Stock Trading Should Enjoy Same Protections as Credit Cards

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NEW YORK (TheStreet) -- My wife has always liked her job. As a young programmer she signed on with a transaction-processing company. She says the programs she works on make money. It may be only a few cents per transaction, but the pennies add up.

During her career, transaction processing has come to dominate the movement of money around the world. When a credit card processor suffers a security breach, or a software error takes down its system, the impacts can be immediate and catastrophic.

What happened at Knight Capital Group last week could happen to any processor.

Reuters reports that a new system was placed online and immediately sent a bunch of fake trades into the market's order flow.

AdvancedTrading.Com wrote that a "buy program" designed to run over several days instead ran in five minutes. The Knight algorithm went rogue for half an hour before it was turned off.

The loss came to $440 million and threatened Knight's very existence.

I don't know much about my wife's job, except for this: It's really complicated. The industry got its start on mainframe computers, and while there's often talk of moving to client-server or cloud systems, the fact is that any change is like rebuilding a freeway. You have to keep the traffic flowing even while you're making the change.

With credit cards, a lot of the technical regulation is done by credit networks like MasterCard and American Express .

Visa is the most important because it's the biggest payment network. When Visa says jump, processors ask how high. When it changes its requirements -- and it does so regularly -- obeying its orders becomes everyone's top priority. That's because Visa can cut off a processor that fails to meet its standards, and when that happens you're pretty much out of business.

The stock market has no analogue to this. Regulation is done by the Securities and Exchange Commission or (in the case of futures trades) the Commodity Futures Trading Commission. Trades are routed through the New York Stock Exchange, but it's more a competitor to Knight than a regulator.

Regulators, meanwhile, may understand law and finance, but they're not software people, they're not data processing professionals. Even if they were, they can't do the kind of ongoing, detailed procedural requirements monitoring that Visa can. The stock exchange's regulatory arm, NYSE Regulation, is more concerned with the what of trading than the how.

The key to technical regulation is that it defines how you do things. Action can be taken and penalties assessed before something goes wrong. Establishing, maintaining, publishing and enforcing those kinds of rules won't keep bad things from happening. But it will make them less likely, it will minimize them, and it will establish a checklist of procedures to follow before software goes live and a checklist to follow when something does go wrong.

Any company whose computer systems are part of the equity order flow, not just those engaged in high frequency trading, as CFTCLaw puts it, should be subject to regulation of this sort, private regulation that will kick in and get processors kicked offline long before the SEC or CFTC would ever be called, even before firms could put themselves at risk.

I don't think our stock trades have the same protection as our credit card transactions.

That scares me. Does it scare you?

At the time of publication, the author had no investments in the companies mentioned here..

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Tickers in this article: AXP KCG MA V