A joint SEC/CFTC report largely laid the blame for the Dow plunge on a large sale of e-mini futures by an un-named market participant, with asset management house Waddell & Reed fingered as the chief culprit by observers.

In a blog post on the Themis Trading Website, Arnuk urges onlookers not to take the bait, and instead points to the role played by broker-dealer/large market maker internalisation desks in flooding the market with retail order inventory.

"As the market was falling dramatically, the internalisers continued to short stock to retail market buy orders, but they dramatically stopped internalising retail market sell orders, and instead flooded the public market with those orders," he notes, referring to the SEC/CFTC investigation data. "When the market stopped falling, and rose dramatically almost as quickly as it fell, the internalisers reversed that pattern, and internalized retail sell market orders, and flooded the public market with retail market buy orders."

In other words, the crossing engines used their speed advantage to pick and choose which orders they wanted to take the other side of, and redirected the others to the main exchanges as riskless-principal trades. If that limit order could not be filled because the market continued to fall, then the internaliser set a new lower limit price and resubmitted the order, following the price down and eventually reaching unrealistically-low bids.

"The practice not only strikes us as patently unfair, but the number of orders that flooded the marketplace was massive," says Arnuk. "As such it caused data integrity issues (widening the difference between speeds of the CQS public data and the co-located data), further perpetuating the downward cycle in the marketplace."

Analysis of the trade data from the day by the SEC and CFTC shows that one large internaliser (as a seller) and one large market maker (as a buyer) were party to over 50% of the share volume of broken trades, and for more than half of this volume they were counterparties to each other."

Concludes Arnuk: "Retail investors were clearly the biggest loser on May 6th. They trusted that their brokers would execute their orders in a fair and efficient manner. However, considering that half of all broken trades were retail trades, and that the arbitrary cutoff was 60% away from pre flash crash levels, the retail investor ended up paying the highest price for the structural failings of our market."