SECURITIES INDUSTRY Additional Testing Needed to Ensure Efficient Post-Trade Processing of Stocks - ..--.---_-~~ -___ --.---- (;A( I,, I kI’1’15( ‘-!wcl I I ’ i ~ 4 I ,,. ,_ .,,, ..I ..l,l _..._ . l-l. .._ -.._- -..... . - ._-.- .._.....---... -. - -.---- . -__-- ..--..______...__ united states GAO General Accounting Office Washington, D.C. 20548 Information Management and Technology Division B-240623 September26,199O The Honorable John D. Dingell Chairman, Committee on Energy and Commerce Houseof Representatives Dear Mr. Chairman: During the October 1987 market crash, the U.S. stock markets experi- encedbacklogs in correcting problem trades, where buyers and sellers disagreeon the terms of their transactions. The backlogs during the week of October 19, 1987, resulted in delays in determining market par- ticipants’ financial obligations totalling over one billion dollars. This report respondsto your June 27, 1989, request for information on (1) automated systems developedto correct problem trades more expedi- tiously; (2) the extent to which these systems have beentested to ensure that they can processincreasedwork load volumes such as those experi- encedduring the 1987 market crash; (3) the impact these systems will have on reducing the 5-day period neededto clear and settle stock trades; and (4) the role the Securities and ExchangeCommission(SIX) played in reviewing and approving these systems. As specified in your request, we reviewed the New York Stock Exchange’sOvernight Comparison System,the American Stock Exchange’sIntra-Day ComparisonSystem, and the National Association of Securities Dealer’s (NASD) Automated Confirmation Transaction System. As agreedwith your office, we also reviewed the Redesigned Comparison System used by the National Securities Clearing Corpora- tion (NSCC) becauseit plays a critical role in identifying problem trades and transmitting them to the stock markets for correction processing. These four systems are a collective effort by the exchanges,NASD, and NSCCto streamline the processfor correcting problem trades. Details of our objectives, scope,and methodology appear in appendix I. The exchanges,’NASD, and NSCCare improving the post-trade processing Results in Brief of stocks. Specifically, they (1) implemented computer systems in the last year that processthe results of each day’s trading activity earlier than before, and (2) reduced reliance on inefficient manual correction ‘For purposes of this report, the term exchanges refers to the New York Stock Exchange and Amer- ican Stock Exchange. Page 1 GAO/IMTECXO-83Securities Industry J I B-240628 processes.Consequently,these organizations have cut the time needed to correct problem trades from 3 days to 1 day. However, obstacles remain to reducing the overall time required to settle stock transactions. As a result, clearanceand settlement still takes 6 days, and the risks to market participants and clearing organizations associatedwith waiting 6 days to receive payments remain. We also found that the new systemsused to improve clearanceand set- tlement were not stress-testedto assesstheir capability to processan- ticipated peak work loads. Specifically, while these four organizations, to varying degrees,performed systemsdevelopment tests prior to sys- tems implementation, they did not fully test these automated systemsin an operational environment that simulates extreme market conditions. For this reason,the securities industry and its participants cannot be completely assuredthat these new automated systemswill be able to correct trades promptly and accurately during peak processingperiods. However, since these systemswere implemented, these organizations have tested or plan to further test their systemsunder high-volume transaction work loads. With regard to SEC’s role in reviewing the development and implementa- tion of these systems,the commissionhas begun to strengthen its over- sight. It has (1) issued an automation policy that recommendsthat the stock exchangesand NASD assessand test their systems’ capacities and (2) established a group to assesscompliance with the new policy. How- ever, as we previously reported, the commission’soversight of auto- mated systems remains superficial.2 For example, SECdid not assess these systemsduring development and testing to ensure that the exchanges,NASD, and NY.32adhered to critical systems development prac- tices. As a result, SECcannot be certain that these systemscan consis- tently processproblem trades, especially during extreme market conditions. Clearanceand settlement takes place after trades have been executed Background and are the processesthat traders use to complete their transactions. Clearanceinvolves collecting and matching data on the terms of a trade-such as price- from traders who buy and sell stocks, and typi- cally takes 1 day. Settlement is the processwhereby buyers and sellers 2SeeFinancial Markets: Oversight of Automation Used to Clear and Settle Trades Is Uneven (GAO/ IMTE-90-47 July 12 1990), Financial Markets: Tighter Computer Security Needed (GAc,IMTEG 00-16, Jan. 6, iSSO>,&d Financial Markets: Preliminary Observations On The October 1087 Crash (GAO/GGD88-38,Jan. 26,1988). Page 2 GAO/lMTEG9O-83Securities Industry B240626 exchangefunds for stocks traded, and generally takes 6 days. Because the two processesoccur concurrently, completing