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September 1, 2012

Cover Story: Glitch!

Industry Ponders Remedies as Software Malfunctions Multiply

By Peter Chapman

Is trading out of control?

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Given the spate of high profile blow-ups this year, industry professionals and the regulators are starting to wonder. All the snafus were caused by software glitches, which leads trading experts to question whether brokers and exchanges know what they're doing when building complex automated systems.

First came the Ronin Capital debacle on Feb. 24, when the options market maker disrupted trading at NYSE Amex with more than 30,000 wildly mispriced quotes. Then came the failed public offering of BATS Global Markets by BATS itself on March 23. That was followed by the botched public offering of Facebook by Nasdaq OMX Group on May 18, resulting in millions of dollars in losses for market makers. Finally, on Aug. 1, Knight Capital Group lost $440 million due to a software malfunction that flooded the New York Stock Exchange with a series of bad orders.

Taken together, the perception is the industry is losing control. "The complexity of some systems overcomes the best efforts of designers to keep them under control," says Harish Devarajan, chief executive of Deep Value, a developer of trading algorithms used at the New York Stock Exchange and elsewhere. "All systems start off as things that do our bidding. But some rise in complexity to the point where we masters become the servants of the system."

New Rules 

Mary Schapiro, SEC

A week after the Knight debacle, the Securities and Exchange Commission announced it would convene a roundtable of trading technologists in Washington on Sept. 14 in an effort to determine if brokers and exchanges are in control of their trading systems. The SEC has billed the session as an information-gathering workshop, but Chairman Mary Schapiro has also stated that her agency intends to roll out new rules, as well.

At a minimum, the SEC is targeting the exchanges and other market centers with a rule requiring them to make sure their systems function properly. The regulator has had a so-called "Automation Review Policy" for more than 20 years that requires exchanges to make sure their systems are working properly and to report any outages that occur. This is a statement of policy, however, and not a set of rules. Schapiro said last year ARP should become mandatory.