What does NASDAQ meltdown mean for future IPOs? In Markets’ Tuned-Up Machinery, Stubborn Ghosts Remain

AUGUST 22, 2013, 8:38 PM

In Markets’ Tuned-Up Machinery, Stubborn Ghosts Remain

By FLOYD NORRIS

A generation ago, when the stock market crashed on Oct. 19, 1987, the Nasdaq stock market appeared to have done much better than the New York Stock Exchange. While the Dow Jones industrial average fell 23 percent that day, the Nasdaq composite index was off just 11 percent.

It was not, it turned out, that Nasdaq stocks were more highly regarded. It was, instead, a question of the technology used.At the New York Exchange, trading was still largely done by people, in person. At Nasdaq, trades were done by phone. The difference was that the market makers at the Big Board could not escape dealing with the flood of sale orders. But many Nasdaq market makers could, and did, decide not to answer their phones.

The Nasdaq market appeared to be operating, even though it really wasn’t.

Markets are far more automated and far more fragmented today. That makes trading much faster and — when everything works — more efficient.

And when it doesn’t? Chaos can briefly emerge while people try to figure out what went wrong with the computers.

That has been demonstrated twice this week. In the most publicized failure, the Nasdaq market found itself unable to put out stock quotes and halted trading in all its listed stocks for more than three hours on Thursday.

Most such problems last only a little while. On Monday morning, options markets were briefly roiled by a computer error at Goldman Sachs, which caused it to send out ridiculous trade orders for options on stocks whose ticker symbols began with the letters I, J or K.

In a less publicized problem, soon before the Nasdaq market had to be shut down on Thursday, the Arca electronic exchange, operated by the same company that runs the New York Exchange, NYSE Euronext, was unable to report trades on Nasdaq stocks whose ticker symbols came after TACT in the alphabet. It canceled some orders during the period, which lasted less than nine minutes. Other markets routed orders away from Arca.

Just what went wrong in each case will be sorted out eventually, as were the technical failures that caused the “flash crash” on May 6, 2010, when some stocks fell to $1, and the disastrous first day of trading in Facebookshares on May 18, 2012, when Nasdaq’s computers were overwhelmed. It was just more than a year ago that Knight Capital, a large market maker in Nasdaq stocks, suffered significant losses when its computer system caused numerous incorrect trade orders to be submitted.

Why is this happening, and happening so often?

One reason is the need for speed. Another is increased competition.

The need for speed comes from a market in which high-frequency traders expect to be able to get in and out of positions within a second. Any market that cannot offer such speed will be at a competitive disadvantage. But such speed is not compatible with safety features that could cause suspicious orders to be delayed while someone — a slow person, perhaps — checked to see whether something was amiss.

The competition comes from the fact that there are now numerous exchanges for every stock. That has caused the cost of trading to plunge. But it has also meant that each exchange is under pressure to keep costs to a minimum, which itself could be a deterrent to safety features.

While Nasdaq’s failure on Thursday appears to be one of the most significant technology problems to strike the markets, it was less important than the earlier errors in one key way.

When Nasdaq determined it was unable to distribute quotes on all stocks listed on its exchange, it asked that other markets that trade Nasdaq stocks also halt trading, and they did. As a result, no one could trade. Traders who have grown used to the idea they can get in and out of positions quickly were frustrated, and Nasdaq suffered another humiliation. Investors curious about the market reaction to specific news events had to wait. But it does not appear that any bad trades were made.

In the earlier Arca problem, it is possible that some trades that had been sent to the market were not executed, and that as a result someone missed a brief market opportunity to send the order somewhere else. But, as with Nasdaq, there do not appear to be any trades that someone will want to cancel.

That was not true on Monday, during the period when Goldman’s computers were spewing out mistaken orders, just as it was not a year ago when the Knight computers went haywire.

When that happens, exchanges have to decide which orders to cancel, and they have developed rules about just how ridiculous a trade has to be to justify canceling it.

Myron Scholes, who shared a Nobel Prize for developing the Black-Scholes options pricing model, told the Financial Times this week that no options trades should be canceled. If Goldman and other firms “internalized all of the losses associated with program errors and bad algorithms, they would be more careful,” he said.

That might work in options, where Goldman’s errors appear to have led Goldman itself to make bad trades. But in other cases, it would create its own injustices. During the “flash crash,” erroneous sell orders caused some $30 stocks to fall to $1. Innocent individual investors who had put in orders to sell shares at the market price lost money when their trades were executed. Others who had put in “stop loss” orders, to sell a stock if it fell below a given price, found they had similarly suffered.

None of that would have happened back in 1987. Then there were people involved, and if there was a crescendo of sell orders they would not all get executed at lower and lower prices. On the Big Board, where the specialists could not avoid the orders, they could — and in some cases did — halt trading to sort things out.

Those halts, as it happened, helped to end the crash. It had largely been caused by foolish institutional investors using something called “portfolio insurance,” which required them to sell stock index futures when stock prices fell, and to sell more when prices fell further. The market makers who bought the futures then tried to hedge by selling stocks, which drove prices down further, and so on and so on.

When the Big Board began to halt a lot of stocks on Oct. 20, the Chicago futures exchanges threatened to halt trading in index futures contracts. Only then did Goldman and Salomon Brothers, the two largest brokerage firms serving institutional investors at the time, step in and offer to put up capital to reopen trading in stocks. Prices began to recover.

Now, in most cases exchanges are not willing to halt trading just because prices have defied all logic. They figure that would send business to their competitors.

