Exchange executives and securities regulators will discuss improvements in systems for distributing price data as they meet in Washington today in the latest attempt to strengthen the fragmented U.S. equity market.
Securities and Exchange Commission Chairman Mary Jo White plans to hold private talks with the chief executive officers of the 13 U.S. stock exchanges to discuss the Aug. 22 failure in Nasdaq OMX Group Inc.’s backup system for disseminating prices, which prompted a three-hour trading halt for thousands of companies.
The malfunction was the latest in a series of mishaps that have shaken confidence in computerized trading since May 6, 2010, when an algorithm briefly caused markets to erase about $862 billion in share value. The SEC expects Nasdaq and NYSE Euronext to explain that incident and coordinate with other exchange operators to prevent future occurrences.
“They are encouraging the exchanges to work together to make sure the systems are as redundant as possible,” said David A. Herron, chief executive officer of Chicago Stock Exchange Inc., who will attend the meeting. “I think the industry will step up and do the right thing.”
White, who was a Nasdaq Stock Market Inc. board member from 2002 to 2006, has said she will seek new protocols for breaking trades if a network fails and push to advance rules that would require exchanges to show trading can continue through natural disasters and programming glitches.
SEC Enforcement Co-Chief Andrew Ceresney, speaking yesterday at a Practicing Law Institute seminar in New York, said Nasdaq’s trading halt demonstrated the need for investigators to take a closer look at whether market participants have adequate policies and safeguards in place to keep up with the technology they use.
Nasdaq’s computers were flooded Aug. 22 with data from NYSE Arca, a rival exchange, revealing a bug in Nasdaq’s software that disabled systems that should have prevented the malfunction from snowballing, according to a statement. The challenges were “clearly within the control of Nasdaq OMX,” the company said.
Nasdaq experienced another glitch with the system on Sept. 4. This time, the backup worked and the problem only lasted six minutes. The exchange said the data feed suffered a “hardware memory failure” that forced a switch to a backup.
The private meeting will focus new scrutiny on the price networks, known as securities information processors, that distribute stock prices to the public. The three SIPs for U.S. equity markets are run by Nasdaq and NYSE Euronext.
SIPs gather price data from each exchange, consolidate it, and then sell the information to brokers and other securities firms. All exchange participants share the revenue earned from selling the data, which is prescribed by an SEC rule.
Nasdaq’s recent failures underscore the risk of relying on a single system to disseminate market data. An SEC advisory committee recommended in 2001 that the commission encourage competition by opening up the market-data business to outside consolidators. The commission rejected that idea in a 2005 update of national-market system rules known as Regulation NMS.
“This notion that people should pay for the quotes by regulatory mandate was back in a time when you needed mainframe computers and hundreds of millions of dollars to aggregate quotes and provide information to the public about security prices, but we haven’t needed that for 25 years,” said Harold S. Bradley, who served on the 2001 committee and is a former chief investment officer for the Ewing Marion Kauffman Foundation. “So the SIP ends up being a choke point in a high-frequency trading world and an enormous source of revenue for the exchanges.”
A committee that oversees Nasdaq’s SIP proposed on Sept. 4 “short-term” actions to prevent future failures. The changes include terminating a connection if the network detects an unusual surge in data traffic and increasing the frequency of stress testing.
The SEC meeting also will allow White and fellow regulators to explore how a rule proposed in March, known as Regulation SCI, may help prevent future failures of key exchange technology. The exchanges have resisted key sections of the proposal, saying it would cover too many systems and require them to report too much information.
The SEC also plans to discuss how a trading halt due to a SIP failure can be better communicated. Some exchanges had systems programmed to stop trading based on a message from the market-data networks. That message couldn’t be relayed by Nasdaq’s SIP after it went down on Aug. 22.