Transposition Position

In early December, 2005, a Japanese telecom company called J-Com made its debut on the Tokyo Stock Exchange. J-Com was a small company — about 60 employees in four offices — which recruited salespeople for temp work at electronic stores, selling mobile phones. J-Com’s initial public offering (IPO) raised about $14 million (¥1.7 billion) for the company, which at the time was valued at just under $100 million. Most people didn’t notice or care — the IPO of such a small company barely makes news, usually. And for the first few days of J-Com’s life as a publicly-traded company, this was true for it as well.

But on December 8th of that year, all that changed. Shares of J-Com put the entire Tokyo Stock Exchange at risk.

That morning, J-Com shares were trading at ¥610,000, or about $5,000. A trader at Mizuho Bank, one of the largest financial services companies in the country, placed an order to sell one of the bank’s shares at that price. No big deal — except that he flipped the numbers around. Instead of offering one share for sale at ¥610,000, the trader offered 610,000 shares for sale at  ¥1. That’s a difference of about ¥40 billion, or about $300 million.

Oops.

At first, the trader and bank tried to pull the sale order back, but were unable to do so — the Tokyo Stock Exchange (TSE) had no mechanism for canceling a trade made in error. The error went through like a normal, intended trade, and as a result, sent the TSE into pandemonium. The Economist detailed the chaos:

Having tried frantically to cancel the order and failed, Mizuho scrambled to buy the shares it had sold but did not own. Some of the nicest sharks in finance, including Morgan Stanley, UBS, Nomura Securities and Nikko Citigroup, detected blood in the water. Meanwhile, as rumours swirled, investors sold the shares of brokers who might have made the mistake (Mizuho did not own up until trading ended). They also sold more broadly, calculating that a troubled broker would unload its own holdings to cover its losses.

The Economist further noted that the Nikkei 225 — the major stock market index for the TSE — collapsed that day; the drop was the third-worst one-day fall in 2005.

But why did Mizuho’s error spread to the wider market? In part, because the error shouldn’t have been possible. J-Com only had about 15,000 shares outstanding, so even a cursory set of controls would have stopped the trade from being carried out. And, more to the point, Mizuho detected the problem nearly immediately, but the TSE did not provide the bank with a way of canceling the order. The Wall Street Journal noted that Japanese regulators were less than pleased with the TSE’s safeguards, or lack thereof:

The FSA, which oversees the country’s financial markets, ordered the Tokyo exchange to improve its operations to prevent a similar trading gaffe from happening in the future. The computer systems at the exchange and Mizuho couldn’t communicate with each other properly, a problem that prevented Mizuho from canceling the problem order once it was detected. Though the exchange initially blamed Mizuho’s technology for the problem, it has conceded that shortcomings in its own system allowed the mistake to snowball.

In other words: accidents happen — even multi-billion yen accidents — and we should plan accordingly.

Mizuho was on the hook for the $300 million or so in losses but ended up paying out much less than that. The Wall Street Journal further noted that some of the beneficiaries of Mizuho’s mistake were pressured by politicians to give back some of the money. Further, Mizuho successfully sued the TSE for the latter’s failure to allow the bank to cancel the errant trade; the court awarded Mizhuo about 25% of the the ¥40 billion lost.

Bonus Fact: Not all weird market happenings are the result of typos and other errors — just ask Steve Perkins, then an oil futures trader. In the summer of 2009, Perkins had a little too much too drink and — even though he had limited recollection of the events the next day — ended up buying so many oil futures that global oil prices rose $1.50 a barrel in about half-an-hour’s timehe Telegraph described the price movement as “the kind of sharp swing caused by events of geo-political significance.” Perkins’ firm lost nearly $10 million due to his drunk trading, and Perkins himself was banned from trading for five years and fined the equivalent of about $100,000.

From the Archives: Onion Ring: Financial chicanery and vegetables.

Related: “Liar’s Poker” by Michael Lewis. One of my favorite books; highly recommended. 614 reviews averaging to 4.3 stars on Amazon, but there’s no accounting for taste.