SEC to meet with stock exchanges regarding NASDAQ trading glitch

SEC Chairwoman Mary Jo White
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The Securities and Exchange Commission will be holding a meeting with all the stock exchanges (NASDAQ, NYSE, Direct Edge, BATS) on Thursday. The impetus for the meeting is the Aug. 22 NASDAQ trading snafu of the public data network that carries the quotes and trades for NASDAQ, known as the SIP (Securities Information Processor). The SIP was shut for more than three hours that day, effectively shutting down NASDAQ.

The meeting begins at 9:30 a.m. ET. There are two items on the agenda:

One: infrastructure resilience. Simply put: the SEC wants to make sure there are adequate back-up capabilities for both the NASDAQ SIP and the corresponding public feed that the NYSE runs. Believe it or not, they both run on different "silos." Neither one can talk to the other. Expect discussions on how they can both effectively become backups for each other.

There's another issue: the SEC wants to see better protocols for testing and backing up systems. Believe it or not, the rules around testing and backing up systems are fairly squishy...they revolve around "best practices" rather than hard and fast regulations that the exchanges are required to follow.

The SEC would like to change that, and they have a blueprint. It's called Reg SCI. It would require that the technology used in all the exchanges met uniform standards and were continuously tested, and provide certain notifications in the event of systems disruptions and other events.

The timing is perfect: Reg SCI has been discussed for several years. The rules have been written, and a public comment period ended a few months ago. The SEC is now examining the responses. Hopefully, we will get a decision before the end of the year.

What's the hangup? The exchanges have pushed back, arguing that the rules are too onerous, that there is too much emphasis on regulatory reporting, and that it may not necessarily improve the technology.

This is a major problem: the business of running an exchange is terrible right now. The stock trading business is awful. Neither the NYSE nor the NASDAQ want any more regulations or expensive requirements to upgrade their technology.

"We're going to be hiring more lawyers, but not necessarily more technology guys," one exchange official griped about Reg SCI.

The SEC is in a bind. The SEC has the power of enforcement. Exchanges must uphold...bylaw...certain standards for running exchanges, and if they don't meet those standards, that's a problem.

But you cannot mandate standards that are so onerous that they cannot be met.

Regardless, the one thing that seems glaringly obvious is that there has been an underinvestment in technology, perhaps by ALL the exchanges. That needs to be addressed.

Second: halting or breaking trades.

  • Under what circumstances should the entire market be halted due to trading glitches?
  • What kind of "kill switches" should be installed to shut down trading to all or part of the market? The lack of a "kill switch" was one of the major problems in the Knight trading glitch in August 2012 that almost brought down the company.
  • Under what circumstances should trades be broken, particularly in derivative businesses, like options? Goldman Sachs had a major problem on August 20 when their desk generated a flood of erroneous options orders because of a technical error.

So what will happen? The SEC is likely to assign some "homework" to the exchanges...they will want more data.

But it's unlikely they will stop there: the SEC will likely want to give the appearance that they are acting. I expect some kind of announcement that all participants agreed on the need to strengthen the trading infrastructure and that they are looking into making changes to the oversight of the public feeds for both NASDAQ and NYSE.

I would hope for some clear indication on which way the SEC is leaning on Reg SCI, but that may be too much to ask.

By CNBC's Bob Pisani