Once again, it is about the plumbing.
Under heavy volume pressure, systems ensuring that trade orders are properly recorded and processed failed on a crucial day in mid-September, reviving fears of a trade-processing collapse like the one that accompanied the market crash of October 1987.
For several hours on Friday, Sept. 19, broker-dealers and financial advisers couldn't place orders through online systems at Pershing LLC and National Financial Services LLC, forcing some to use phones and faxes — routes that by Wall Street standards are prehistoric, not to mention error-prone,
InvestmentNews has learned.
What's more, many brokers and advisers couldn't access current position and balance information on accounts.
"It was tremendously serious," said the head of a regional brokerage firm who asked for anonymity be-cause so many of his firm's vital functions are provided by his clearing firm. "They weren't taking orders, or were taking them orally. That's insane in this day and age."
Meanwhile, a senior regulatory official, who demanded anonymity, said the volume capacity issue is of deep concern and an investigation is in the early stages.
Trade processing failures — which led to the demise of many securities firms in the 1960s and '70s and to the creation of today's processing utilities — expose clients to errors and delayed trade executions that can have important pricing implications in volatile markets. The malfunctions came at the end of one of the most tumultuous weeks in financial history.
Over the previous seven days, Lehman Brothers Holdings Inc. of New York failed, Merrill Lynch & Co. Inc. of New York negotiated its sale, a major money-market fund "broke the buck," American International Group Inc. of New York got an emergency $84 billion loan from the U.S. government, the Securities and Exchange Commission banned short selling in hundreds of financial stocks, and word of a $700 billion government bailout of banks and financial services institutions began leaking.
There couldn't have been a worse time for investors to suffer delays because stocks that week began experiencing violent market fluctuations. The brokerage firm executive said his company has been reimbursed by his clearing firm for more than 80 large trades that were executed at inferior prices because of the delays.
A Chicago-based lawyer representing another broker-dealer said he has initiated arbitration proceedings against a securities options clearing firm that was hobbled that day. The lawyer asked not to be identified.
Leading clearing firms have acknowledged the problems.
Pershing, a Jersey City, N.J.-based subsidiary of The Bank of New York Mellon Corp., sent a weekend memo Sept. 21 to clients that attributed the "delay in the normal availability of our order management and other online systems" to "the extraordinary market and regulatory changes of the past week." Pershing is the biggest clearing firm for broker-dealers.
"We worked quickly to provide our customers with appropriate trade entitlements and pricing adjustments such that no investors were harmed," Michael Geller, Pershing's vice president of corporate communications, wrote in an e-mail statement. "We have already in-creased our system capacity and re-engineered components of our platform to ensure our ability to process significantly higher volumes than the peak transactional daily volume we experienced on Sept. 18."
The positive news, he added, is that the firm has since processed even higher volume without incident.
A spokesman at National Financial Services, the clearing unit of Boston-based
Fidelity Investments, similarly confirmed that an "unprecedented amount of volume on our platform caused some intermittent slowness for approximately one hour after the market opened on Sept. 19."
He said the issue was industrywide, and noted that NFS is attempting to resolve customer concerns about specific trades "in a fair and appropriate way."
The problems, Pershing told clients, were caused by clogged pipelines deeper in the financial system as a result of an overwhelming number of trades being processed from Sept. 18. The clearing firms received requests from industry service providers and government agencies to extend trading cutoff times on that day because of delays in receiving data from exchanges and other marketplaces.
One of those service providers, National Securities Clearing Corp., confirmed that it was late in filing trade settlement information to clearing firms and its other big bank and securities firm members that Thursday.
NSCC, a unit of The Depository Trust and Clearing Corp., is a central counterparty that nets trades to reduce financial obligations requiring settlement and ensures the exchange of money for securities in virtually all broker-to-broker trades of equities, bonds, mutual funds, exchange traded funds and unit investment trusts in the United States. NSCC received late inputs from some exchanges and electronic markets Sept. 18, said Steve Letzler, a company spokesman.
Delayed file deliveries from NSCC to clearing firms are not extraordinary, he said, adding that he has no explanation for what happened at some broker-dealers the following day. That's what concerns regulators, who believed that past trading crises had led to sufficient systems upgrades in the bowels of the securities industry.
In 1987, E. Gerald Corrigan, then president of the
Federal Reserve Bank of New York, rallied fellow regulators and industry participants to focus on the underbelly of trade settlement because "the hard fact of the matter is that linkages created by the large-dollar payments systems are such that a serious credit problem at any of the large users of the system has the potential to disrupt the system as a whole."
Regulators now pushing the industry for central clearing settlement of credit default swaps and other exotic off-exchange products must be stunned that issues with core securities processing remain, analysts said.
"Plumbing is the heart of the solution, because in panics, there are blizzards of trades," said Robert Litan, head of research and policy at the Ewing Marion Kauffman Foundation of Kansas City, Mo., who has long studied the world's banking systems. "But given what's happened in this crisis, nothing surprises me."
E-mail Jed Horowitz at [email protected].
