However, there is one area of concern with these system-wide halts: how are orders already placed but not yet executed handled by individual firms?  The Securities and Exchange Commission has published rules outlining how broker-dealers should manage orders at these times[3].  In this publication, the SEC noted that many firms appeared confused about the proper procedures.  This may have resulted in some customers not getting the appropriate order execution after these trading halts occurred.

Technical Outages That Can Put You at Risk

Unfortunately, the March 2020 Coronavirus Crash also revealed some shortfalls in technology capabilities at certain firms.  For example, in March 2020, the online trading firm Robinhood experienced multiple outages, leaving millions of customers unable to trade during the exceptionally volatile period.

While that was particularly widespread, these issues were not new.  The SEC noted that broker-dealers needed to ramp up their technology to prepare for high volatility times in its previous 1998 bulletin.

Regardless, firms have struggled to keep pace with growing trading volumes and expanding volatility.  In January 2021, as trading volumes surged, several established online brokerages experienced short service disruptions[4].  These included Schwab, Vanguard, Fidelity, and several others.  The customers encountered brief delays executing trades or brief periods of access issues.

Trading Restrictions on Individual Stocks

The rise of “meme” stocks such as GameStop and AMC Entertainment has also impacted the playing field.  These stocks have become the subject of concern since they can experience significant price changes, sometimes over 100% or more in a single day.

These popular stocks have created a new category of trading interruptions.  Some brokers have taken the step of banning the trading of these stocks[5] altogether (except if people are closing out existing positions).

Many firms have cited the need to do that because clearing firms (who handle the settlement and delivery of investments) could not process these high volumes on single stocks.  So in these cases, the clearing firms may have required these broker-dealers to restrict trading.

At issue was the fact that individuals were frozen out of these trades, yet hedge funds and other institutional investors were allowed to continue trading these securities freely.  Two members of congress commented on it publicly, suggesting a congressional investigation[6].  After that, several of these brokerage firms reversed course, allowing investors to continue trading these volatile stocks.

Regardless, these restrictions may have caused losses, since in these cases, not all firms provided notice and simply implemented restrictions without advance warning.

Trading Restrictions Imposed by Robo-Advisors 

There have been instances of even more intrusive decisions by firms.  In the aftermath of the 2016 “Brexit” decision, popular robo-advisor Betterment limited the ability of its customers to trade at all for half of the trading day[7].

There was no advance notice to customers.  When asked, Betterment authorities explained, “We made the decision to not start trading until around noon in the best interest of our clients.” The firm caters to long–term investors, not day traders.  Because they are a discretionary broker, halting trading was within their rights.

While the firm experienced an inflow of new accounts after that, regulators were not so positive. The following year they published an Investor Alert[8] warning investors to be sure to understand the terms and conditions of these fully automated investment accounts.

What are Your Rights as a Customer? 

As technology proliferates and more volume moves onto online platforms, regulators are also struggling to keep pace.  As a result, regulations are not always clear on how these broker-specific actions or problems impact you as a customer.

Recently, however, there has been some light shed on the topic.  The regulator FINRA fined Robinhood a historic $70 million[9] for not providing critical brokerage functions during these outages, along with many other violations.

As a fully online firm, part of the issue was that Robinhood customers did not have an alternative way to call their trades in to the firm. So, in this case, investors were locked out of placing any trades altogether.  As you can imagine, this had the potential to cause significant financial loss since other brokers continued to function normally.

Even before this record penalty by FINRA, some investors were already putting this to the test legally.  One Robhinood client initiated a class-action suit against the company for negligence[10].  The lawsuit claimed the company breached its contract by failing to “provide a functioning platform,” leaving traders unable to move money while stock markets surged.

While the scale may have been more significant, this issue is nothing new.  Back in 2008, online brokerages were already dealing with the fallout from outages in the form of customer complaints and lawsuits[11].  Fast forward to today, and similar criticisms and legal actions[12] are still a reality.

Take-Home Message

As an investor, you already know there are many factors beyond your control.  Unfortunately, these outages and restrictions simply add a new angle of concern.  If you are more of a trader than an investor, it’s even more critical that you have access to your accounts when you need to.

While marketwide circuit breakers are not anything you can control, you can choose which broker you use.  Here are some tips to keep in mind:

• Do your due diligence before opening an account.  Research if the firm has records of past outages or issues.
• If you’re a frequent trader, spreading accounts at different brokers can make you less likely to be impacted by individual firm issues.
• If access is critical to you, consider a firm that has telephone-based broker access as a backup.

Finally, keep in mind that the online brokerage industry spends big on advertising and creating a brand image.  As a customer, it’s important to take marketing promises with a grain of salt.  Instead, evaluate the actual record of the firm, so you can have a better chance of getting the service and features you need most.