--Stock exchanges, brokers and Finra suggest new automatic
trading shutoff
--Further measures could be implemented at clearinghouse level,
group says
--New safeguards floated ahead of SEC's Oct. 2 meeting
(Updates with further details from trading group's letter to the
SEC and comments on proposals.)
By Jacob Bunge
U.S. stock market operators and major brokers on Friday proposed
that exchanges develop new controls that could shut off a financial
firm's trading if its positions grow too large.
Exchanges and broker-dealers also are exploring further
safeguards that could be installed at a central repository where
all U.S. stock trades are settled, according to a letter submitted
to regulators Friday.
The suggestions came in response to the Aug. 1 trading errors
that nearly felled Knight Capital Group Inc. (KCG), a chief handler
of domestic share trading and central player on exchanges.
Faulty trading software at Knight led the firm to mistakenly
trade millions of shares before the error was stopped, prompting
questions around risk controls at the firm and what measures might
have prevented the episode. The wayward trading drove a $440
million loss for Knight and further damaged confidence in
fast-moving automated systems that underly the domestic stock
market.
The ideas outlined Friday by exchanges including NYSE Euronext
(NYX) and Nasdaq OMX Group Inc. (NDAQ), as well as major
broker-dealers and the Financial Industry Regulatory Authority,
could have helped mitigate the Knight debacle, according to members
of the group.
Exchange and brokerage officials described a new system that
would track the size of firms' net exposures in securities,
accounting for both long and short positions.
If a firm's position grows too large, an automated warning would
be sent to the exchange member doing the trading, according to the
letter. Should a firm run up against its exposure limit set by an
exchange, that firm no longer would be able to do business at the
market for the remainder of the trading session, and other
exchanges may be alerted to the shutoff.
The concept amounts to a so-called "kill switch" that has been
discussed in recent weeks by exchange and brokerage officials, as
well as regulators. Such a tool might have more quickly clamped
down on Knight's errant trading, which mostly avoided setting off
market halts because the trades didn't create heavy spikes or drops
in share prices.
Some worried the new proposals don't go far enough. "Firms
execute [trades] all over the Street," one retail brokerage
executive said Friday. "How does each exchange know how much
exposure a firm has elsewhere? You can't do it piecemeal."
Patrick Healy, head of the consulting firm Issuer Advisory
Group, said the exchanges, brokers and market supervisors who
developed the proposal should have sought input from investors and
public companies.
"Issuers are starting to view the market as a casino with their
stock used as the chips," Mr. Healy said. "We need to focus on
investors, not traders."
The Friday letter to securities-market regulators suggested
further exploring new halts triggered by unusually heavy trade in
securities and more rapid submission of trade information to the
Depository Trust & Clearing Corp., which clears all U.S. stock
transactions.
Faster submission would enable the facility to keep a closer
watch on firms' exposures across all exchanges and trading venues,
according to the letter.
The suggestions arrived ahead of a Securities and Exchange
Commission meeting on market technology set for Oct. 2., when
operations and technology officials from the biggest U.S. stock
exchanges and trading firms will detail ways to prevent automated
trading programs from running wild, according to a notice from the
SEC Friday.
Market operators NYSE Euronext, Nasdaq OMX, BATS Global Markets
Inc. and Direct Edge Holdings LLC will send officials who oversee
exchange functions to the daylong roundtable meeting, according to
the SEC's Friday notice.
The event also will host technology and trading experts from UBS
AG (UBS, UBSN.VX), Citadel LLC, TD Ameritrade Holding Corp. (AMTD),
Investment Technology Group Inc. (ITG) and Getco LLC, brokers and
traders that are central to the billions of shares that trade
across U.S. markets daily.
The meeting comes as the SEC this month has embarked on a
wide-ranging review of the way broker-dealers manage their trading
systems and respond to malfunctions in response to the Knight
mishap, which raised fears of larger-scale market damage that could
be caused by misbehaving computer programs.
Write to Jacob Bunge at jacob.bunge@dowjones.com
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