Edition: U.S. / Global

THE MARKETS: Market Place; Nasdaq and the Pacific exchange criticize each other's actions during a computer-related mishap.

By Floyd Norris
Published: December 9, 2003

THE battle over a computer system that went crazy, spewing out unintentional orders to buy and sell millions of shares of a single small company escalated yesterday as two stock markets traded accusations that the other had acted irresponsibly.

Within 12 minutes on Friday morning, an unidentified firm managed to make thousands of unintended trades in the stock of Corinthian Colleges, buying 230,990 shares while selling 3,123,800 shares as the price of the stock plunged.

When it was over, Nasdaq canceled all the trades during the period, and other markets followed suit. A result was that the firm that placed the bad orders apparently suffered no losses. But because trading in the stock was allowed to resume before it was announced that the trades were going to be canceled, some traders who bore no responsibility for the errors -- and who thought they had bought low and sold high -- ended up with losses.

Both the Nasdaq stock market and the Pacific Stock Exchange asked the Securities and Exchange Commission to intervene and to determine that the other had acted improperly. An S.E.C. official said it would be best if all markets could work out a solution but said the commission might have to act if no agreement was reached.


Corinthian is listed on Nasdaq but trades on other markets, including the Archipelago Exchange, which is regulated and owned in part by the Pacific Exchange. The Archipelago Exchange, sometimes abbreviated as ArcaEx, allowed trading to resume before Nasdaq did, an action Nasdaq denounced.

''The lack of coordination among the markets caused widespread confusion and unnecessarily harmed investors,'' said Edward Knight, the general counsel of Nasdaq, in a letter to Annette Nazareth, the director of market regulation for the S.E.C. ''At the time trading resumed on ArcaEx, it was unclear whether certain trades would be broken or would stand, and firms had no reasonable way of determining their outstanding position at that time.''

Mr. Knight asked that the S.E.C. make it clear that other exchanges have an obligation to respect trading halts declared by the listing exchange.

Dale Carlson, a spokesman for the Pacific exchange, said it was sending its own letter to the S.E.C. ''We will ask for a formal investigation of Nasdaq's handling of the trading halt,'' he said. ''We will argue that the trading halt should not have occurred and that the trades should not have been busted.''

''People make mistakes in the market all the time,'' Mr. Carlson added. ''We have provisions to deal with clearly erroneous trades. But sometimes you make a mistake and you just have to eat the trade. This has the appearance of Nasdaq attempting to protect one large firm.'' He said he did not know which firm was involved but said he assumed that would come out in the investigation.

In an interview, Mr. Knight defended Nasdaq. ''This is a situation in which our systems worked well, our people worked well, and we acted to protect investors' interests,'' he said, adding that Nasdaq had begun to investigate what was going on within three minutes of the beginning of the trading frenzy at 10:46 a.m. and had halted trading at 10:58 a.m.

Asked whether Nasdaq was trying to protect a major firm, Mr. Knight responded: ''Of course not. How do you justify not breaking trades when there is clearly erroneous action?''

The S.E.C. gave Nasdaq the authority last year to halt trading in such situations but said it was up to a committee involving all exchanges to determine whether such a halt would constitute a regulatory halt, thereby making it mandatory for all exchanges to respect the halt. Nasdaq believed that agreement had been reached, but Archipelago evidently did not. Normally, a regulatory halt is declared to allow important news about a company to be disseminated, but in this case there was no company news.

''Nasdaq had a systems problem,'' Mr. Carlson said. ''They tried to make everybody else halt trading while they cleaned it up. We halted trading and subsequently determined there was no regulatory issue involved. So we told them we were going to resume trading, and we did.''

Ms. Nazareth, the S.E.C. official, said the commission would review the letters. ''The real regulatory issue here is, when you have these linked markets and one market knows there is a problem, should the market that calls for a trading halt be able to impact trading on other markets?'' she said, adding that the markets need to discuss the issue and try to reach consensus. ''If they can't,'' she added, ''the S.E.C. might have to act.''

While it has not been disclosed which brokerage firm was involved in sending out the orders, Gr8Trade, a subsidiary of the Instinet Group, said that its software was involved. Andrew Goldman, an executive vice president of Instinet, said yesterday that a risk-management feature, introduced in April, was disconnected by Instinet late Friday morning during the Nasdaq trading halt.

''It is not clear exactly what went on between the trader taking advantage of the feature and the feature itself,'' Mr. Goldman said. ''We're trying to figure out where the problem lies in the interface between the trader and the software.''

In his letter to the S.E.C., Mr. Knight said that the trader had set a zero-loss parameter, so that the trader's position in Corinthian would be sold if the price fell to the amount the trader had paid. But after it sold the stock, the program apparently sold a lot more, then realized it was short and issued buy orders.

''This cycle of buys and sells created thousands of orders and the system was unstoppable. Nasdaq's halt of the security ended the order generation process for the firm,'' Mr. Knight wrote. He said the brokerage firm that cleared the trades ''stated that there were approximately 100,000 executions and that the firm sold 3,123,800 shares while only buying 230,990 shares.''

''The firm's position at the time of the halt was short 2,892,900 shares.''

For Corinthian, that short position, had it been allowed to stand, would have more than tripled the outstanding short position in the stock. And the trader, having driven the stock from $57.50 to as low as $39.50, would have suffered huge losses. Once the trading problem was disclosed, the stock recovered to $56.80 Friday, and yesterday it gained 29 cents, to $57.09.