There’s a good chance the date Aug. 1, 2012, will be burned into the collective memories of stock trading executives just as much as May 6, 2010.
That was the day Knight Capital Group unintentionally built up a gross position of $7 billion in just 40 minutes as it lost control of one of its algorithms at the New York Stock Exchange. The market maker lost $440 million getting out of those trades, pushing it to the brink of collapse.
If not for the willingness of a group of broker-dealers to come to its rescue, Knight would have ranked as one of the industry’s most spectacular flameouts since that of Drexel Burnham Lambert in February 1990.
And while it didn’t scare the bejesus out of the American public as did the flash crash of May 6, 2010, the Knight catastrophe clearly delivered another jolt to a business almost entirely dependent on computers.
Knight’s gone-wild algorithm was the fourth prominent software glitch of the year and the straw that broke the Securities and Exchange Commission’s back. The public, regulators and politicians pounced on the industry at once; their collective patience had run out. Shortly thereafter, the regulator summoned industry executives to Washington D.C. to participate in a “roundtable” to discuss what might be done to prevent further mishaps.
The Knight fiasco followed the Nasdaq-Facebook fiasco in May, which itself followed the BATS Global Markets fiasco in March, which itself followed the Ronin Capital fiasco in February. (See Traders Magazine, September, for details.)
Why so many glitches all of a sudden? Were there, in fact, more than usual? Or has the media simply been more vigilant in covering computer-generated trading errors since the flash crash?
Some industry veterans argue the media spotlight is just shining brighter. Trading software glitches have been a regular occurrence over the past 15 years, they say, as automation has taken hold in both the stock and the options markets.
In fact, the last major blowup was in 2004 in the options market. The event received little press. Again it was Knight that nearly blew up, trading about $1 billion in notional value at off-the-mark prices. Most of the bad trades were busted, however, and Knight lived to trade another day.
In any event, the problem has come to a head. Industry players and Washington regulators are calling for change. They blame scant testing, poor monitoring and lack of accountability for the problems.
“We’re not going to eliminate mistakes,” Matt Andresen, co-chief executive of proprietary trading house Headlands Technologies, told Traders Magazine in August. “But we can try to minimize them by insuring best practices. That means mandating procedures and policies for how someone interacts with the marketplace.”
Broker-dealers are already required to police the orders they send into the market. The SEC made that a requirement with its Rule 15c3-5 this year. Now there is talk the regulator may go even further.
For more than 20 years, the SEC has used its “Automation Review Policy” to push exchanges to make sure their systems are working properly and report any outages. Now the SEC is considering codifying the policy into law and extending its coverage to brokerages.
