Corinthian Debacle Shows Electronic Trading's Underbelly

Electronic trading may be the wave of the future, but Friday's fiasco involving shares of Corinthian Colleges (COCO) raises questions about ECNs' alleged superiority to the New York Stock Exchange's human-based specialist system. The episode also calls into question the wisdom of having decentralized marketplaces under various regulators.

In the wake of scandals early this year at the NYSE over ousted chairman Richard Grasso's pay package and the alleged front-running of customers by some specialists, the Big Board's system has come under fire for being antiquated at best, ripe with corruption at worst.

But advocates of the specialist system say the Corinthian Colleges' episode demonstrates why having a human element is critical despite the electronic communication networks' advantages of speed, anonymity and, potentially, price.

"You lose something by going all electronic," said Terry Hendershott, a professor at the University of California at Berkeley's Haas School of Business.

Although a believer in electronic trading, Hendershott said human-based markets are often superior to electronic ones when extraordinary events occur and the market is under stress.

Case in point being last Friday, when the Nasdaq Stock Market halted trading in Corinthian Colleges for nearly an hour after mistakenly placed sell orders caused a 32% swoon in the shares of the secondary-education provider in a mere 12 minutes.

Judging there to be no news event to justify the trading halt -- the Nasdaq's original rationale -- Archipelago, an electronic marketplace owned by a consortium of major Wall Street firms, resumed trading in Corinthian Colleges more than 30 minutes before the Nasdaq lifted its halt.

Archipelago's decision meant that while some investors were unable to trade Corinthian Colleges during Nasdaq's trading ban, others were buying and selling shares via Archipelago at what were arguably artificially low levels. That became crucial when the Nasdaq later canceled a swath of trades from earlier in the day.

Shares in Corinthian College bounced back to near their previous highs after trading resumed on the Nasdaq, but investors could have been inadvertently caught selling the stock short, i.e., selling shares they believed they had bought earlier in the day via Archipelago, but didn't actually own because those transactions were canceled.