NASDAQ Shutdown Forces SEC’s White Into Fight With Market Perils

A 3-hour shutdown of NASDAQ Share Market marks the first test of Securities & Exchange Commission Chairman Mary Jo White’s ability to push through stronger technology safeguards for electronic trading. Mary, a former prosecutor who lacks a background in market regulation responded to the failure by vowing to finish a rule proposed in March to need exchanges to test the reliability of their technology. Exchanges want to limit the number of systems covered by the rule and how much info they have to report about glitches. SEC has grappled with how to enhance market stability since 2010 flash crash, when $862 billion in equity was erased in 20 minutes before share prices recovered.

Andrew M. Klein, Partner at Schiff Hardin LLP and Former Director of markets and trading at SEC said Mary needs to be convinced these guys, all of them take this with utmost seriousness. NASDAQ is starting to look like you cannot be stopped from having these issues and it needs to stop. White signaled in her Senate confirmation hearing in March that she would scrutinize the dispersed, high tech and high speed marketplace, so that it can be optimally and wisely regulated.

Connectivity Issue                                    

NASDAQ said its failure this week stemmed from a connectivity issue between the network and exchange, known as securities information processor, which offers data about prices and quotes. SIPs or such systems are owned by 2 most significant operators – NYX (NYSE Euronext) and NDAQ (NASDAQ OMX Group Inc.). The rule proposal of SEC called Regulation SCI would need exchanges, clearing firms and SIPs for adopting policies to prevent failures, stress test their systems to make sure trading continues through a disruption, including a natural disaster or software glitch. The rule would also cover exchange competitors called alternative trading systems such as dark pools.

No Competition

SEC warned in its March proposal that SIPs could be vulnerable to glitches as there is virtually no competition amongst market data feeds offered to the public, which could lead to little incentive in ensuring high quality product with minimal disruptions. David Easthope, Research Director for securities and investment group at Celent, San Francisco said if you are thinking about investing in your budget for technology, you are going to invest in things, which bring in revenue not necessarily things, which are infrastructure or shared services across the industry.

Software failures have mounted as stock trading becomes more dispersed across multiple alternative trading venues and 13 United States equity exchanges. Larry Tabb, Chief Executive Officer at Westborough, Massachusetts based financial market consultant, Tabb Group LLC said the demand for faster dissemination of market data has forced exchanges to accelerate the movement of information through high speed proprietary data feeds and SIPs.

Faster Systems

Tabb said the way you wind up getting software to speed up is you take out all the protection. Exchanges are resisting Regulation SCI as they worry it will be used to fine them for software glitches which are impossible to eliminate. The rule would replace a voluntary program created after 1987’s share market crash and would expand SEC’s oversight to more systems, including those which support surveillance and regulatory compliance. James J. Angel, Finance Professor at Georgetown University’s McDonough School of Business in Washington said Reg SCI fundamentally gives provides SEC the ability to ding any exchange for any problem.

White’s Response

On 22^nd August, Mary White said that she would work to advance the proposal that passed SEC unanimously on 7^th March. She also said she would convene a meeting of exchange executives and other market participants for accelerating ongoing efforts to further reinforce our markets. Michael Piwowar, SEC Commissioner who joined the agency in August yesterday advised caution on advancing the regulation. Regulation SCI may or may not have contemplated what ultimately caused these disruptions. Thus, we should reconsider the assumptions underlying the Regulation SCI proposal before moving forward with further rulemaking.

Limiting Reports

Exchanges also want SEC to limit the rule to systems which support clearance, trading, order routing, market data and settlement in real time. They also say the commission should adopt materiality threshold to limit the number of system intrusions or compliance failures that must be reported to the regulator. The problem is finding a device to prevent this and recognize the truth of what the industry based message is, that you can’t have this kind of technology-based elaborate system and expect no failures.