Does Nasdaq (NDAQ) have its priorities straight? The three-hour shutdown of the exchange on Aug. 22 raises the question anew, but the Securities and Exchange Commission first identified it in March, when it proposed rules that would set standards for electronic trading and make exchanges more accountable for preventing outages. The exchanges are pushing back, which means the SEC has to move quickly.
The culprit behind Nasdaq’s failure was a still-mysterious software error in its connection with the New York Stock Exchange’s electronic trading system. The breakdown meant that Nasdaq couldn’t collect all the pricing and order data through its securities information processor, or SIP, and distribute that data over what is called the consolidated tape. Nasdaq was then unable to meet its legal obligation to be fair and transparent to all traders—whether that’s a $500 billion mutual fund or Uncle Jack in his bathrobe.
Nasdaq Chief Executive Officer Robert Greifeld was right to call a systemwide halt, even though proprietary data feeds to professional traders continued. Otherwise, the national market system that Nasdaq is tasked with running would quickly have devolved into a private market in which high-frequency traders and hedge funds—or anyone paying Nasdaq a fee for customized data—held all the cards.
There have been many technology-related trading problems in recent years, including the 2010 “flash crash” and the flubbed Facebook (FB) initial public offering (another Nasdaq failure). Last week’s Nasdaq outage exposes a more serious flaw involving a bottleneck. The data collection system was upended by a single point of failure. It can’t be right that, when one exchange’s SIP connection is broken, the global stock market and trading in options and related instruments must halt.
When the SEC in May settled charges with Nasdaq over the flawed Facebook IPO, the regulator was withering. Daniel Hawke, chief of the enforcement division’s market abuse unit, said, “Too often in today’s markets, systems disruptions are written off as mere technical ‘glitches,’ when it’s the design of the systems and the response of exchange officials that cause us the most concern.”
News that BATS Global Markets is merging with its electronic-market rival, Direct Edge, is another reason for SEC concern. The U.S.’s 13 stock exchanges, 50 or so privately traded dark pools, and dozens of brokerages that internally match bids and offers are consolidating in a race to get bigger and faster. Most transactions take place on supercomputers that match orders in millionths of a second. A BATS-Direct Edge combination would vault it ahead of Nasdaq, the No. 2 exchange behind the NYSE in volume of shares traded.
Yes, the stock markets are complex, and most transactions occur at lightning speed. And yes, technology will never work perfectly. That’s all the more reason for the exchanges and the SEC to make sure the plumbing is as foolproof as possible.