Are Exchange System Errors the New Normal in High Speed Markets?

Technical blips that cause computerized exchanges to go dark or breakdown for a few minutes have become a frequent occurrence lately. Perhaps that’s the reason why Wall Street professionals calmly reacted to the latest event reported by BAT Global Markets, which executed hundreds of thousands of short sale trades at incorrect prices due to a programming bug.

A string of errors has plagued other US exchanges even in the weeks and days prior to the BATS discovery, again reigniting conversation about the complex systems that fuel modern, highly automated exchanges.

Friday’s New York Times enumerated a slew of technology glitches that occurred at the New York Stock Exchange, the largest U.S. stock exchange, which has had two-shorter breakdowns since Christmas, and two separate problems with its data reporting system. On Jan. 3, customers of the Nasdaq Stock market experienced a blackout in stocks listed on the second biggest exchange when the reporting system broke down for about 15 minutes. One day before BATS announced the finding on Wednesday, the National Stock Exchange (known as NSX) stopped functioning correctly for more than an hour, causing other exchanges to route trades around it, noted the NY Times.

In the wake of this steady stream of snafus with electronic trading, the industry has focused on testing its systems, while exchanges have talked about adopting kill switches to control rogue algorithms. At a hearing in December, exchange executives told Congress they are focusing on testing their systems more vigorously, yet these systems errors seem to be occurring more frequently.

On Thursday, Joe Ratterman, chief executive of BATS, suggested that in dynamic markets, these errors are difficult to prevent. He also told Reuters and other media outlets that it’s possible that other such problems could be found as the exchange operator seeks them out.

“Handling orders right is a challenging problem to solve,” Ratterman also told the Wall Street Journal.

But if these errors are the new normal, what does this say about quality control?

“If you had another business building cars and you said that mechanical errors is just part of the business,” that wouldn’t be okay would it?” said a Wall Street Journal reporter in this video interview.

Meanwhile, more details have emerged about the BATS' programming mistake that led 435,000 trades to be executed wrong prices over the last four years, violating securities laws that they be routed to the best price. The error affected 119 member firms that lost a total of $420,000 over the four –years, and some lost less than $100. The error only impacted a small category of complex trades coming from investors that were trying to do short sales of stocks, Ratterman told the New York Times. Those trades accounted for 0.0003 percent of all equity and options trades over the last four years, the CEO explained to the NY Times.

Unlike the other recent technical glitches, the BATS’ error didn’t disrupt trading. Yet the situation could be worrisome to regulators because BATS is regarded highly as one of the most sophisticated of the 13 public exchanges. If BATS is having these issues, then perhaps there are more hidden errors that haven’t been discovered at other exchanges.

While the systems error disclosed by BATS did not seem to worry traders who are accustomed to daily alerts of errors, outages and other mishaps, it seems to have struck a chord with a former exchange chief.

"It appears this wasn't intentional, but how do you have a system glitch that allows orders to violate one of the central principles of the securities market, and that goes on for years?" Neal Wolkoff, former chairman and chief executive of the American Stock Exchange who is now a consultant and lawyer with Richardson & Patel LLP.

Now regulators are said to be concerned that similar kinds of things are happening at other exchanges but they haven’t been told of. While these kinds of blips are unnerving to retail investors, some suggest that institutions are concerned as well. Robert Hegarty, global head of market structure for Thomson Reuters, tweeted: “The number and severity of glitches has been scaring even large investors away.”

Click here for the Wall Street Journal video interview: