Computer Reliability and Stock Exchanges

By: Jerry Han

"Electronic funds transfer is the next place where I have a lot of problems because the potential for fraud is so great. I've heard of banks that are doing funds transfer on public-access networks. In 1980 I issued a public challenge to any bank that would guarantee in writing not to prosecute me that I would steal $10 million from them via wire fraud. We weren't actually going to rip off the bank; in fact, we were going to call the bank president and ask him to come and get his money. We'd have a $10 million cashier's check waiting for him. Of course, no bank took me up on the offer.

As for the stock exchange, my God! There has never been an opportunity like that. Who is going to count the shares? Who really knows who owes who what? I think it's madness." -Adam Osborne [1]

First a quick review of stock exchanges: stock is bought or sold at an exchange. The price is determined by the brokers on the trading floor, and at the various trading houses and investors hooked up to the exchange electronically. They do this through an auction system, where somebody will say "Selling GM at 56", or "Buying Microsoft at 78." If somebody takes them up on their offer, the stock market board will change, to reflect the updated price.

Throughout the system, computers are involved. Even brokers on the floor use computers to declare their intentions, or people outside the exchange use computers to send their orders in. A computer determines who had the best price, and who was first with that price, and, thus, who gets the stock. A computer records the trade, and informs all the parties involved of the result. The NYSE boasts a 22 second turnaround time for orders once all the auction details have been settled and an error rate of under 1%. [2]

The NYSE realizes the importance of computers in its day to day operations. It recently spent $125 million to upgrade and enhance its hardware and software capabilities, as part of its Integrated Technology Plan. Further on, the NYSE plans to implement wireless communication systems, so brokers can perform trades away from their computer workstations. [3]

Unfortunately, there have been problems with computer systems and the NYSE. The most recent example occurred on December 18th, 1995, when trading was halted on the NYSE for an hour due to "system upgrade problems." [4] Other stock exchanges have also had computer problems: the Hong Kong Stock Exchange, on December 12th, 1996, suffered a wave of panic selling after a computer incorrectly reported the current value of the exchange. [5] Finally, for an example closer to home, the Alberta Stock Exchange was closed for an entire day, on March 12th, 1997, when a new computer system failed to operate correctly. [6]

Is this dangerous? Possibly. There is a public conception that computers are infalliable, and that we can take for granted the reliability of institutions like the NYSE or the Toronto Stock Exchange. Computers can fail, and the results can be seen above. However, in the case of stock exchanges, there is a realization that trillions of dollars are at stake here, and that everything must be handled correctly the first time. (The 9.6 trillion value of the NYSE is enough to cover the debt of the United States and Canada combined.) It is a testimony to the computer systems of the NYSE and the TSE that errors are rare given the amount of transactions that occur from day to day. It is a testimony to the administrators of the NYSE and the TSE that they are willing to spend the money to guarantee this reliability.

However, not all stock exchanges are willing to spend that type of money, or they spend it in the wrong ways. Alberta's problems have led to decreased confidence in its stock exchange, and a stock exchange relies mostly on confidence. That's what makes the NYSE so powerful; it has been around for such a long time, it has built up a storehouse of confidence.

Should anything be done? Fortunately, the answer appears to be no. Stock exchanges usually realize their importance to the health of a modern economy, and thus reliability is a key feature in their system implementations. Even Alberta realizes this; it is only bad implementation that is hurting them. Thus, the only worry is malicious intent, as alluded to in Osborne's quote, above. How easy is it for somebody to take down the system, irrevocably damaging a country's economy in the process?

Such information is very hard to get, because stock exchanges have a interest in making this information as difficult to locate as possible. In theory, it is possible. Tom Clancy details one of the more fanciful, fictional scenarios in his book Debt of Honour, where a programmer disables the computer responsible for tracking trades. Other scenarios belong in the realm of fiction, with the possibility of becoming fact.

The US Securities and Exchange Commission, responsible for illegal trading and other infractions in the US, has very little public data on computer fraud at the exchange itself. However, it is still possible to do massive amounts of damage without the use of computers: the self-destruction of Baring's Bank in 1996 is a good example of that. And there is the usual scare of fraudulent schemes using the Internet.

In the end, the investor can only be as informed as possible, which is the usual rule of thumb. Luckily, stock exchanges do a better job then most other areas when it comes to computer use. The investor must only insure that the stock exchanges keep on doing that good job.

Notes:

1. Quoted by Lauren Wiener in RISKS.Digest 15.86, from The Naked Computer, 1983, Rochester&Gantz, Wm Morrow & Co., NY
2. Taken from the NYSE WWW Site: http://www.nyse.com
3. Ibid.
4. RISKS Digest 17.55
5. RISKS Digest 18.67
6. RISKS Digest 18.87

References:

• The New York Stock Exchange has an excellent WWW site at: http://www.nyse.com
• The US Securities and Exchange Commission also has a WWW site at: http://www.sec.gov
• As usual, the RISK Forum digest at http://catless.ncl.ac.uk gives a broad overview of everything that can go wrong with systems. In this event, a search on the words "stock exchange" results in fascinating, and in some ways, frightening, reading.
• Tom Clancy, in his book Debt of Honour(1993, GP Putnam, New York), details a deliberate attack on the financial markets of Europe and the United States. (I guess Canada isn't important enough. (8-)) Fiction, yes, but an example of how nothing can be made foolproof. At best, you might protect it from all accidental tampering, but you can't prevent deliberate malicious action. You have to trust somebody at some point to have highest access to the computer (to do maintenance, if nothing else), and, as cynics say, "Everybody has their price."

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