them only takes 6 bus- iness days after the trade date. Prior to the implementation of the new automated comparison and correction systems,trades used to clear by the third day and settle on the fifth. Clearanceand settlement is performed by exchanges,NASD, and clearing organizations that work together to gather and compare trades and arrange for them to be settled by the traders. Most trades are success- fully matched and settled without complications. Trades are matched using key elementsof each transaction, such as stock price and quan- tity, to ensure that buyers and sellers each have accurate data and as such, agreeto the terms of the trade. Disagreementsbetween buyers and sellers on trade terms result in problem trades that must be resolved before the transactions can be cleared and settled. The extraordinarily high trading volume during the 1987 market crash created backlogs and increasedthe number of problem trades. For example, before the crash, the normal percentageof unmatched trades on the New York Stock Exchange,the American Stock Exchange,and the NASD was 1.6,2.4, and 6.7 percent, respectively. However, during the market crash, these percentagesfor the New York, American, and NASD more than doubled to 3.4,6.6, and 12.8 percent, respectively. To resolve the October 1987 backlogs,the stock markets closedearly for several days, and trading firms and exchangepersonnel worked evenings and weekendsuntil the trade correction problems were eliminated. NMD also extended the operating hours of its automated correction system-the Trade Acceptanceand Reconciliation System-to provide traders with more time to resolve their transactions, and NSCCprovided trading firms with additional time to report corrected problem trades to the clearing corporation. After the crash, the primary federal regulator of the stock markets (SEC);the President’s Working Group on Financial Markets;3and an international private-sector group-called the Group of Thirty4 - studied the manual trade correction processesand the S-day period “The Working Group on Financial Markets was created by the President in March 1088 to identify issues, make recommendations, and seek resolution of the complex problems raised by the crash. The Working Group is chaired by the Secretary of the Treasury, and its members include the Chairmen of the Commodity Futures Trading Commission, the Federal Reserve System, and the SEC. 4The Group of Thirty studied the clearance and settlement systems in the world securities markets and made recommendations to standardize these systems across international borders. The group’s members are from the United States and other countries’ financial services industries. Page 3 GAO/IMTJSG90-83Securities Industry 0-240623 neededto clear and settle stocks and made recommendationsfor improving the clearanceand settlement processin these two areas.SEC and the Working Group generally recommendedthat (1) exchanges automate their trade correction processesand (2) the securities industry shorten the 6-day period for stock clearanceand settlement. The Group of Thirty recommendedthat, by 1992,trades be settled by the third bus- iness day after the trade. In responseto the trade correction problems experiencedin October Securities Industry 1987, the stock exchanges,NASD, and NSCC developedand implemented Has Implemented computer systemsthat speedup the gathering, comparison, and correc- Computer Systems to tion of trade data. The four systems,their functions, and implementa- tion dates are summarized in table 1 below. Address Trade Correction Delays Table 1: Trade Comparison and Correction Sybtemr, Primary System Functions, and Implementation Dates Primary System Functions Correct8 W;parer trade unmatched trade Date of Orasniratlon System name data imolementation American Stock Exchange Intra-Day Comparison System X November 1989 ;t;p,:;l Association of Securities Automated Confirmation Transaction X X February 1990 System National Securities Clearing Redesigned Comparison System X August 1989 Corporation New York Stock Exchanae Overniaht Comoarison Svstem X Julv 1989 These systemsenable these stock markets to compare and correct all trades, including problem ones,within 1 day after the trade date. NASD’S system can perform these tasks even soonerin that trades can be com- pared and corrected on the sameday they are executedm6 By speedingup trade comparison and correction, these four systemsoffer the stock markets the capability to avoid the delays associatedwith correcting trades that were encounteredduring the 1987 crash. While these sys- tems have yet to perform in an operational environment under extreme work load conditions, to date they have successfully processedproblem trades within established time frames. A detailed description of how each system operates is included in appendix II. “The American Stock Exchange designed its system so it could be modified in the future to compare and correct trades on their execution day. Page4 GAO/IMTJ3G9O-t33!SecurkiesInduetry \ L 5240528 Testing systemsto assesstheir ability to processdata during periods of Tests to Assess peak work load, commonly referred to as stresstesting, helps identify Performance at Peak and correct system weaknessesbefore they causedata processingdis- Work Volumes Have ruptions in a live operating environment. For this reason, in