Nasdaq Focus on ‘Defensive Driving’ After Trading OutageSam Mamudi and Whitney Kisling
Nasdaq OMX Group Inc. halted trading for three hours yesterday to protect the integrity of markets as a technology malfunction left some investors without stock quotes, Chief Executive Officer Robert Greifeld said in his first public remarks since the incident.
The exchange operator was in constant communication with rivals during the outage and decided to halt trading of listed stocks to prevent “information asymmetry” among traders, Greifeld said in interviews at Nasdaq’s offices with Bloomberg Television’s Betty Liu and Andrew Ross Sorkin on CNBC. Greifeld said he supports developing a backup data feed to prevent the issue from happening again.
“The general theme we’re focused on going forward is that we have to improve our defensive driving ability,” Greifeld told Bloomberg TV. “This system has been around for 20 years, it works and it works remarkably well. Then things happen in the external environment that causes a problem.”
A faulty connection between the two biggest operators of U.S. stock exchanges brought half of the world’s largest equity market to a standstill, the second time this week U.S. trading was shaken by a computer malfunction.
Connectivity was disrupted between NYSE Arca, where about 11 percent of American share volume occurs, and the data processing subsidiary of Nasdaq Stock Market, home to 2,150 U.S. companies, according to a person with direct knowledge of the matter. That led Nasdaq to freeze thousands of stocks from Apple Inc. to Facebook Inc. that trade on about 50 markets from Kansas to New Jersey for more than three hours.
“We have to make sure no matter what happens the system stays up and the system has a resiliency and a robustness that we did not exhibit yesterday,” Greifeld said on Bloomberg TV.
President Barack Obama was told about the malfunction and Mary Jo White, the chairman of the Securities and Exchange Commission, plans to convene market officials to discuss ways of making trading more reliable. Just three days ago, Goldman Sachs Group Inc., which made $5.8 billion from stock trading in 2012, flooded options markets with unintentional orders.
“For three hours not a single person in the world could trade any Nasdaq-listed stock,” Manoj Narang, the chief executive officer of Tradeworx Inc., a high-frequency trading firm in Red Bank, New Jersey, that designed a system to monitor markets for the SEC, said in a phone interview. “That’s not acceptable, especially for something as simple as a quote feed not working.”
The disruption is the latest to signal unreliability in electronic markets just as individual investors who withdrew from stocks after the global economic crisis have shown signs of embracing equities. About $30 billion poured into exchange-traded funds that own U.S. shares in July, the most since 2008 and the second-highest ever, according to data compiled by Bloomberg since 2000.
Failures are increasing as global markets get more fragmented. U.S. equity trading, which began on Wall Street more than two centuries ago and was dominated by the New York Stock Exchange for most of that period, has become dispersed among more than 50 electronic platforms accessible around the world.
It’s the latest challenge for Greifeld, the 56-year-old leader of Nasdaq OMX, which was criticized for mishandling the initial public offering of Facebook in May 2012. Nasdaq agreed to pay $10 million to settle SEC charges related to the IPO as regulators cited “poor systems and decision-making.”
While Nasdaq’s closure yesterday kept brokers from executing client trades and raised fresh concerns about exchange fragility, investors praised the decision to stop activity before chaos snowballed.
Nasdaq’s own shares, which were covered by the halt, fell 3.4 percent to $30.46 in New York yesterday. That was the biggest drop in four months and trimmed the 2013 advance to 22 percent. The stock rebounded 0.6 percent to $30.63 at 12:30 p.m. in New York trading today.
The Nasdaq Composite Index, which didn’t move during the outage, gained 1.1 percent to 3,638.71 yesterday. The Nasdaq 100 Index of the biggest companies listed on the exchange climbed 1 percent to 3,101.82.
“It’s a good thing to halt the data before the trades go crazy because it could have easily turned into a flash crash,” said James Angel, a finance professor at Georgetown University in Washington. “It certainly doesn’t make them look good when their market went down but they pulled the switch before the market went crazy.”
Nasdaq froze transactions in all of its shares just after noon, stopping the buying and selling on its platform and dozens of others where the securities trade. Bad connectivity between an exchange that wasn’t identified and Nasdaq’s securities information processor, or SIP, led to a “degradation in the ability of the SIP to disseminate consolidated quotes and trades,” according to a Nasdaq release.
The exchange was NYSE Arca, according to the person with direct knowledge, who asked not to be identified because the matter is private. Rob Madden, a Nasdaq spokesman, declined to comment on the matter, as did Rich Adamonis, a spokesman for NYSE Euronext.
Nasdaq and NYSE, which almost all U.S. companies use to go public, each operate 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.
“In order for the trade to be consummated, it has to hit the tape,” said Sayena Mostowfi, senior analyst at Tabb Group LLC based in New York. If it doesn’t, “you can’t really trade,” she said. “That’s why the entire market goes out.”
