The FTSE 100 closed off 206.3 at 5,690.5 as stock prices fell to reflect the sudden glut of shares on the market. Although no single stock ended more than 5 per cent lower, the cumulative effect was to wipe 130 points off the index.
The lurch downwards wiped out five weeks of hard-fought gains for the beleaguered equity market, but the index was expected to bounce back this morning. Investors said they would ignore the distorted closing share prices and resume trading at the levels before the Lehmans sell-off.
Market sources blamed a single "basket trade", a complex share transaction involving a number of different stocks, which Lehmans carried out in the closing auction.
Basket trades can be used if a fund manager is reshuffling a portfolio of investments. Or an investor might want to buy or sell all the constituents of an index as happened yesterday with the FTSE 100 to limit the risk of losing money on movements by the index.
One source said dealers at the bank in question were "not entirely happy with the way they did the trade", but Lehman Brothers refused to comment last night.
The London Stock Exchange, which is understood to have launched an investigation into the share sales, confirmed that the transactions will not be cancelled. It is possible that it will suggest ways dealers can limit the market impact of complicated basket trades.
Last July, one fund manager's portfolio reshuffle, involving 90 different stocks, added more than 40 points to the FTSE 100 in the closing auction and made a mockery of dozens of closing share prices.
The auction, conducted after the end of official trading at 4.30pm, electronically matches any outstanding buy and sell orders, and allows brokers a last chance to conduct the day's business. Dealers may have to complete basket trades by the end of the day, or at the closing price, leaving them little option but to use the auction system.
Wild price movements were widely criticised by dealers and investors when the auction was introduced a year ago, but the Stock Exchange argues dealers have time to see the effect of their orders and adjust them accordingly.