November 1989, SEC issued a policy statement recommendingthat the stock Not Been Completed exchangesand NASD, amongothers, conduct such tests.6We evaluated the extent to which these organizations had conducted stress tests to validate that each system and its market participants could process, within established time frames, peak work loads anticipated by these organizations during extreme trading periods. In each case,anticipated extreme work loads were in excessof those encounteredduring October 1987. We found that none of these organizations conducted stresstests to sim- ulate the behavior of systems and market participants in an operational environment with anticipated peak work load levels. While each organi- zation, to varying degrees,conductedtests that provided them indica- tions that their systems could processvolumes roughly equal to or in excessof those experiencedduring the October 1987 crash, this testing failed to provide complete assurancethat these systemscould process such work loads. Specifically, the tests either did not validate that (1) system performance (including, for example, its responsetime) was acceptable;(2) the system could handle the number of corrections antici- pated under extreme market conditions; (3) the system could support all users expected to be on the system; or (4) the system could process trade data simultaneously with other applications expectedto coexist on the system. For example, before its system becameoperational, NSCC successfully demonstrated that it could processwork loads in excessof those experiencedduring the October 1987 market crash. However, in this test, the system was dedicated solely to comparing trades and did not run the other major systems applications it normally executes simultaneously. Officials from the exchanges,NASD, and NSCCsaid they did not conduct such tests becauseit is extremely difficult to accurately predict and sim- ulate the post-trade processingenvironment during stressful market conditions. Further, it is expensive and time-consumingto coordinate the participation of all securities industry organizations and personnel involved in the post-trade processingof transactions. We agreethat rig- orous stress-testingof automated systems is complicated and not without costs. However, until these organizations conduct thorough “See Securities and Exchange Commission Release No. 34-27446, 64 Fed. Reg. 48703 (1989). Page5 GAO/IMTEG90-33 Securities Industry E240622 stress tests, they cannot give market participants complete assurance that the new automated systemswill be able to efficiently compare and correct trades during periods of extreme market activity. Sincethese systemshave been made operational, the organizations have taken or plan to take steps they believe provide additional assurance that these systemscan handle increasedwork loads. Specifically, NSCC conducted another test that demonstrated its system could successfully processthree times the trade comparison volume experiencedduring the October 1989 market break. This test included the operation of other major applications, that run simultaneously on the computer, at normal operating levels rather than those anticipated during increasedmarket activity. The American Stock Exchangeprocessed2 normal days of unmatched trade data during a Saturday work session.Although this exercise did not fully validate the system’s ability to handle anticipated high volume work loads, exchangeofficials believe it showed their system should be able to processincreasedwork loads, and added that the exchangealso recently supplementedthe hardware in its system to further speedup the processingof such trades. NASD has also conducted stresstests to determine whether its system can operate at required work load levels. To date, these tests have shown that vendor-supplied software cannot consistently processanticipated high volume work loads. NASD is working with the vendor to correct the problem and plans to retest the system in the near future. New York Stock Exchangeoffi- cials also plan to stresstest their system in mid-September1990 at work load levels anticipated by the exchangeduring extreme market conditions. Becauseof the importance of following a structured systemsdevelop- Additional System ment approach, in gathering information on system testing, we also doc- Development umented the systemsdevelopment practices followed by these Weakness organizations. Failure to follow a structured systems development approach can contribute to the development of systemsthat do not per- form neededfunctions or cannot operate at required work load levels.7 In this regard, we found that one organization overlooked certain critical systemsdevelopment practices. Specifically, the organization did not ‘Generally accepted systems development practices involve a structured, step-by-step process for developing, operating, and maintaining automated systems over their whole life. By using a struc- tured approach, organizations (1) help assure automated systems are developed, evaluated, and oper- ated in an effective manner at the lowest overall cost; (2) assure management accountability for the successor failure of the system’s development; and (3) reduce the risk that the system will not operate as intended. Page 6 GAO/IMTECBO4l3Securities Industry 4 &240522 fully (1) assesssystem