SEC probes electronic platform failures

The Securities and Exchange Commission is investigating computer system failures at electronic marketplaces including Nasdaq to determine whether internal controls are sufficient, according to people familiar with the matter.

The investigation is being handled by the enforcement division’s market abuse unit and is part of a broader regulatory review of stock exchanges following last year’s “flash crash”, recent hacking attempts and trading glitches.

Mary Schapiro, SEC chairman, signalled in March that exchanges could face new rules governing their technology policies, which would formalise guidance issued following the 1987 stock market crash. The guidance, known as Automation Review Policies, advises exchanges to “acquire appropriate technology and assure its functionality”.

Ms Schapiro suggested new rules “would require market participants to meet adequate standards for the capacity, resiliency and security of their automated systems”.

Regulators are concerned that exchanges may have let risk and internal controls weaken in a race to develop innovative trading platforms, according to a person familiar with the matter.

The SEC declined to comment, as did the four largest US stock exchanges – Nasdaq, the New York Stock Exchange, BATS Global Markets and Direct Edge.

One area under scrutiny is whether exchange operators are complying with SEC rules that require quote feeds to be delivered to all investors at the same time, these people say. The agency is interested in whether exchanges are transmitting proprietary feeds that are sold to private investors faster than they are distributing feeds to the consolidated tape.

SEC investigators are also looking at whether the for-profit exchange operators are following their own rules and describing them accurately to the public. For example, they are looking at whether exchanges have notified the SEC of changes to their platforms such as execution priority, so they can be scrutinised and so investors are fully informed, people familiar with the matter say.

SEC investigators have grown concerned about the stability and security of computer systems following glitches at Nasdaq and other exchanges and hackers’ ability to penetrate the Nasdaq’s computer system last year, these people say. The recent run of computer problems at the London Stock Exchange, which is not regulated by the SEC, has added to that concern.

Those glitches follow the flash crash on May 6 2010, which sent the Dow Jones Industrial Average down 700 points in minutes before it rebounded.

The combination of events has exposed the fragility of the stock market and undermined confidence in the system.