Considerations for a Better Regulatory Response to Failure, Lessons from the Aviation Industry (with Lofchie Comment)

In an article posted by Harvard's Kennedy School Review, System Logic consultants Chris Clearfield, Andras Tilcsik and Benjamin Berman discuss inevitable consequences of increasing complexity in the emerging securities markets. Research shows, they argue, that as electronic trading continues to increase in complexity, "unexpected interactions between components" within the stock trading industry can turn even trivial incidents into major meltdowns before operators are able to understand and address nascent errors.

According to the article, securities regulators, whose tools of examination and enforcement are designed to identify bad actors, have struggled both to understand such risks before they occur and to develop effective programs to increase the reliability of securities trading.

The article suggests that securities regulators should consider implementing the tools that increase systemic reliability in commercial aviation, such as anonymous self-reporting, industry-led reliability monitoring and no-fault investigatory practices. While such a change would require both a radical cultural shift and new capabilities from regulators, the article argues, the alternative is a catastrophe-prone and unreliable national market system that ultimately will shake confidence in the vitally important U.S. securities market.

Lofchie Comment: It is unfortunate that U.S. financial regulators regard problems of this type as a demonstration of either a crime or negligence so gross as to constitute indifference to the public. Such a response is harsh. Complex human systems are flawed and things are going to go wrong. The question raised by the article is this: given the inevitability of human failure, is punishment the best deterrent?

See: Preventing Crashes: Lessons for the SEC from the Airline Industry.