Securities regulators are probing whether traders have intentionally exacerbated volatility or unlawfully exploited the deeply fragmented stock markets, Securities and Exchange Commission Chairman Mary Schapiro said on Wednesday.

A lack of surveillance across the 50 some trading venues, and between the mostly electronic stock, futures and options markets was a clear focus at a congressional hearing into how to avoid a repeat of the May 6 flash crash.

Since the unprecedented market plunge, the SEC and the Commodity Futures Trading Commission have been under intense pressure to bolster the integrity of the markets now seen by many as flawed and unstable.

SEC enforcement staff are investigating whether market participants intentionally contributed to market volatility or manipulated the price and volume of securities at the expense of innocent investors, Schapiro told a congressional panel.

Schapiro said her staff was examining trading practices such as spoofing, which includes when a trader submits many bids and offers with no intention of carrying them out.

The flash crash reverberated across asset classes, rocked investor confidence in the vast trading network and has prompted lawmakers to demand fixes to the markets.

At the hearing, Senator Carl Levin dropped a stack of paper measuring five inches high that he said contained the message and trading traffic across all exchanges in one major U.S. stock over the course of one second.

There is a long, long way to go particularly with respect to coordinating market protections and surveillance across market venues and across the futures, options, and equities markets, said Levin, who along with fellow Democratic Senator Jack Reed, chaired Wednesday's hearing.

Levin said that coordinated protections across asset classes isn't even on the drawing board, adding: It took the CFTC and the SEC five months of intense work to figure out what happened over a few minutes on May 6.

The SEC is painfully aware that it cannot see the entire marketplace or easily collect data from the dozens of trading venues.

The regulator has proposed to improve market surveillance by tracking stock orders across all U.S. equity markets -- a plan generally supported by market participants.

Kevin Cronin, the global head of equity trading at Invesco, told lawmakers that regulators need to be able to analyze the data. Tradeworx CEO Manoj Narang agreed that regulators needed better analytical tools.

Regulators need to see markets in the same way its most active participants see it, said Narang, whose hedge fund runs high frequency trading strategies.


Schapiro and CFTC Chairman Gary Gensler are looking for potential remedies for the markets, where high-frequency algorithmic traders are increasingly dominant.

A report by their agencies found that a large trade by a single trader helped send the Dow Jones industrial average down nearly 700 points on May 6 in minutes before recovering.

Had there been safeguards in place and coordinated rules across the bevy of trading venues, some companies might not have seen their stocks temporarily lose nearly all their value in seconds and investors may not have been stuck on the wrong side of the trade.

The SEC, which in 2009 had already started reviewing and pondering new rules for the marketplace, was forced prematurely into action by the flash crash and adopted the temporary circuit breaker program in June.

As you know our market structure review is not a theoretical exercise, Schapiro told the senators.

Regulators are struggling to catch up to today's marketplace while at the same time creating a new regulatory framework for the nearly $600 trillion over-the-counter derivatives market.

The SEC and CFTC must implement dozens of rules that would force private swap contracts onto transparent trading venues and through clearinghouses.

Earlier on Wednesday, major U.S. exchanges including the New York Stock Exchange and the Nasdaq Stock Market proposed extending by four months the temporary circuit breaker program, which pauses trading in a volatile stocks and was due to expire on Friday.

The SEC is expected to approve the petition. An extension would give the SEC more time to develop its new solution that involves slowing trading during sharp swings, instead of halting trades.

Exchanges would also get more time to implement the SEC's new flash crash remedy known as limit up/limit down.

The SEC has tried to clarify when and at what prices exchange operators such as NYSE Euronext would have to cancel erroneous trades. It also eliminated so-called stub quotes, or quotes priced well off the public price of a stock.

Schapiro said on Wednesday that additional remedy -- to create a consolidated record of all trading -- would cost dramatically less to implement, and take less time, than initially thought.

(Reporting by Jonathan Spicer and Rachelle Younglai; Editing by Tim Dobbyn, Bernard Orr)