Advisers spooked by fund's sudden nosedive

ETF dropped 9.6% and lost $7.9 billion — but, wait, it was another glitch

Oct 19, 2010 @ 1:48 pm

By Jessica Toonkel

A glitch yesterday at NYSE Euronext's Arca stock market that caused State Street Global Advisors Inc.'s SPDR S&P 500 ETF Ticker:(SPY) to drop 9.6% has some advisers spooked.

“It does create concern to see these kinds of glitches, especially for advisers like myself who are relying a fair amount on ETFs,” said Charles E. Fitzgerald, a principal with Moisand Fitzgerald Tamayo LLC. His firm has a little under $1 million invested in the SPDR S&P 500 ETF.

“And it's not like we are using exotic ETFs, we tend to use ones that are based on broad indexes,” added Mr. Fitzgerald, whose practice advises on a total of $180 million in client assets.

A new software release at Arca caused the hiccup by initiating a closing auction in the ETF at 4 p.m. Eastern time instead of 4:15 p.m. Eastern, said Raymond Pellecchia, a NYSE spokesman.

As a result, the closing price of the ETF was shown as $106.46, down from the opening level of $117.74. That would have meant a $7.9 billion loss for the ETF. All trades at the $106.46 price were later voided, and the closing price was updated to $118.54, Mr. Pellecchia added.

NYSE Euronext sent a notice to customers and related firms and individual investors explaining the error and that it had been resolved, Mr. Pellecchia said. “The software issue was resolved overnight and operations are normal today,” he said.

But even though yesterday's glitch was minor and was resolved quickly, even the smallest hiccups are a cause for concern to advisers — particularly in light of the May 6 flash crash, when the Dow Jones Industrial Average dropped 1,000 points before rebounding within minutes. Most of the affected trades were later canceled and because more than two-thirds involved ETFs, regulators are investigating the funds' role in the event.

Yesterday's error serves as a reminder to advisers to set limit orders when buying ETFs, Mr. Fitzgerald said.

Such glitches should serve as a reminder that ETFs are complicated products with a number of “moving pieces,” said Mark Matson, a registered investment adviser with Matson Money Inc., which manages $2.7 billion and does not use any ETFs.

“I expect that we will see more of this kind of stuff,” Mr. Matson said. “There is a law of physics that says that the more moving pieces you have, the more opportunity for failure.”

The glitch is a compelling reason for regulators to do more to protect investors of ETFs, said Paul Justice, an ETF analyst at Morningstar Inc. “It just reinforces the fact that we need more safeguards in place by the exchanges and clearer rules about how trades are going to be canceled,” he said.

SSgA has spoken to the NYSE and isn't concerned about this error recurring, said senior managing director Jim Ross.

“I don't see this as systemic,” he said. “We haven't had a lot of inquiries from advisers.”

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