Using Regulation to Create a Reliable National Market System (System Logic Memo) (with Lofchie Comment and YouTube Selection)
Despite the high potential cost of electronic trading disasters, why have broker-dealers, exchanges, and the national market system suffered from a string of highly-public catastrophic failures and near misses, and why do the tools of regulatory examinations and enforcement actions fail to tame such errors?
The attached analysis from independent research and consulting firm System Logic, submitted as part of Steven Lofchie's testimony to the House of Representatives Committee on Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, argues that complex systems, like electronic trading, cause and magnify errors due to unexpected interactions that are difficult to understand and stop in real time.
Unfortunately, according to the analysis, the tools of regulatory examination and enforcement actions on which securities regulators ordinarily rely are not well suited to address errors that arise from complexity. Rather, reliance on enforcement actions inadvertently create an environment that exacerbates the likelihood and severity of such errors, leading to a less robust and stable national market system. Instead, securities regulators should consider the tools that increase systemic reliability in commercial aviation, such as anonymous self-reporting, industry-led reliability monitoring, and no-fault investigatory practices. This memorandum discusses each of these issues in turn.
Lofchie Comment: The idea that the SEC might look to another regulator (e.g., the National Transportation Safety Board ("NTSB")) as establishing an alternative and perhaps preferable process of regulation (one that favors investigation and prevention over enforcement) is an intriguing one. Certainly, airline safety is at least as critical a matter as the efficient operation of trading systems, and so the NTSB's process cannot be dismissed as one that is relevant only to areas of lesser importance.
Click here to view the memo, "Using Regulation to Create a Reliable National Market System," by Chris Clearfield of System Logic.YouTube Selection: Link here.