ChiefsPlanet - Misc Kansas Mutual Fund Is Linked to Market’s Plunge

<nyt_headline version="1.0" type=" ">Kansas Mutual Fund Is Linked to Market’s Plunge</nyt_headline>

<nyt_byline> By NELSON D. SCHWARTZ

</nyt_byline> Published: May 14, 2010

<nyt_text> <nyt_correction_top> </nyt_correction_top> The flash crash on May 6 that transfixed investors — and has been the source of finger-pointing ever since — may not have originated in the canyons of Wall Street or a hedge fund manager’s European lair.
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Gary Gensler, head of the Commodity Futures Trading Commission, spoke at a Congressional hearing about the crash.

How about Kansas?

Futures trades by Waddell & Reed, a conservative 70-year-old mutual fund based in Overland Park, Kan., have been linked to the plunge, during which the Dow dropped hundreds of points in a matter of minutes. The company was identified in a Chicago Mercantile Exchange document, according to Reuters.

In a statement, Waddell & Reed said it was among the firms that traded the stock index futures contract suspected of being a crucial link in the cascade of events leading up to the plunge that began shortly after 2:30 p.m.

“On May 6, as on many trading days, Waddell & Reed executed several trading strategies, including index futures contracts, as part of the normal operation of our flexible portfolio funds,” the firm said. “Like many market participants, Waddell & Reed was affected negatively by the market activity of May 6.”

On Tuesday, Gary Gensler, the chairman of the Commodity Futures Trading Commission, said at a Congressional hearing that during the crucial time period, a single futures trader, which he would not identify, accounted for about 9 percent of trading volume in the most actively traded stock index derivative contract, known as the 500 e-mini futures contract.

“One of these accounts was using the e-mini contract to hedge and only entered orders to sell,” Mr. Gensler testified. “That trader entered the market at around 2:32 and finished trading by around 2:51.”

Reuters, in an article citing a document from the Chicago Mercantile Exchange, reported that regulators and market officials were focusing on the sale of 75,000 contracts of the 500 e-mini future by Waddell & Reed during the time period in question. The document said the trade “superficially appeared to be anomalous activity,” according to Reuters.

The Chicago Mercantile Exchange declined to comment on Friday’s report about Waddell & Reed, as did the C.F.T.C., which regulates futures trading.

While confirming trading activity that day, Waddell & Reed insisted it was not responsible for setting off the market break or doing anything out of the ordinary. Waddell & Reed said it was among 250 firms that traded the e-mini during the critical minutes.

Founded in 1937, Waddell & Reed has $74 billion under management in a variety of funds, covering both stocks and fixed-income assets.

Trades like the one identified by Waddell & Reed pick up during stock market downdrafts, as money managers try to offset the risk of holding stocks if the market goes lower, a process known as hedging.

“Such trades often are executed in response to market activity, and are undertaken to protect fund investors from downside risk,” the firm said. “We use futures trading as part of this strategy, broadly known as hedging.”

The 500 e-mini is a basket of stocks that can be used to bet on the future direction of the Standard & Poor’s 500-stock index.

Like water draining into a narrower and narrower funnel, orders that couldn’t be completed on the New York Stock Exchange flooded electronic exchanges, where trading continued. What is still being analyzed is why hundreds of stocks briefly traded at levels more than 60 percent below their market value, some for pennies on the dollar.

Many of those trades have since been canceled, but the incident has raised many questions about the stability and safety of what are now larger computer-controlled markets. Initial reports suggested that an erroneous order, a so-called fat-finger trade, prompted the sudden move, but that has been dismissed as unlikely by Mr. Gensler and other regulators.

Without enough human oversight, computerized trading in today’s markets can easily overwhelm the current technology, said James Angel, a professor of finance at the McDonough School of Business at Georgetown University. In a February 2010 study commissioned by the Knight Capital Group, a major market maker, Mr. Angel warned of such a possibility.

“The key thing when the dust settles will be the idea that this has elements of the 1987 crash, when computers and systems couldn’t keep up with volumes and failed,” he said. “It’s not about too many computers, but too few.”