What distinguishes Thursday’s Nasdaq mishap from other recent computerized trading malfunctions is that it involved the dissemination of prices, not the submission of bad orders. With no prices available, trading had to halt. Brokers and exchanges lost business, but it does not appear that anyone lost money from making bad trades.

In that sense, it was a return to what was good about 1987. When things were out of control, markets could stop until sanity returned. There’s no guarantee that will happen in the future.

What does NASDAQ meltdown mean for future IPOs?

By Dan Primack August 22, 2013: 2:45 PM ET

NASDAQ survived its last glitch. Will it be as lucky this time?

FORTUNE — When Facebook (FB) first tried to trade as a public company in May 2012, it didn’t work. Literally. The NASDAQ machinery was overwhelmed, causing so much chaos that the exchange eventually paid out $10 million in the largest SEC penalty of its kind.

At the time, some speculated if the Facebook experience would cause future new issuers to choose The New York Stock Exchange. But it didn’t come to pass. In fact, NASDAQ actually made up ground.

Between January 2011 and April 2012, there were 92 NASDAQ IPOs and 119 NYSE IPOs. Between June 2012 and the present, there have been 100 NASDAQ IPOs and 110 NYSE IPOs. In other words, NASDAQ actually has been gaining market share when it comes to number of issuers.

Seems that companies accepted two arguments being put forth by NASDAQ’s (NDAQ) new listings department: (1) The Facebook situation was an anomaly caused by record-breaking volume that would not be applicable to most other listings; and (2) Even if such volume is repeated, we fixed the glitch.

All of which brings us to today, when NASDAQ’s entire system went dark for more than three hours. No trading of Facebook or Apple (AAPL) or Amazon (AMZN). No trading of options. No nothing.

How on earth are NASDAQ’s listings folks supposed to spin this? Every single company on the exchange has been affected, not just the super-popular ones. And this is the second major technical problem in two years. Even if this one is fixed — and it is beginning to be as of this writing — what assurances can be made that another isn’t just around the corner. Does anyone want to risk becoming the next Regado Biosciences (RGDO), which priced a small IPO last night and found itself stuck in limbo during its first day of trading?

NASDAQ pulled a rabbit out of its hat once, but this time it will be much more difficult…

Updated August 22, 2013, 1:22 p.m. ET

Trading Halted in Nasdaq Securities

Large Chunk of U.S. Stock Market Paralyzed by Technical Problem

JACOB BUNGE, KAITLYN KIERNAN And TOMI KILGORE

A trading halt on the Nasdaq Stock Market NDAQ +0.82% neared an hour after an unexplained technical issue, paralyzing the market for thousands of securities and raising new questions about the robustness of U.S. trading systems following a series of high-profile glitches.

The second-largest U.S. stock exchange expected to resume trading shortly, a person familiar with the matter said just after 1 p.m. ET. The exchange said in a notice to traders that it wouldn’t cancel open orders, but that customers could do so. The exchange would resume trading at a time “to be determined,” the notice said.

The outage saw a large chunk of the U.S. stock market effectively come to a standstill at midday, freezing prices in stocks, exchange-traded funds and options listed on Nasdaq and prompting other trading venues to stop trading those securities. Dark pools and other electronic trading platforms were also forced to suspend trading in Nasdaq-listed stocks, since there were no publicly quoted prices on those securities, traders said.

Traders said there was confusion about what stocks were affected, and that phones were lighting up across trading desks as investors tried to figure out what as happening.

“We’re pulling out our orders to wait until the system works itself out,” Rick Fier, director of equity trading at Conifer Securities. “The best thing clients can do is take a break.”

The episode meant a widely tracked market gauge, the Nasdaq Composite Index, wasn’t being updated for the first time in memory. The outage was also expected to skew the calculation of other major market measures such as the Dow Jones Industrial Average and the S&P 500-stock index.

Nasdaq-listed stocks represented about 28% of all shares traded so far this month, according to data from BATS Global Markets Inc. Nasdaq listings include some of the most prominent companies in the world, including Apple Inc. AAPL -0.67% and Microsoft Corp.

“It’s really shocking. We’re stuck,” said Ramon Verastegui, head of global engineering and strategy at Society General. “If we want to trade Apple, we can’t.”

Exchange officials scrambled to resume trading and to figure out what had happened. The issue stemmed from a data feed that provides market data for Nasdaq-listed securities, exchanges said in notices sent to traders.

Regulators said they were communicating with market players but offered no details. “We are monitoring the situation and in are close contact with the exchanges,” said SEC spokesman John Nester.

Nasdaq parent Nasdaq OMX Group Inc. announced the halt at 12:15 p.m. ET Thursday, and other exchanges followed suit. Nasdaq also said it was halting trade in its options markets. A spokesman for Nasdaq declined further comment.

Nasdaq’s announcement came a little more than an hour after NYSE Euronext, operator of the rival New York Stock Exchange, told traders its Arca electronic stock exchange was having technical issues in issues starting alphabetically with ticker TACT through the Z’s.

Arca earlier had problems processing customers’ messages related to some orders among those tickers, it told customers, and said it planned to cancel many currently outstanding orders in the affected securities. Nasdaq said it stopped routing orders to Arca, according to a separate notice.

Thursday’s problem is the latest in a string of technology-related mishaps affecting exchanges and brokers as markets over the past two decades have migrated to electronic systems. System problems marred Nasdaq OMX’s rollout of the Facebook Inc. initial public offering last year, costing Wall Street firms approximately $500 million in trading losses.

Earlier this week, Goldman Sachs Group Inc. flooded U.S. stock-options markets with erroneous orders, most of which were later canceled.