Island Inventor Levine Says Backups Not Enough in Stocks

Systems such as stock markets should be designed to avoid “single points of failure,” though doing so is getting harder, according to Josh Levine, who invented the technology that underlies Nasdaq OMX Group Inc.’s exchanges.

The Nasdaq Stock Market halted trading in shares it lists for three hours yesterday after connectivity was disrupted between its data processor and NYSE Arca, where about 11 percent of American share volume occurs. The breakdown spurred Nasdaq to freeze thousands of stocks from Apple Inc. to Facebook Inc. that trade on about 50 markets from Kansas to New Jersey.

“In general I prefer distributed systems over centralized ones, and distributed systems’ resistance to outages like this is only one of the many reasons why,” Levine, who designed the Island ECN that Nasdaq acquired when it bought Instinet Group Inc. in December 2005, wrote in an e-mail. He said he didn’t have specific details about the Nasdaq outage.

Yesterday’s shutdown raised questions among traders about how problems in Nasdaq’s quote-distributing subsidiary, known as the securities industry processor, were enough to bring half the American equity market to a standstill. Concern bad data could lead to “information asymmetry” among investors spurred the decision, Nasdaq Chief Executive Officer Robert Greifeld said on Bloomberg television this morning.

“Having backups is not enough to assure failure resistance,” Levine wrote. “You must also make sure that you do not have single points of failure.”

Securities Processors

Nasdaq and the New York Stock Exchange, where almost all U.S. companies go public, each operate securities industry processors, known as SIPs. The units receive quotes and trades from around the country and disseminate them in three groups, known as tapes. NYSE operates the Tapes A and B and Nasdaq runs Tape C.

The Nasdaq SIP processed about 100.5 million quotes and 6.75 million trades per day in the first quarter, according to a consolidated exchange data report. NYSE’s handled 394.8 million quotes and 16.6 million trades daily in the same period. During peaks, Nasdaq saw an average of 97,955 quotes and 19,446 trades a second.

“Designing systems and structures that avoid these single points of failure is very hard, and gets harder the more complex and centralized a system is,” Levine wrote. “It is remarkable how rare outages like this are considering the regulatory and structural challenges that systems like Nasdaq are faced with -- they do an amazing job keeping these huge, complicated, and constantly changing systems running almost all the time without incident.”

Big J

In a January 2002 letter to an operating committee reviewing proposals for a quote processor, Levine offered to design a SIP by himself that would be run not-for-profit over an open architecture. Big J SIP, it would be called, according to the letter posted on his website.

“I’m not in this for the money,” he wrote. “I’m offering to create this SIP because I see it as a once-in-a-lifetime opportunity to make a meaningful and lasting improvement in the overall quality of the U.S. equities markets. My ultimate hope is that the SIP would effectively disappear; becoming the infrastructure that invisibly supports the innovations happening inside the marketplaces and data vendors.”

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