requirements and (2) project future system work load needs.Thesesteps were omitted to more quickly develop and deploy the system. However, the system’s implementation was post- poned several times becausethe system did not perform at levels consid- ered acceptable.Organization officials recognizedthat these delays were attributable to lax compliance with their systems development proce- dures and are now requiring systemspersonnel to follow structured sys- tems development practices in developing all future automated systems. We also evaluated the role the automated comparison and correction New Systems Will systemswill play in reducing the 5-day period for clearing and settling Help Shorten Stock stock transactions. The potential benefits of reducing the S-day cycle Clearance and include (1) reducing payment risks and uncertainty by having the pay- ment for and exchangeof stock occur closer to the trade date; (2) coordi- Settlement but nating the stock clearanceand settlement processmore closely with the ObstaclesRemain l-day clearanceand settlement processin the options, futures, and gov- ernment bond markets; and (3) increasing the efficiency and competi- tiveness of the U.S. securities industry in global financial markets. In this regard, the automated comparison and correction systems imple- mented by the exchanges,NASD, and NSCCrepresent progresstoward this goal. Specifically, these systems have reduced the stock comparison and correction processfrom 3 days to 1. The 2-day reduction, fully imple- mented in February 1990, is attributable to (1) NSCC'Sfaster processing system for matching trade data and (2) efficiencies gained by the exchanges’automating their trade correction processesand NASD'S enhancing its automated trade correction capability. However, while trade comparison has been reduced to 1 day, stock set- tlement still requires 5 days. Settlement remains at 5 days due to com- plex legal, financial, and other issuesassociatedwith shortening this processand reducing settlement risks. Theseissuesinclude . reducing the time required to bring physical stock certificates, especially those of small investors, to settlement by, for example, (1) accelerating the delivery of such certificates; (2) storing them in a central location and recording their movement amongtraders in book-entry form, or (3) eliminating the use of certificates entirely; . cutting the time available to trading firms, large institutions (e.g., banks), and retail customersto arrange for (1) trade confirmations and (2) payments and bank financing of certain security purchasesor delivery obligations; Page 7 GAO/IMTEG90-83 Securities Industry 6.240528 . speedingup the availability of settlement payments by increasing reli- anceon same-dayfunds transfers, along with eliminating payments by checksthat do not allow funds to be available until the next day; and . determining whether related federal and state laws and regulations requiring the use of physical stock certificates and allowing a S-day set- tlement period, for example, would need to be modified, As of August 1990, a working committee of U.S. securities and banking representatives is studying these areasin detail, with the goal of pro- posing a strategic plan that the securities industry can follow to reduce the settlement processto 3 days.” Specifically, the working committee plans to survey stock clearanceand settlement organizations to deter- mine the feasibility and acceptability of modifying the stock settlement process,including analyzing the capability of certain existing automated settlement systems used in the clearanceand settlement processto operate under an accelerated3-day settlement schedule.The working committee expects to complete its study and strategic plan by late fall, at which time it hopesto involve the SEC,the Federal ReserveSystem, and the stock clearanceand settlement organizations in implementing the necessarychangesto reduce the entire processto 3 days. In this connection,the working committee briefed SECon its efforts, and the commissionis considering holding a conferencein November 1990 with stock clearanceand settlement organizations to discussthe issuesassoci- ated with making the changeto a 3-day settlement process. Active federal oversight of the use of computers is critical to ensuring SEC Has Not Fully that these systems have sufficient capabilities and controls in place to Ensured That Trade compare and correct trades promptly and accurately. In this regard, SEC Comparison and has taken steps to help ensurethat certain securities industry organiza- tions establish capacity planning and vulnerability assessmentprograms Correction Systems for automated systems and networks. However, SEX’Sdirect oversight in Are Technically Sound assessingautomated systems remains superficial. SECofficials informed us that when the comparison and correction sys- tems were being developed,they (1) visited the involved organizations to gain a better understanding of how the systemswould work and where the processingwould occur and (2) requestedfrom the exchanges and NSCCwritten certifications that their systemswere designedto pro- cesswork loads such as those experiencedduring the October 1987 ‘This committee is the U.S. contingent of the Group of Thirty and is working to implement the Group of Thirty’s recommendations in the United