SEC talks on Nasdaq failure to focus on backing up system

Reuters
Construction crew work outside the Nasdaq MarketSite in New York's Times Square
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Construction crew work outside the Nasdaq MarketSite in New York's Times Square, August 23, 2013. REUTERS/Andrew Kelly

By Herbert Lash and John McCrank

NEW YORK (Reuters) - Federal regulators and stock exchange executives are likely to focus on the stock quotes processor behind Nasdaq's trading halt last month, but a quick resolution of system outages or market weak spots at the meeting on Thursday is unlikely.

Mary Jo White, chairwoman of the Securities and Exchange Commission, scheduled the meeting two weeks ago to address the "securities information processor" (SIP), whose malfunction shut down trading in Nasdaq stocks for three hours on August 22.

The outage was the latest of recent technological failures to hit the U.S. stock market. While none were related, they have raised questions about the system's fragility and the risks they pose.

A potential solution to the outage - and what regulators call the single point of failure - is to create redundancy by having exchange operators Nasdaq OMX Group Inc and NYSE Euronext distribute each other's data to act as a back-up.

A software bug that clogged the processing of stock quotes from 13 exchanges put the spotlight on a little-known area that is a choke point for the U.S. stock market.

The idea that Nasdaq's data could be distributed via NYSE's processor and vice versa has been discussed within the industry, said Jamie Selway, a managing director at brokerage ITG, which also operates the Posit alternative trading platform.

"That's a feasible option. We've heard that from a few places," Selway said. "I think it's the most likely path."

One obstacle to this solution is that the coding of the two SIP systems is different.

Nasdaq now oversees a processor that disseminates the best bids and offers from all 13 exchanges, but only in Nasdaq-listed stocks. It also operates a data feed that churns out the latest sale price from every order execution in Nasdaq stocks.

NYSE also operates a processor, but only for securities listed on its two exchanges. There are no redundancies built into the SIPs, which forced Nasdaq to halt trading when its processor stopped disseminating stock quotations.

Though ideas like back-ups have been floated before, it's doubtful there will be an immediate decision, said a source familiar with the situation.

The exchanges will send their top executives to a closed-door meeting with White at the SEC's headquarters in Washington. The SEC has not released details of what will be discussed or when the meeting begins, which is closed to the media.

"It's mostly going to be a discussion and trying to figure out not just about the SIP, but more generally, single points of failure and general exchange technology," the source said.

There are two issues at hand, the source said. "One is, do you think that you need a back-up of one versus the other? The second is, do you think Nasdaq should be upgraded?"

The number of stock quotations that NYSE's SIP can handle is about six times that of Nasdaq's processor, said Tom Jordan, chairman of the advisory committee at the Financial Information Forum, which compiles data-feed statistics.

NYSE's SIP has never hit its capacity level, Jordan said. The highest volume days for NYSE's processor are about three times the capacity of the Nasdaq processor, Jordan said.

The cost of upgrading Nasdaq's processor would be borne by the exchanges from the revenue they derive from the market data they provide customers. Nasdaq also could relinquish administering the SIP, he said.

The SIPs, centerpieces of the high-margin market data business, cost anywhere from $15 million to $20 million a year to run, according to several sources.

The processors have rarely been in the limelight, but the trading halt highlighted their critical role.

"These 'single points of failure' should be subject to heightened regulatory requirements, including a regulatory mandate for redundancy," Elizabeth King, in charge of regulatory affairs at trading firm KCG Holdings Inc, wrote in May.

White provided an update on the trading halt to the Financial Stability Oversight Council, a panel of regulators established by the Dodd-Frank law, in a closed session on Tuesday at the Treasury Department, a spokeswoman said.

The council is tasked with policing the market for emerging risks and it has the legal power to pressure other regulators to take action if a new risk is identified.

In its 2013 annual report, the oversight council identified operational risks, such as technology failures, natural disasters and cyber attacks as a high-risk area.

"One area of particular concern is the potential for systems failures in an environment where trading activity is more dispersed and automated," FSOC wrote.

(Reporting by Herbert Lash; Additional reporting by Sarah N. Lynch in Washington; Editing by Kenneth Barry)

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