Nasdaq OMX Prepares ‘Kill Switch’ to Avoid Future Trading Debacles

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In response to recent trading problems, particularly the debacle on the Nasdaq OMX’s (NASDAQ:NDAQ) exchange in late August, Securities and Exchange Commission Chair Mary Jo White began pushing executives of the United States’ major stock market exchanges to hammer out reforms, including what is called a “kill switch,” meant to catch trading errors. Technical glitches — which have come as banks, exchanges, and regulators make trading more automated and electronic — have concerned regulators as well as investors. Filings the exchange operator made with the SEC show that a “kill switch,” which would halt trading of its member firms when preset limits are surpassed, will be implemented.

On August 22, trading was halted on the Nasdaq OMX’s exchange in what is known in the industry as a “flash freeze.” The incident, which negligibly affected stock prices, reminded regulators and exchange operators of just how fragile the modern market is given its dependence on intricate software systems. It was a problem with the software — the technology on which trading relies — that forced the Nasdaq exchange to go offline for more than three hours, a slightly ironic problem for an exchange home to many of the world’s biggest technology companies.

Similarly, Knight Capital Group, now a part of KCG Holdings, suffered a glitch in August 2012. A technical problem sent a flood of errant orders to IntercontinentalExchange Group’s (NYSE:ICENew York Stock Exchange. At the time, Knight was one of the largest executors of trades in the United States, and the incident — which cost the firm $461 million — was a prime example of the risks created by high-speed, nearly fully electronic markets. The debacle nearly ended Knight Capital and led to its takeover by rival Getco.

Nasdaq OMX’s kill switch will be functional by March 1, according to a filing with the SEC made public on Wednesday. The exchange’s member firms will be given a tool to set limits on the size of the positions they take, and if a trade nears that benchmark, the tool will generate and send an email to the firm. If the benchmark is surpassed, the kill switch will be triggered, the transaction will be prevented, and the firm’s open orders in the system will be canceled. In the event that the firm wants to reauthorize trading after the kill switch is activated, management will be forced to contact Nasdaq to explain why the breach occurred and why the transaction should be reauthorized.

IntercontinentalExchange Group’s New York Stock Exchange announced its plans to offer a kill switch in December, while the second largest exchange operator, BATS Global Markets, has already implemented the safety measure.

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