House panel to hold stock market inquiry

SEC investigation also looking into huge Dow plunge, possible role of high-speed computers

The House Financial Services Committee today said its securities subcommittee plans to hold a hearing next week to examine the operational issues surrounding the U.S. stock market plunge Thursday.

The Dow Jones Industrial Average dropped nearly 1,000 points in a half hour Thursday before bouncing back to within 348 points of the day's opening. Industry sources said the precipitous drop was likely due to both human error that was exacerbated by high-speed trading platforms rolled out over the past decade.

The Dow fell to 9,867 points from its previous day's close of 10,868 before rebounding to 10,464 points by the close of the market Thursday. Industry experts said it was obvious that there was some sort of "algorithmic error" in the computerized trading systems that caused the pricing in the markets to collapse.

For example, TD Ameritrade said one of its client's stock price orders started at $60 and dropped to 11 cents before rebounding. In another example, The Wall Street Journal's MarketBeat blog reported Accenture's stock price plummeted from more than $40 at 2:47 p.m. to a penny at 2:48 p.m.

The House Financial Services' securities subcommittee plans to hold a hearing at 3 p.m. Tuesday to address the causes of the dramatic drop in the Dow before it recovered.

House subcommittee Chairman Paul Kanjorski, (D-Penn.), said in a statement that Thursday's stock market seemed "just as volatile as it did in the fall of 2008."

"Reports have surfaced that much of this movement was potentially as a result of a computer glitch," Kanjorski said. "We cannot allow a technological error to spook the markets and cause panic. This is unacceptable. In this day and age and with the use of such complex technology, we should be able to make sure that our financial markets are effectively monitored and investors are protected."

Kanjorski also called on the U.S. Securities and Exchange Commission to investigate the problem.

Earlier this year, the SEC sent a letter to brokerage houses saying it was conducting a "broad review" of the equity market structure and asking them for comments. The review would include an evaluation of equity market structure performance in recent years and an assessment of whether market structure rules have kept pace with, among other things, trading technology.

The SEC asked for comment on a wide range of market structure issues, including high frequency trading, order routing, market data linkages, and undisplayed, or "dark," liquidity.

"The Commission intends to use the public's comments to help determine whether regulatory initiatives to improve the current equity market structure are needed and, if so, the specific nature of such initiatives," the letter stated.

In 2005, the New York Stock Exchange dropped its manual system where floor traders shouted out buy and sell orders and adopted hand-held computers.

"What took place yesterday was absolutely crazy," said Sean O'Dowd, senior capital markets analyst at IDC's Financial Insights business.

O'Dowd said this won't be the last time computer errors cause market crashes. The automated trading systems running off software algorithms put in place over the past five years have raised volatility in the marketplace.

"You're going to see this, and you have seen this. The NYSE shut down a year ago," he said. "You've seen a lot of these hiccups on the exchange side over the past couple of years. They're random events, but I think you'll continue to see these. This won't be the last time you'll see a freak market reaction largely influenced and exponentially pushed beyond what it might normally have been because of the automation of things."

One human error can create a landslide effect that under a manual order entry system would be easier to spot and stop, O'Dowd said.

Thursday's market drop was reportedly kicked off by a human error - a trader entering 16 billion shares of S&P 500 stock for sale versus the intended 16 million on an automated trading platform. As the shares flooded the market, buyers stepped back to evaluate what was going on and market liquidity evaporated, O'Dowd said.

"Because of the automation in [trading systems] and the dynamic way in which they react to market changes and then execute on that information without human intervention ... the result ends up in trading patterns that were unintended," he said. "It's happening so fast, it's hard to catch it and correct it as quickly as you would want it."

But O'Dowd said he was also impressed with how quickly the market corrected itself after the drop. "What's interesting is the dynamics of this highly automated trading ecosystem."

Lucas Mearian covers storage; disaster recovery and business continuity; financial services infrastructure; health care IT for Computerworld. Follow Lucas on Twitter @lucasmearian, send e-mail at lmearian@computerworld.com or subscribe to Lucas's RSS feed .

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