States. Page 8 GAO/IMTEGQ 8ecuritiee Industry 5240523 market crash. However, as we have previously found in related finan- cial market reviews, SEC oversight excludes direct technical assessments of systems during critical development and deployment phases.QFor the four systems we examined, for example, SEC’S review was not designed to validate that these organizations had taken adequate steps to ensure that these systems(1) have the capacity to support timely operations under normal and high-volume conditions; (2) have controls in place to prevent unauthorized accessand misuse;(3) are able to provide contin- uous service in the event of equipment and software failures, natural disasters, and intentional malicious acts; and (4) have adequatecontrols to ensure that the systems’ hardware, software, and communications will perform as intended. In discussingthe need for more in-depth assessments,SECofficials explained that the commissiondoesnot have sufficient technical exper- tise and relies on the exchanges,NASD, and the clearing organizations to ensure the soundnessand integrity of their own systems.This superfi- cial systemsoversight by SECreducesthe public’s assurancethat these systems have sufficient capabilities and controls in place to process trades in a prompt and accurate manner. In addition, it also raises ques- tions about the strength of the federal regulator’s oversight in this area and highlights the need for the commissionto do more in the automated systems area. Sincethese four systemswere developed,SEC has begun to increaseits ability to overseethe automated systems and telecommunications net- works used by certain organizations in the securities industry. Specifi- cally, the Commissionissued an automation review policy in November 1989 that asks certain securities industry organizations to establish comprehensivecapacity planning and vulnerability assessmentpro- grams for their automated systems and networks. In addition, SEC estab- lished an automation review group in April 1990 and plans to provide it with technical staff in the third quarter of 1990 with the expertise to (1) assesscompliance with its automation policy and (2) assist commission staff, as needed,in addressingtechnical issuesduring oversight processes. “See GAO/IMTEC-90-47, July 12, 1990; GAO/IMTEC-90-16, Jan. 6, 1990; and GAO/GGD-88-38, Jan. 26,1988. Page 9 GAO/IMTEG99-83 Securities Industry M B-240623 Progressis being made in the stock markets to improve the efficiency Conclusions and and timeliness of post-trade processingactivities. The exchanges,NASD, Recommendations and NSCChave streamlined the trade comparison and correction process, which has enabled the securities industry to cut this processby 2 days. We are also encouragedby the efforts of the Group of Thirty, the securi- ties industry, and the regulators to shorten the overall settlement pro- cess.However, until more action is taken, the payment risks associated with stock traders and clearing organizations waiting 5 days to exchangepayments for stocks are still present. In addition, SEC is begin- ning to take positive steps to increaseits oversight of the use of automa- tion in the stock markets. However, more needsto be done to help assuremarket participants that trade comparison and correction sys- tems are designedto operate smoothly during periods of market stress. Although these systemshave operated well since they have been imple- mented, stress-testinghas not been completed to ensure that they can handle extreme market activity, and one organization overlooked crit- ical systems development practices when developing its system. Accordingly, we recommendthat the Chairman, SEC,ensure that (1) the New York Stock Exchange,the American Stock Exchange,NASD, and NSCCconduct complete stress tests to demonstrate that their trade com- parison and correction systems can handle increasedwork loads antici- pated during peak trading periods and (2) all organizations follow structured systems development practices when developing automated systems. We discussedthe contents of this report with senior officials from the Agency Comments and New York Stock Exchange,the American Stock Exchange,NASD, and Our Evaluation NSCC.We also discussedit with responsibleSECofficials and a represen- tative from the Group of Thirty’s US. working committee. We have incorporated their commentswhere appropriate. Except as noted below, these officials generally agreedwith the contents of our report. SECstaff reiterated that the 1987 market break experiencerevealed the need for further automation of the trade comparison and correction processes.They added that acceleration of the trade comparison func- tion to a next-day basis, coupled with automating the trade correction processes,significantly addressesthe trade correction deficiencies iden- tified during the 1987 break, Commissionstaff also believe that the implementation of these systems,basedon reasonabledevelopment testing along with complete stress-testingafter deployment, provides considerableimmediate benefit to market participants at minimal Page 10 GA0/IMTEG90-83 !SecuritiesIndustry c . market risk. We agreethat significant progress has been made in addressingthe trade correction problems that occurred during the 1987 market crash. However, we believe that thorough stress-testingshould be performed on new