Potential Terrorist Attacks: Additional Actions Needed to Better Prepare Critical Financial Market Participants
Published: 2003-02-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: September 11 exposed the vulnerability of U.S. financial markets to wide-scale disasters. Because the markets are vital to the nation's economy, GAO assessed (1) the effects of the attacks on market participants' facilities and telecommunications and how prepared participants were for attacks at that time, (2) physical and information security and business continuity plans market participants had in place after the attacks, and (3) regulatory efforts to improve preparedness and oversight of market participants' risk reduction efforts.
section_title: What GAO Found
paragraphs: The September 11 attacks severely disrupted U.S. financial markets, resulting in the longest closure of the stock markets since the 1930s and severe settlement difficulties in the government securities market. While exchange and clearing organization facilities were largely undamaged, critical broker-dealers and bank participants had facilities and telecommunications connections damaged or destroyed. These firms and infrastructure providers made heroic and sometimes ad hoc and innovative efforts to restore operations. However, the attacks revealed that many of these organizations' business continuity plans (BCP) had not been designed to address wide-scale events. GAO reviewed 15 organizations that perform trading or clearing and found that since the attacks, these organizations had improved their physical and information security measures and BCPs to reduce the risk of disruption from future attacks. However, many of the organizations still had limitations in their preparedness that increased their risk of being disrupted. For example, 9 organizations had not developed BCP procedures to ensure that staff capable of conducting their critical operations would be available if an attack incapacitated personnel at their primary sites. Ten were also at greater risk for being disrupted by wide-scale events because 4 organizations had no backup facilities and 6 had facilities located between 2 to 10 miles from their primary sites. The financial regulators have begun to jointly develop recovery goals and business continuity practices for organizations important for clearing; however, regulators have not developed strategies and practices for exchanges, key broker-dealers, and banks to ensure that trading can resume promptly in future disasters. Individually, SEC has reviewed exchange and clearing organization risk reduction efforts, but had not generally reviewed broker-dealers' efforts. The bank regulators that oversee the major banks had guidance on information security and business continuity and reported examining banks' risk reduction measures annually.

section_title: Letter
paragraphs: This report presents the results of the review you requested on the preparations that financial  markets have made since the September 11, 2001, terrorist attacks to protect themselves from  physical and electronic attacks and to develop business continuity plans for recovering rapidly and  resuming operations if damage occurs. The massive destruction caused by the attacks on the World  Trade Center and the resulting loss of life, facilities, telecommunications, and power significantly  affected U.S. financial markets. The markets reopened within days despite enormous obstacles, but  the attacks also exposed the vulnerability of the financial markets to disruption by such events. In  conducting this work, we assessed:  the effects of the attacks on the facilities and telecommunications services of participants in the stock  and option markets, the markets for government securities and money market instruments, and the  banking and payments systems and how prepared market participants were for the attacks at that  time;  1. the physical and information security and business continuity measures 15 exchanges, clearing  organizations, electronic communication networks, and payment system processors had in place  after the attacks to reduce the risk of operations disruptions in the future; and  2. the financial regulators’ oversight of market participants’ efforts to reduce their operations risks  and regulatory efforts under way to better prepare the markets for future attacks.  3. This report contains recommendations to the Chairman, Securities and Exchange Commission  (SEC) designed to better ensure that U.S. securities markets are better prepared to recover from  future disasters. The report also contains recommendations to improve SEC’s oversight of  information technology issues.