The Nasdaq SIP processed about 85.4 million quotes and 6.25 million trades per day in the fourth quarter of 2010, according to a consolidated exchange data report. NYSE’s handled 311.3 million quotes and 20.1 million trades daily in the same period. During peaks, Nasdaq saw an average of 58,585 quotes and 14,030 trades a second.
Nasdaq’s malfunction shows that not enough redundancy is built into the quote processing system, according to Jerome Dodson, president of San Francisco-based Parnassus Investments, which oversees about $9 billion. His firm submitted equity trades around noon New York time that weren’t completed.
“The traders said: ‘There’s nothing filling! There’s nothing filling!’” said Dodson, who oversees the Parnassus Fund that has beaten 93 percent of its peers in the past five years. “No doubt there should be a backup system.”
Signs of strain appeared shortly after 10 a.m. when NYSE Arca began alerting traders to problems, saying it was having issues routing orders in certain Nasdaq-listed securities, according to emails the exchange sent to subscribers. Although the exchange said it resolved the issue within about 10 minutes, live orders for those securities were canceled 20 minutes later and quoting didn’t resume until 11:16 a.m., status updates show.
About 30 minutes later, Nasdaq sent an alert that its SIP was having “momentary interruptions” disseminating quotes, and exchanges began halting Nasdaq-listed security data shortly after noon. NYSE Arca stopped at 12:14 p.m. at the request of Nasdaq, according to alerts.
Nasdaq equity indexes didn’t update during the outage and volume in stocks listed on the New York Stock Exchange also dwindled as liquidity dried up around the country. As happened after Goldman Sachs’s mishap, traders said losing access to so many stocks would expose trading positions to losses.
“The real fear is that we get stuck wearing some kind of risk because of an interruption that is not of our doing,” Max Breier, a senior equity derivatives trader at BMO Capital Markets Corp. in New York, said in a phone interview. “Any halt in information or ability to trade is going to hinder our ability to manage our risk and take positions.”
Obama was briefed on the disruption by his chief of staff, Denis McDonough, according to an e-mail from Josh Earnest, deputy White House press secretary, to reporters traveling with the president in upstate New York.
A meeting of exchange leaders will be convened in Washington to “accelerate ongoing efforts to further strengthen our markets” by the SEC’s White, according to a government statement.
The SEC and the Commodity Futures Trading Commission have stepped up scrutiny of trading since the so-called flash crash of May 6, 2010, when $862 billion in equity value was erased in 20 minutes before prices recovered. The CFTC, the top U.S. derivatives regulator, is poised to announce a range of potential methods for overseeing automated and high-frequency trading, according to four people with knowledge of the matter.
The decision to freeze stocks halted dozens of other markets around the country that trade securities. Exchanges from Bats Global Markets Inc. in Lenexa, Kansas, to Jersey City, New Jersey-based Direct Edge Holdings LLC published notices saying they were following the main exchange.
Nasdaq “has to recommit to making sure they are delivering their core value proposition, which is reliable, transparent and effective market making,” Brad McMillan, chief investment officer for Waltham, Massachusetts-based Commonwealth Financial Network, said in a phone interview. His firm has more than $71 billion under management.
“If it gets to the point of, ‘Oh, yeah, Nasdaq went down again, and that’s not news,’ that’s when they lost their ability to deliver their core function.”
The disruption resulted in the second-fewest shares changing hands on U.S. exchanges in at least five years during a full-day session. About 4.4 billion shares traded yesterday, 30 percent below the three-month average. Volume was lower only on Oct. 8, 2012, excluding holiday trading, according to data Bloomberg began compiling in 2008.
About 740 million exchange-listed shares changed hands during the three hours through 3:20 p.m. in New York following the suspension, or a third of the total transactions over the first three hours, data compiled by Bloomberg show.
American stock markets regularly shut down as share volume rose in the late 1960s before computers were in widespread use. According to the Depository Trust & Clearing Corp.’s website, exchanges closed every Wednesday and shortened trading hours as daily share volume of 10 million to 12 million shares meant “brokers were literally buried in paperwork.” Volume has averaged more than 6 billion shares a day in 2013.
Yesterday’s outage was longer than an approximately 40-minute shutdown in 1994 that was triggered when a squirrel chewed through a power line in Shelton, Connecticut, disrupting electricity near a Nasdaq computer facility in Trumbull. That same year, a communications-software error shut the exchange for two-and-a-half hours. Another squirrel was to blame for a 1987 outage that lasted 82 minutes, according to a New York Times report at the time.
Investors in China were whipsawed by a computer malfunction last week. State-controlled brokerage Everbright Securities Co. reported a trading loss of 194 million yuan ($32 million) and apologized to investors after errors in order-execution systems on Aug. 16 sparked the biggest intraday swing in China’s benchmark index since 2009.
Yesterday’s halt “is not a Nasdaq issue, this is a much broader issue,” Sal Arnuk, a partner and co-founder at Themis Trading LLC in Chatham, New Jersey, said in a phone interview. “This is a black eye and an egg on the face of the structure of all the exchanges.”