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Poorly timed software upgrade paralyzes Nasdaq

Traders were unable to buy or sell stocks for 17 crucial minutes Tuesday after Nasdaq officials attempted a software upgrade on the fly in the last half hour of trading. Something went wrong and investors were the ones who paid the price.

The timing of the outage couldn't have been worse. Following the Federal Reserve Board's decision to raise short-term interest rates one-quarter of a percent and adopt a "neutral" bias, traders pushed the Nasdaq composite up 74 points to another record close of 3,293.07 on volume of 1.48 billion shares, also an all-time record.

From 3:40 p.m. to 3:57 p.m. the nation's largest electronic stock market was unable to process trades.

Wayne Lee, a Nasdaq spokesman, said the software upgrade was necessary to "handle the extremely high volume of trading" late in the session. The move appeared to trigger problems with the market's trade reporting and quotation systems.

Lee said he didn't know if Nasdaq would be installing or upgrading more software Wednesday night or in the future to accommodate skyrocketing volume on the tech-laden exchange.

Lee was also unable to say what might have happened had the exchange not tried to upgrade the software in the last half hour of the trading day.

"I don't have an answer for that," he said.

While the trading volume was extremely high, the Nasdaq has recently eclipsed the 1.3 billion share level on a number of occasions and moved above 1.4 billion shares on April 14.

Apparently, the difference between 1.4 billion shares and 1.48 billion shares was enough to require an immediate software update.

Brokers were scrambling to call their clients and explain the outage or fill those orders in after-hours trading.

After-hours trading surges

Nasdaq officials were able to restore its systems in time to keep them open from 4 p.m. until 6.30 p.m. Recently, Nasdaq decided to keep its pricing systems open until 6.30, even though it still officially shut its own last trading session at 4 p.m.

"It was down for 20 minutes. It came up for a few seconds at the end, but then went back down," James Volk, co-director of institutional trading at D.A. Davidson and Co., told Reuters.

The delay in processing orders meant a sharp increase in volume at after-hours services such as the Island ECN.

Longtime traders said Tuesday's outage was the first of its kind and likely a result of the frenzied trading near the close of trading.

"Basically, around 3:35 (p.m.), the system just went down. Maybe it was overloaded," said a Nasdaq trader, who wanted to remain anonymous. "I called Nasdaq and they said it was systemwide."

Because the outage came so late in the day, some traders weren't affected by the glitch but said it could create some uncomfortable situations for both brokers and their clients.

"I guess the only thing you could do is write down the time and the price of the stock that a client wanted to sell or buy the stock at and then try to reconcile it once it's back up and running," said a trader at Olde Discount. "It's potentially a major problem, especially if the trade ended up going against the client and he or she tried to back out of it."

New extranet was recently installed

Back in September, the Nasdaq and MCI WorldCom Inc. (Nasdaq: WCOM) announced the completion of a $600 million extranet that was supposed to double the speed and capacity of the exchange's trading network. MCI WorldCom's Enterprise Wide Network II was purportedly capable of handling volume up to 4 billion shares a day and could be scaled up to handle 8 million shares a day.

Officials said the EWN II was completed ahead of schedule, due to an accelerated 18-month process during which MCI WorldCom successfully migrated 7,000 trading workstations to the new Extranet.

At the time, the Nasdaq said "users of the highly reliable EWN II are assured no single point of failure can affect any part of the entire system."

Reuters contributed to this report.>