Corinthian Debacle Shows Electronic Trading's Underbelly

Had Corinthian Colleges been an NYSE-listed stock, the specialist for the stock may have alerted regulatory officials to a potential erroneous trade at the onset, potentially prompting a halt before the swoon, not after (or during). Because specialists have an obligation to use their own capital to maintain so-called orderly markets in their stocks, they are more sensitive to potential disorderly developments than faceless electronic marketplaces.

If the NYSE calls a trading halt on a stock, trading is effectively stopped because electronic alternatives to the system aren't widely used by institutions. Meanwhile, under NYSE rules, if any trades occur after trading is officially halted, the responsibility for reversing those trades and making investors whole is up to the specialists.

But on the Nasdaq, trades are handled by numerous electronic exchanges, including not only Archipelago, but also the Island and Brut ECNs. Archipelago says that on any given day, about 27% of the trading volume in Nasdaq stocks is done through its systems.

The advantage of a decentralized system is that much like the Internet, it can route around problems. When blackouts knocked out markets on the East Coast in August, Nasdaq stocks still could be traded over ECNs. But that decentralization also makes possible situations such as what happened on Friday.

The decentralization issue is compounded by the fact that Archipelago answers to a different regulator than other ECNs.

"This is something on [SEC Chairman William] Donaldson's plate to figure out," said Seth Merrin, CEO of Liquidnet, an electronic exchange designed for institutional investors.

Given that Donaldson already has a pretty full plate, some observers say the quick and easy answer is that a trading halt should apply to all markets no matter what the reason.

"If everybody can't trade, then no one should trade," whether trading is disrupted because of a regulatory issue or a systems issue, Epstein said.

But others question that view. It's a benefit to investors that electronic networks can work around problems such as blackouts, they argue. In addition, shares trade hands every day after hours on electronic marketplaces long after the Nasdaq market closes.

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