A Fast-Paced Stock Exchange Trips Over Itself
The stock market claimed an unlikely victim on Friday: one of its own.
Just as its shares started selling to the public for the first time, BATS Global Markets, one of the nation’s newest and largest electronic exchanges, halted trading on its own stock, after a series of technical glitches and errors in its system that also affected the shares of Apple and other companies.
A few hours after the embarrassing debacle, the financial company withdrew its initial public offering of stock. Investors who tried to buy the new shares will have their trades canceled, and owners who wanted to sell their stake will not be able to cash out for now.
While trading on the BATS exchange was back to normal in a few hours, the technical problems raise questions about the vulnerability of the broader market system, which has allowed new competitors like BATS to take on traditional exchanges like the New York Stock Exchange and the Nasdaq.
As stock trading has shifted to high-speed computers and electronic exchanges, trading costs have dropped sharply. But regulators and others have worried that the increasingly fast-paced and fragmented market also poses a risk to investors. The fears intensified after the flash crash in May 2010, when the Dow Jones Industrial Average plunged roughly 700 points and quickly recovered in the same day. Some investors were caught in the downdraft, suffering unexpected losses.
Since then, regulators have struggled to fully understand the growing complexity of the markets and how to safeguard the system. Analysts worry that the problems at BATS, which accounts for 11 percent of the trading volume in American equities, are a sign that new mechanisms put in place by the industry since the flash crash may not be sufficient to protect investors.
“This shows that the market structure of the U.S. equity market has been seriously compromised over the past few years,” said Joseph Saluzzi, a co-founder of Themis Trading, a brokerage firm. “It’s a black mark for the industry.”
The initial public offering of stock should have been a moment of celebration for BATS.
Founded in 2005, BATS, which originally stood for Better Alternative Trading System, was started by a group of Wall Street companies that wanted to break the duopoly of the stock market. The initial offering of BATS, which would have been the first company to be listed as well as traded on the exchange, would have represented the evolution from a tiny upstart to a serious competitor, rivaling the New York Stock Exchange and Nasdaq.
While investor interest for the offering was tepid, BATS was able to raise $101 million, giving owners like the trading firms Getco and Instinet a chance to sell their shares. The stock was priced at $16, at the bottom of the company’s expectations.
Friday began like any other at BATS. On the floor of the exchange in Lenexa, Kan., executives rang a bell at 9:30 a.m. to begin trading.
Then disaster struck.
At 10:45 a.m., BATS suffered technical errors, affecting securities with symbols A through BFZZZ. The market’s most valuable company, Apple, was swept up in the maelstrom. The BATS system executed “three erroneous trades” of the technology company, it said. As a result, shares of Apple sank to $542.80, prompting trading in the stock to be temporarily halted.
BATS’s own shares were ensnared by the mess, and the exchange quickly sought help. Nasdaq disclosed that it was “investigating potentially erroneous transactions” involving shares of BATS from 11:14 a.m. to 11:15 a.m. Nasdaq soon canceled all the trades executed during that period.
“My heart goes out to the guys,” said Larry Tabb, the founder and chief executive of the Tabb Group, a financial research firm. “On the biggest day of their corporate history, their own platform backfired.”
Regulators had already taken a keen interest in the company’s technology systems and trading strategies.
BATS disclosed in a February regulatory filing that it had received a written request from the enforcement division at the Securities and Exchange Commission for documents and information about the exchange’s ties to “certain market participants.” The agency is examining the relationship between the exchange and high-frequency trading firms.
“The investigation is in the early stages and we are cooperating with the staff,” the exchange said in the February filing.
On Friday, the extent of the problem at BATS was at first unclear. But minutes after the technical problems appeared, the S.E.C. was trading phone calls with employees at the exchange, and regulators quickly decided that it was not a broad systemic problem. Other regulators and exchanges said they watched the situation with concern, leaving it to the S.E.C. to police the problem.
By the lunch hour, the S.E.C.’s trading and markets team had a working theory for the cause of the chaos: a BATS server, it suspected, had malfunctioned. Exchanges typically have multiple servers for different securities, grouped in alphabetical order. Apple, being one of the first stocks appearing in order, was affected when the system went haywire.
“As is our practice, S.E.C. staff has been and will continue to be in discussions with BATS to determine the cause and extent of the incident and steps BATS is taking to remedy the situation,” an S.E.C. spokesman, John Nester, said in a statement.
The agency’s theory, at least for now, has largely matched BATS’s account of the disastrous day. The exchange said on Friday that the trouble stemmed, in part, from a software bug in one of its computer systems. The error, BATS said, “rendered open customer orders in this symbol range inaccessible.” The system bug also prevented BATS from soliciting orders on its own stock.
BATS initially hoped to start trading in its shares again. After getting the system up and running, the exchange figured that it could reopen its own stock at 1:15 p.m. But BATS ultimately decided to pull back indefinitely from the public markets and cancel the earlier trades.
“Although our affected market has reopened, in the wake of today’s technical issues, which affected the trading of certain stocks, including that of BATS, we believe withdrawing the I.P.O. is the appropriate action to take for our company and our shareholders,” Joe Ratterman, the company’s chief executive, said in statement.