Securities Pricing:

Trading Volumes and NASD System Limitations Led to Decimal-Trading Delay

GGD/AIMD-00-319: Published: Sep 20, 2000. Publicly Released: Oct 24, 2000.

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Thomas J. McCool
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Pursuant to a congressional request, GAO examined the progress that the securities industry has made toward the implementation of decimal pricing for U.S. stocks, focusing on: (1) what were the specific reasons that the Nasdaq market was not ready for the July 3, 2000, implementation date and how the National Association of Securities Dealers', Inc. (NASD) decimal-trading preparations compared with those of the New York Stock Exchange (NYSE); (2) how the Securities and Exchange Commission (SEC) approached oversight of the securities industry's implementation of decimal trading and how this compared with its year 2000 oversight effort; and (3) what challenges remain regarding implementing decimal trading for the industry.

GAO noted that: (1) although the Nasdaq market experienced a surge in trading volume in late 1999, its existing systems were able to process the resulting message traffic; (2) however, NASD was unable to meet the original July 2000 implementation date for decimal trading in stocks because the new system it developed for quoting prices in decimals had insufficient capacity to process the increase in trading volume; (3) the primary reason that this system's capacity was insufficient was that it lacked the capability to use multiple computers for processing; (4) in addition, NASD's volume forecasting methodology does not adequately incorporate the volatility of the trading on its market; (5) it lacks effective criteria for determining whether its systems have sufficient excess capacity; (6) in contrast, both NYSE's processing environment and approach for preparing for decimal trading differed from that of NASD; (7) NYSE reported being ready to trade in decimal prices by the original July deadline; (8) NYSE experienced lower increases in its trading volumes than did the Nasdaq market, and its officials indicate that they use a more flexible information technology architecture that allows their exchange to more easily expand processing capacity; (9) SEC's approach for overseeing the securities industry's implementation of decimal trading was similar to the approach it used to oversee the industry's year 2000 readiness efforts; (10) although SEC conducted various reviews of NASD that raised capacity concerns, SEC officials relied on NASD's representations regarding its decimal-trading preparations and did not identify in advance the system limitations that caused NASD's delay; (11) various challenges remain for the industry as it progresses toward implementing decimal trading for all securities yet to be converted to decimals; and (12) additional challenges for securities market participants may arise if all securities listed on NYSE and the other regional exchanges begin trading in decimal prices before such trading begins for Nasdaq-listed securities, but industry participants indicated that various steps could be taken to address these challenges.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: According to SEC Market Regulation Division staff, Nasdaq has acquired commercial software to develop capacity and performance statistics that does address market factors, including trading volume volatility, for use in its capacity planning methodology. SEC staff are satisfied that Nasdaq has addressed this issue. During work on the 9/11 follow-up report (GAO-04-984) we confirmed that NASDAQ has implemented such capacity planning software, and maintains its system capacity high enough to accomodate volumes well above even the projected high trading volumes. In addition, NASDAQ officials told us that they can quickly add additional capacity.

    Recommendation: The Chairman, SEC, should take steps to ensure that NASD develops a volume forecasting methodology that better incorporates the volatility of the Nasdaq market's trading environment.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: According to SEC Automation Review Policy staff, Nasdaq has begun implementing its new trading system called Supermontage. Nasdaq officials have represented that this system is designed to allow its capacity to be increased overnight through resource reconfigurations for short term needs, and can have additional hardware added for long-term expansion.

    Recommendation: The Chairman, SEC, should take steps to ensure that NASD develops systems that are capable of being quickly expanded to handle increased processing levels.

    Agency Affected: United States Securities and Exchange Commission

  3. Status: Closed - Implemented

    Comments: In January 2001, SEC Automation Review Policy Staff recommended that Nasdaq develop a policy that defines the required processing capacity of all its systems as a value relative to its historical peak workload and maintain adequate absolute capacity to accommodate the relative capacity of each system. According to SEC, Nasdaq's policy is to develop separate desired values for processing capacity for each component of a system rather than have one single multiple of historic volume for its systems as a whole, because different components are affected by volume increases differently. Its goal is to provision systems to handle projected volume with sufficient excess capacity over a 12-month period. SEC accepted this policy given the complexity of Nasdaq's systems and the capacity flexibility of the new Supermontage system.

    Recommendation: The Chairman, SEC, should take steps to ensure that NASD develops criteria for determining the minimum amount of excess capacity to be maintained for both existing and planned information technology systems that adequately consider its market's trading volatility and speed at which its systems' capacities can be expanded.

    Agency Affected: United States Securities and Exchange Commission

  4. Status: Closed - Implemented

    Comments: SEC conducted an examination of Nasdaq following the issuance of GAO's report to assess Nasdaq's progress in readying its systems for decimals.

    Recommendation: The Chairman, SEC, should also direct SEC staff to conduct more on-site examinations of NASD as a means of collecting and verifying additional information on that market's progress in implementing decimal trading in accordance with the current implementation schedule.

    Agency Affected: United States Securities and Exchange Commission


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