As we agreed with your office, unless you publicly announce the contents of this report earlier, we  plan no further distribution until 30 days from the date of this letter. We will then send copies to the  secretary, Treasury; the Chairman, SEC; the Chairman, Federal Reserve;  and the Comptroller of the Currency; and others who request them.
subsections: section_title: Introduction
paragraphs: Thousands of market participants are involved in trading stocks, options,  government bonds, and other financial products in the United States. These  participants include exchanges at which orders to buy and sell are  executed, broker-dealers who present those orders on behalf of their  customers, clearing organizations that ensure that ownership is  transferred, and banks that process payments for securities transactions.  Although many organizations are active in the financial markets, some  organizations, such as the major exchanges, clearing firms, and large  broker-dealers are more important for the overall market’s ability to  function because they offer unique products or perform vital services. The  participants in these markets are overseen by various federal securities and  banking regulators whose regulatory missions vary. Financial markets also  rely heavily on information technology systems and extensive and  sophisticated communications networks. As a result, physical and  electronic security measures and business continuity planning are critical  to maintaining and restoring operations in the event of a disaster or attack.
subsections: section_title: Various Organizations Participate in Stock and Options Markets
paragraphs: Customer orders for stocks and options, including those from individual  investors and from institutions such as mutual funds, are usually executed  at one of the many exchanges located around the United States. Currently,  stocks are traded on at least eight exchanges, including the New York  Stock Exchange (NYSE), the American Stock Exchange, and the NASDAQ.  Securities options are traded at five exchanges, including the Chicago  Board Options Exchange and the Pacific Stock Exchange. Trading on the  stock exchanges usually begins when customers’ orders are routed to the  exchange floor either by telephone or through electronic systems to  specialist brokers. These brokers facilitate trading in specific stocks by  matching orders to buy and sell. For stocks traded on NASDAQ, customers’  orders are routed for execution to the various brokers who act as market  makers by posting price quotes at which they are willing to buy or sell  particular securities on that market’s electronic quotation system. Some  stocks traded on NASDAQ can be quoted by just a single broker making a  market for that security, but others have hundreds of brokers acting as  market makers in a particular security by buying and selling shares from  their own inventories. Orders for options are often executed on the floors  of an exchange in an open-outcry pit in which the representatives of  sometimes hundreds of brokers buy and sell options contracts on behalf of  their customers.
The orders executed on the various markets usually come from broker- dealers. Individual and institutional investors open accounts with these  firms and, for a per-transaction commission or an annual fee, the broker- dealer buys and sells stocks, bonds, options, and other securities on the  customers’ behalf. Employees of these firms may provide specific  investment advice or develop investment plans for investors. Although  some firms only offer brokerage services and route customer orders to  other firms or exchanges for execution, some also act as dealers and fill  customer orders to buy or sell shares from their own inventory.
In addition to the exchanges, customers’ orders can also be executed on  electronic communications networks (ECN), which match their customers’  buy and sell orders to those submitted by their other customers. The  various ECNs specialize in providing different services to their customers  such as rapid executions or anonymous trading for large orders.
After a securities trade is executed, the ownership of the security must be  transferred and payment must be exchanged between the buyer and the  seller. This process is known as clearance and settlement. Figure 1  illustrates the clearance and settlement process and the various  participants, including broker-dealers, the clearing organization for stocks  (the National Securities Clearing Corporation or NSCC), and the  Depository Trust Company (which maintains records of ownership for the  bulk of the securities traded in the United States).
The Options Clearing Corporation plays a similar role in clearing and  settling securities options transactions. After options trades are executed,  the broker-dealers on either side of the trade compare trade details with  each other, and the clearing organization and payments are exchanged on  T+1.
Banks also participate in U.S. securities markets in various ways. Some  banks act as clearing banks by maintaining accounts for broker-dealers and  accepting and making payments for these firms. Some banks also act as  custodians of securities by maintaining custody of securities owned by  other financial institutions or individuals.
section_title: Government Securities and Money Market Instruments Are Traded Differently from Stocks
paragraphs: The market for the U.S. government securities issued by the Department of  the Treasury (Treasury) is one of the largest markets in the world. These  securities include Treasury bills, notes, and bonds of varying maturities.  Trading in government securities does not take place on organized  exchanges. Instead, these securities are traded in an “over-the-counter”  market and are carried out by telephone calls between buying and selling  dealers. To facilitate this trading, a small number of specialized firms,  known as inter-dealer brokers (IDB) act as intermediaries and arrange  trades in Treasury securities between other broker-dealers. The use of the  IDBs allows other broker-dealers to maintain anonymity in their trading  activity, which reduces the likelihood that they will obtain disadvantageous  prices when buying or selling large amounts of securities.
