U.S. regulators required stock exchanges to show they can prevent technology disruptions under new rules intended to limit the frequency of malfunctions that have undermined investor confidence.

The Securities and Exchange Commission (SEC) voted unanimously today to approve rules that will cover the Nasdaq Stock Market, the New York Stock Exchange (NYSE), and venues operated by Bats Global Markets Inc., as well as dark pools including those owned by Credit Suisse Group AG and UBS AG. The SEC will separately consider expanding the rules to brokers, such as Citigroup Global Markets Inc. and Citadel Securities LLC, that fill orders themselves away from exchanges.

“We need to address any regulatory gaps that exist for market participants whose systems would have a significant market impact if they were disrupted,” SEC Chair Mary Jo White said at today’s meeting.

The revisions will mark the first update in 23 years of voluntary technology standards that were put in place after the October 1987 market crash known as “Black Monday.” White vowed to make them mandatory after the August 2013 failure of Nasdaq’s system for reporting quotes and prices caused a three-hour trading halt.

Former SEC Chairman Mary Schapiro made a similar promise after the May 6, 2010, flash crash, when the Dow Jones Industrial Average suddenly dropped 9.2 percent before recovering.

The new rules, known as Regulation SCI, require exchanges to conduct tests to ensure they have adequate backup systems to endure natural disasters and terrorist attacks. Exchanges would have to inform the SEC of significant disruptions within 24 hours and provide regulators with a written report of what caused it. The rules include a safe harbor to shield executives from liability when they can show they followed their internal policies.

Twelve dark pools, broker-owned competitors to exchanges that don’t publish quotes, will also have to comply under the rules approved today. Alternative trading systems for corporate and municipal bonds are not subject to the rules.

Eric Ryan, a spokesman for NYSE, said the rules are a “first step” in improving technology at trading centers.

“We agree that technology should be implemented in a way that protects investors, minimizes market disruptions, and makes the development process more consistent,” Ryan said in a statement.

Jim Gorman, a Bats spokesman, said the company “supports the policy goals” of the rule. Robert Madden, a Nasdaq spokesman, declined to comment.

SEC Commissioner Daniel Gallagher, a Republican, said today that exchanges already have incentives to prevent technology failures.

“No exchange wants to mishandle an IPO,” Gallagher said.

 

Knight Capital

White said the agency will separately consider whether the rules should be applied to brokers, which have had similar technology malfunctions. Knight Capital Group Inc. lost $450 million in August 2012 when a software error caused the firm to enter millions of faulty trades in less than an hour.

Intercontinental Exchange Inc.’s NYSE and Democratic SEC commissioners Luis Aguilar and Kara Stein pushed for extending the requirements to wholesale brokers that fill orders away from exchanges, citing failures such as Knight’s.

“Around $14 trillion worth of equity trades are ignored by Regulation SCI,” Stein said today before voting for the measure. “We should be doing more in this rule. I am disappointed in this missed opportunity because so many important trading centers are left out.”

While Aguilar agreed that the rules should have covered brokers, he highlighted support for other provisions, such as greater responsibility for exchange executives. A senior manager will have to review the company’s annual report of compliance with the rules, he said.

“I am optimistic that Chair White’s direction to the staff to develop recommendations to expand Regulation SCI’s reach to additional market participants will be acted upon promptly in order to make a future ’flash crash’ or Knight Capital debacle less likely,” he said.

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