Just a day after the Securities and Exchange Commission held a roundtable on technology issues raised by a series of serious trading glitches, another event can be added to the list, as irregularities occurred in the trading of Kraft Foods Group that raised questions as to whether orders should be executed or cancelled.
Participants in the roundtable and similar events have been careful to say that there are glitches all the time, but only a few of them go down in history as major events that threaten the stability of financial markets and the confidence of investors.
One of the themes of the roundtable was that the trading venues and the regulators do not have the systems in place that are needed to contain anomalies that can occur in one of the many trading platforms and dark pools before they spread to the national market. The most popular containment device discussed at the roundtable was a “kill switch,” which could be employed to detach the problem entity, whether it be a broker dealer or a trading venue, from the national market in time to avert marketwide damage. However, the participants disagreed as to how to design and implement such a device.
For example, the panelists agreed that market surveillance and response to anomalies need to occur in real time. Yet, the SEC has issued with great fanfare a proposal for a Consolidated Audit Trail (CAT), a project it has been working on since 1980. Inexplicably, the proposal provides that the system not require trades to be reported through the CAT until 8 a.m. the following morning at the earliest.
So, the SEC is saying that even if someone could come up with a way to provide these data in a form that is manageable and affordable, the SEC doesn’t want to hear about it. Also, the notion of affordability needs to take into account the question of whether it is affordable to have as many potentially destructive trading events as we have under what one panelist called “the new normal.”
As I write this, reports continue daily of close calls on American Airlines due to loose equipment, such as passenger seats. One can imagine airlines introducing a new class of service where, for an extra $5, a technician would check to make sure the seats are attached to the floor.
At the SEC roundtable, Nancy Leveson, professor of aeronautics and astronautics and engineering systems at MIT, compared the cultures of regulators like the Federal Aviation Administration and the Nuclear Regulatory Commission, where it is understood that the consequences of errors can be catastrophic, with the financial regulators, where this understanding seems to be lacking. She stated that the most successful industries and regulators control risk, such as the risk posed by complicated software, “with an iron hand.”
The financial industry, on the other hand, “needs to learn that this is a goal, but not yet a reality.” She concluded, “If instead this industry engages in hubris and wishful thinking, we’re all going to have to live with the consequences.”
Who can think of an industry more marked by “hubris and wishful thinking” than the financial industry? This state of mind is unlikely to change, because for leaders of the industry, the “consequences” have been expanded size, enhanced political power and larger bonuses.
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