U.S. exchanges to create kill switches following Nasdaq outage

By Sarah N. Lynch and Herbert Lash WASHINGTON (Reuters) - U.S. stock exchanges agreed with regulators on Thursday to reforms including a "kill switch" to stop trading during emergencies, after a software glitch with Nasdaq's stock quote processor last month led to a three-hour trading halt. Securities and Exchange Commission Chair Mary Jo White met privately in Washington with top executives of the major exchanges and later announced five reforms in response to recent trading problems. The exchanges will be required to draft action plans to establish testing and disclosure protocols about systems changes for their securities information processors, or SIPs, which disseminate stock quotes and other data. They also are required to provide a plan to address how regulatory halts are communicated, assess their other critical infrastructure systems and review their current rules for busting trades and reopening trading after a halt. "Today's meeting was very constructive," White said in a statement after the meeting concluded. "I stressed the need for all market participants to work collaboratively - together and with the Commission - to strengthen critical market infrastructure and improve its resilience when technology falls short." The August 22 Nasdaq trading outage escalated the SEC's concerns about the stability of exchanges. The SEC in March proposed reforms to strengthen the robustness of exchanges' technology after a series of glitches over the past year. Last month's outage was caused by a software bug that clogged Nasdaq's processing of stock quotes from the country's 13 various exchanges. A kill switch would address a problem with quotes or orders being sent to a SIP, but not issues with a processor itself. "We didn't focus on any one day's event," Gary Katz, president and chief executive of the International Securities Exchange, told Reuters after the meeting. Katz said the meeting's purpose was not to rehash what had gone wrong but instead to have the participants focus on how best to deal with disruptions in the future. Other exchange executives who spoke briefly with reporters after leaving the SEC's headquarters said the meeting was constructive and that the rival exchanges were ready to work together. "Mary Jo ran a very good meeting. We all have pretty clear homework assignments," NYSE Euronext Chief Executive Duncan Niederauer told two reporters. "It's all about working together. We are collectively responsible for investor confidence." The reforms will need to be filed by the exchanges as formal changes to their rules, as required by federal securities laws. The SEC would then review them before they could go into effect. Niederauer and William Brodsky, executive chairman of Chicago Board Options Exchange operator CBOE Holdings Inc, said the exchanges are supposed to come back to the SEC within 60 days. Another attendee in the SEC's meeting, however, said the 60-day time frame is just a benchmark to help speed things along, and the rule changes are not expected to be completed by then. The August 22 outage at Nasdaq was the latest in a series of high-profile software errors that have shaken investor confidence. Nasdaq suffered another major failure - and ultimately paid a $10 million civil fine to the SEC - after it fumbled the May 2012 initial public offering for Facebook. In August 2012, major market maker Knight Capital nearly collapsed after a software error led to a $440 million trading loss. It was around that time that the kill switch idea first started to gain momentum. At an SEC roundtable in October, exchanges generally endorsed the concept of deploying kill switches to stop trading so that errors could not be unleashed onto the broader marketplace. The details of how such a switch would be triggered still need to be ironed out. One person who attended the SEC's meeting on Thursday said that individual broker-dealers would likely set their own exposure limits, and if those thresholds were crossed, then an exchange's technology would kick in and halt trading. In March, the SEC proposed rules for a broader set of market participants, including trading platforms known as "dark pools," that would require them to conduct certain testing and have steps in place to prevent or address systems problems. That proposal is still being weighed by the SEC. The source, who spoke anonymously because Thursday's meeting was not public, said it is possible the exchange rule changes discussed on Thursday could get completed first. SEC Commissioner Luis Aguilar, a Democrat, said he hopes the agency will work toward adopting a strong version of the March proposal. He also said he is happy to see a kill switch is being considered. "These market interruptions are unacceptable. It is long past the time for the SEC to take action," Aguilar said. (Reporting by Sarah N. Lynch in Washington; additional reporting by Herbert Lash in New York.; Editing by Karey Van Hall, Nick Zieminski, Tim Dobbyn, Bill Trott and Lisa Shumaker)