automated systemsto help ensure that they are appropriately designedto handle work loads anticipated during extreme trading periods. Additionally, SECstaff questioned the need for the commissionto use its scarceresourcesto perform direct technical assessmentsdescribedin this report and others when independent assessmentsand internal eval- uations currently are performed by or on behalf of the exchanges,NASD, and the clearing corporations. We continue to believe that, given the important role automation plays in the securities markets, SEC needsto be more directly involved in reviewing and assessingthe markets’ use of automation. We are providing copiesof this report to other interested membersof Congress,legislative and executive branch agencies,and the public. We will also make copiesavailable to others upon request. This work was performed under the direction of Howard G. Rhile, Director, General Government Information Systems,who can be reached at (202) 276-3466.Other major contributors are listed in appendix III. Sincerely yours, Ralph V. Carlone Assistant Comptroller General Page 11 GAO/IMTEC90-83 Securities Industry contents . Letter 1 Appendix I Objectives, Scope,and Methodology Appendix II 16 Description of Comparison and Correction Systems - Appendix III 18 Major Contributors to This Report Table Table 1: Trade Comparison and Correction Systems, Primary System Functions, and Implementation Dates Abbreviations GAO General Accounting Office GGD GeneralGovernment Division 1MTF.C Information Managementand Technology Division NASD National Association of Securities Dealers NS4X National Securities Clearing Corporation SEC Securities and ExchangeCommission Page12 GAO/IMTEG90433Securities Industry GAO- SecurItlea Industry Appendix I Objectives,Scope,and Methodology Our objectives were to provide information on computer systemsused to reconcile market participants’ trades executedon three major U.S. stock markets-the New York Stock Exchange,the American Stock Exchange, and the National Association of Securities Dealers(NASD). Specifically, our objectives were to (1) provide information on automated systems developedby these stock markets to more easily correct problem trades; (2) assessthe extent to which these systems have been tested to ensure that they can processincreasedwork load volumes such as those experi- encedduring the 1987 market crash; (3) determine the impact these sys- tems will have in reducing the 5-day period neededto clear and settle stock transactions; and (4) assessthe role that the Securities and ExchangeCommission(SEC) played in reviewing and approving the use of these systems.Becauseof the important role the National Securities Clearing Corporation (NSCC) plays in gathering trade data from market participants trading on the stock markets and identifying those problem trades needing correction, we also reviewed a redesign of the automated comparison system used by the clearing corporation. To determine the development status of these systems and to under- stand how they operate, we obtained available systemsdevelopment documentation and met with senior officials at the New York Stock Exchange,American Stock Exchange,NASD, and NSCC.We also toured these organizations’ computer and trade reconciliation facilities and observeddemonstrations of the systems’ capabilities. Further, we observedat the exchangesand NASD how traders use the systemsto cor- rect trades in a live working environment. In looking at testing of these systemsto ensurethat they can processthe increasedwork load volumes, we reviewed generally acceptedsystems development criteria and federal rules, regulations, and policies to deter- mine the systemsperformance tests that should be performed when developing and implementing computer systems.We met with and dis- cussedthis issue with senior exchange,NASD, and NSCCofficials. We also reviewed their systemsdevelopment documentson testing, including any test plans, to assessthe degreeof testing performed to demonstrate that these systems would be able to processincreasedwork loads in a prompt and accurate manner. Additionally, becauseof the importance of following a structured systemsdevelopment process,we reviewed other systemsdevelopment documentation to assesswhether these orga- nizations had adhered to generally acceptedpractices in developing their systems.In this connection,we reviewed and evaluated available performance statistics on these systems,such as responsetimes and Page 14 GAO/IMTEG90-83 Securities Industry ~- ~~~ --~~ Ame* 1 ObJeaivea, &ope, and Methodology volumes processed,to determine whether the systemswere processing trade data at intended performance levels. To assessthe role of SECin reviewing and approving these systems,we met with responsiblecommissionofficials to discussand document how they processedthe exchanges’,NASD'S, and NSCC’S requeststo develop and implement these automated systems,including what technical assessmentsthey had performed before approving their use. We also reviewed the requests-called rules-submitted to SECby the exchanges,NASD, and NSCC to develop and implement these systems, along with any relevant industry comments.In addition, we reviewed and discussedwith appropriate SECofficials the commission’sautoma- tion review policy and documentedSEC plans to establish a group to overseecompliance with