Investigators Look at Diebold's Sudden Drop

Minutes before a June 2 meeting with investors, Diebold (DBD) Chief Executive Officer Thomas W. Swidarski saw his company's share price plummet more than 30 percent in six seconds. As Swidarski tried to figure out what to say at the meeting, the price shot back up. By the end of the day, trading of the maker of cash machines had surged to about 11 times its usual volume. The stock closed at $29.08, or 3 percent above its opening price.

Trading specialists and enforcement attorneys at the Securities & Exchange Commission and the Financial Industry Regulatory Authority are examining what triggered the Diebold trades and whether the sell-off could have resulted from manipulation or inside information, according to people familiar with the matter who declined to be identified because the probe isn't public. Two stock exchanges, NYSE Arca and Nasdaq (NDAQ) OMX Group, which reviewed the trades for misconduct and errors, determined they should stand.

The plunge may have occurred when a shred of Diebold news bounced into the growing network of computer programs that search out financial information, analyze it, and trade instantly without human intervention, market analysts said. Diebold's experience poses the same concerns about high-speed trading as the May 6 sell-off that erased $862 billion from the stock market in less than 20 minutes.

Diebold's June 2 freefall started after the SEC announced that the company would pay $25 million to settle allegations of fraudulent accounting. The accord was old news; a year earlier, Diebold had announced it agreed in principle to pay that amount to end the investigation of its discontinued practice of recording some sales before machines were delivered. The SEC on June 2 also filed suit against three former Diebold executives. At 12:22 p.m., the stock plunged $8 in six seconds, to $18.26, according to Bloomberg data. It recovered and was trading above $25 by 12:23 p.m.

The use of software to analyze press releases, headlines, and news stories and trade within milliseconds has taken off in the past three years, says Timothy Sargent, CEO of Quantitative Services Group. The software is based on algorithms that process historical data, events, or keywords that have moved stock prices in the past. "There is a parsing activity to look at the flavor of the words chosen," says Sargent. "Obviously, there will be negative words and positive words." (News for algorithmic trading is supplied by News Corp.'s (NWS) Dow Jones, Thomson Reuters (TRI), and Bloomberg LP, the parent of Bloomberg News.)

Traders don't care if algorithms occasionally misinterpret data as long as the computers make the correct moves most of the time, says Sargent: "The dollars and the money to be made being right a majority of the time is enough to pursue these strategies."

To respond to the May 6 crash, the SEC and exchanges are instituting curbs on a trial basis. If a stock rises or falls 10 percent in less than five minutes, trading in the stock will halt for five minutes. The test, scheduled to last through Dec. 10, only covers stocks in the Standard & Poor's 500-stock index, which doesn't include Diebold. On June 16, Washington Post Co. (WAPO) became the first company to have its stock halted under the rule when its shares briefly doubled,

The point is to avoid scaring off investors. "If people think the market is rigged or does all these weird things," says Terrance Hendershott, an associate professor of finance at the University of California at Berkeley's Haas School of Business, "why would people choose to put money in the markets to help firms grow and raise capital?"

The bottom line: Regulators are struggling to cope with computer trading that causes sudden swings in stock prices, undermining confidence in the market.

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