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U.S. stock exchanges offer plans to prevent trading glitches

A trader works on the floor of the New York Stock Exchange, November 12, 2013. REUTERS/Brendan McDermid
A trader works on the floor of the New York Stock Exchange, November 12, 2013. REUTERS/Brendan McDermid

By Herbert Lash

NEW YORK (Reuters) - U.S. stock and option exchanges said on Tuesday they reached a general agreement on how to strengthen securities markets after federal regulators ordered them to come up with new rules in the wake of Nasdaq's three-hour trading halt in August.

Exchanges, including New York Stock Exchange operator NYSE Euronext and Nasdaq OMX, said they agreed on the timing and nature of certain regulatory proposals, including rules designed to protect the securities information processor (SIP) at the center of the August 22 trading halt.

The exchanges were given a soft deadline of 60 days after a September 12 meeting at the Securities and Exchange Commission's headquarters in Washington with SEC Chair Mary Jo White.

They were asked to come up with reforms in five areas, including a kill switch to halt trading during disruptions and new testing and disclosure protocols for the processors, which disseminate stock quotations and last sale prices to investors.

The exchanges' joint statement came as White spoke to the annual meeting of the Securities Industry and Financial Markets Association in New York, which represents hundreds of brokerages, banks and asset managers.

"We have made very good progress," she told the audience. "I am expecting today... some concrete steps to implement all of the five areas that we talked about."

White declined to comment on specifics, saying she had yet to see what the exchanges submitted. In a statement she later said "today's reports are very constructive, but work remains to be done."

Given the severity of the trading halt, the exchanges' response seems underwhelming, said Lev Lesokhin, an executive vice president at CAST, a French software analysis and measurement company.

Lesokhin said a common refrain from the industry is that technology is not perfect, which he called a type of propaganda blitz that eases the exchanges off the hook.

"The root cause of a lot of these issues is bad software," he said. "They can go a lot closer to being a zero-defect operation in terms of the software they build. I don't see them addressing that issue head on."

The software bug that clogged the SIP's ability to disseminate quotes in August was the latest software glitch to disrupt markets. Faulty software was involved in the botched Facebook IPO last year and the forced sale months later of brokerage Knight Capital after a $440 million trading loss.

The exchanges did not delve into specifics about their proposals, saying those would be presented in subsequent rule filings to the SEC and amendments to its rules governing securities trading in the national market system, or Reg NMS.

The proposals by the exchanges, known as self-regulatory organizations (SROs), will be subject to public comment and SEC approval.

SROs have legal responsibilities to self-police their markets to ensure members comply with federal regulations.

The exchanges and other SROs, including the Financial Industry Regulatory Authority and clearing houses Depository Trust & Clearing Corporation and Options Clearing Corporation, agreed on five areas to strengthen the market from a spate of technology failures that have rattled public confidence.

The SROs said their proposals would address the SIPs, critical infrastructure, halts and trading resumptions, trade breaks and kill switches.

The SROs and their committees that govern the SIPs compiled proposals designed to improve the operational resiliency of the processors, strengthen interoperability standards and disaster recovery capabilities related to them, and establish a clear testing framework.

The SROs also said they established a pathway to identify contingencies related to such critical areas as the open and close of the markets, the launch of initial public offerings and potential outages at the clearing houses, among other issues.

A series of glitches that hit the U.S. exchanges over the past 18 months revealed their growing vulnerability to operational risk, ratings agency Standard & Poor's said in September, and could trigger credit downgrades.

White said the glitches are of concern because they could undermine investor confidence, and she added that the exchanges should strive for "zero tolerance" when it comes to errors.

"Our objective has to be zero tolerance. I think we all know that technology is never going to be perfect," she said.

(Additional reporting by Sarah N. Lynch in New York.; Editing by W Simon, Chizu Nomiyama, Nick Zieminski and Bob Burgdorfer)

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