this policy. With regard to the impact these systemswill have on shortening the 6- day clearanceand settlement period for stocks, we obtained information from senior SECofficials on how the systemswill affect the S-day period. In addition, we discussedthis, issue with representatives from (1) the Group of Thirty committee responsiblefor implementing in the US. the group’s recommendation for shortening the clearanceand settlement processand (2) the Securities Industry Association. Further, we obtained and evaluated the views of senior exchange,NASD, and NSCC officials. We conducted our review in accordancewith generally acceptedgovern- ment auditing standards, between August 1989 and July 1990. Page 15 GAO/IMTEGfM)-S3 Securities Industry Appendix II Description of Comparison md Correction Systems The following describesNSCC’Scomparison system and the exchanges’ and NASD'S correction systems and includes a brief description of how the systemsoperate. NSCC'Sredesignedsystem comparestrades and identifies unmatched trades faster than its old system. Specifically, the redesignedsystem comparestraders’ transaction data, identifies unmatched trades, and transmits this information electronically to the exchanges’correction systems before the start of the next trading day.’ In the past, NSCCcould not complete these processingactivities until the end of the day after the trade execution date. The redesignedsystem involved extensive modifications to the computer system and data processingscheduleused by the clearing corporation to compare trades. The primary modifica- tions involved (1) the development of new software to processpost- trade data more quickly and efficiently and (2) new requirements placed upon traders to submit their data earlier than under the previous system. The New York Stock Exchange’sand the American Stock Exchange’s correction systems-called the Overnight ComparisonSystem and the Intra-Day Comparison System, respectively-are similar in that they consist of a network connecting a central computer to terminals. Specifi- cally, the New York Stock Exchangesystem consistsof a mainframe computer with 470 terminals, while the American Stock Exchange’s system usesa minicomputer with 70 terminals. Located at the exchangesand at traders’ offices, the terminals (1) receive unmatched trade data from NSCCbefore the start of the next trading day and (2) allow traders to more quickly correct unmatched trades. Oncesuch data is successfully matched-that is, when traders agreeto the terms of the transactions-the correction systems electronically transmit the trades to NSCCat the end of the day to be prepared for settlement. NASD'S system-the Automated Confirmation Transaction System-also consistsof an extensive network of computer terminals and minicom- puters that are used by NASD traders to correct unmatched trades.2How- ever, unlike the exchanges,NASD'S system can also compare and match trades within minutes after execution. Specifically, NASD requires ‘NSCC used to compare trades executed on the exchanges and by NASD. However, since NASD’s new system compares trades, NSCC no longer performs such comparison processing for NASD. 2NASD has over 3,000 terminals capable of accessing the Automated Confirmation Transaction system. These terminals can also be used to accessother NASD automated trading and support sys- tems, Conversely, the terminals of the exchange correction systems are devoted solely to trade correc- tion activities. Page 16 GAO/lMTEG9O-S3 Securities Industry Appsndlxn: Dcudptlon olCbmparlson and corrrsaion Sy*tenu traders, after executing trades, to enter their trade data directly into the new system for it to be compared and matched, rather than having NSCC perform this step. NASD rules require traders to enter their transactions into the system during the trading day, within 90 secondsof each trade’s execution. The trade information is immediately transmitted to the other party for verification or correction. When no differences exist, or after traders resolve inconsistencies,the system automatically matchesthe trades, and NASD transmits daily the matched trade infor- mation to ~scc to be prepared for settlement3 As a result, NASD trades can be matched and compared on the sameday they are executed. 3When differences exist, NASD requires traders to resolve them by 1:OOp.m. of the next trading day. Trades not responded to by the opposite party within this time frame are automatically matched by the system and transmitted to NSCC for settlement. Trades rejected by the other party are automati- cally deleted from the system. Page 17 GAO/IMTEZo88 Securities Industry Appendix III Major Contributors~to This Report Richard J. Hillman, Assistant Director Information William D. Hadesty, Technical Assistant Director Management and Gary N. Mountjoy, Project Manager Technology Division, Gregory P. Carroll, Staff Evaluator Washington, DC. Bernard D. Rashes,Senior Evaluator New York Regional Garry Roemer,Deputy Project Manager Office Daniel P. Schultz, Staff Evaluator Diana Gershon,Staff Evaluator (810468) Page 18 GAO/IMTEGBO-S3 Securities Industry
Securities Industry: Additional Testing Needed to Ensure Efficient Post-Trade Processing of Stocks
Published by the Government Accountability Office on 1990-09-26.
Below is a raw (and likely hideous) rendition of the original report. (PDF)