Trades between the IDBs and other broker-dealers are submitted for  clearance and settled at the Government Securities Clearing Corporation  (GSCC). After trade details are compared on the night of the trade date,  GSCC provides settlement instructions to the broker-dealers and their  clearing banks. Settlement with these banks and the clearing organization’s  bank typically occurs one business day after the trade (T+1) with  ownership of securities bought and sold transferred either on the books of  clearing banks or the books of the Federal Reserve through its Fedwire  Securities Transfer System. Two banks, JPMorgan Chase and the Bank of  New York, provide clearing and settlement services for many major broker- dealers in the government securities market.
Many of the same participants in the government securities markets are  also active in the markets for money market instruments. These are short- term instruments that include federal funds, foreign exchange  transactions, and commercial paper. Commercial paper issuances are debt  obligations issued by banks, corporations, and other borrowers to obtain  financing for 1 to 270 days. Another type of money market instrument  widely used for short-term financing is the repurchase agreement or repo,  in which a party seeking financing sells securities, typically government  securities, to another party while simultaneously agreeing to buy them  back at a future date, such as overnight or some other set term. The seller  obtains the use of the funds exchanged for the securities, and the buyer  earns a return on their funds when the securities are repurchased at a  higher price than originally sold. Active participants in the repo market  include the Federal Reserve, which uses repos in the conduct of monetary  policy, and large holders of government securities, such as foreign central  banks or pension funds, which use repos to obtain additional investment  income. Broker-dealers are active users of repos for financing their daily  operations. To facilitate this market, the IDBs often match buyers and  sellers of repos; and the funds involved are exchanged between the  government securities clearing organization and the clearing banks of  market participants. According to data reported by the Federal Reserve,  repo transactions valued at over $1 trillion occur daily in the United States.
section_title: Payment Systems Processors Transfer Funds for Financial Markets and Other Transactions
paragraphs: Payments for corporate and government securities transactions, as well as  for business and consumer transactions, are transferred by payment  system processors. One of these processors is the Federal Reserve, which  owns and operates the Fedwire Funds Transfer System. Fedwire connects  9,500 depository institutions and electronically transfers large dollar value  payments associated with financial market and other commercial activities  in the United States. Fedwire is generally the system used to transfer  payments for securities between the banks used by the clearing  organization and market participants. Another large dollar transfer system  is the Clearing House Inter-bank Payments System (CHIPS). CHIPS is a  system for payment transfers, particularly for those U.S. dollar payments  relating to foreign exchange and other transactions between banks in the  United States and in other countries.
section_title: Certain Market Participants Are Critical to Overall Functioning of the Securities Markets
paragraphs: Although thousands of entities are active in the U.S. securities markets,  certain key participants are critical to the ability of the markets to function.  Although multiple markets exist for trading stocks or stock options, some  are more important than others as a result of the products they offer or the  functions they perform. For example, an exchange that attracts the greatest  trading volume may act as a price setter for the securities it offers, and the  prices for trades that occur on that exchange are then used as the basis for  trades in other markets that offer those same securities. On June 8, 2001,  when a software malfunction halted trading on NYSE, the regional  exchanges also suspended trading although their systems were not  affected. Other market participants are critical to overall market  functioning because they consolidate and distribute price quotations or  information on executed trades. Markets also cannot function without the  activities performed by the clearing organizations; and in some cases, only  one clearing organization exists for particular products.
In contrast, disruptions at other participants may have less severe impacts  on the ability of the markets to function. For example, many of the options  traded on the Chicago Board Options Exchange are also traded on other  U.S. options markets. Thus if this exchange was not operational, investors  would still be able to trade these options on the other markets, although  certain proprietary products, such as options on selected indexes, might be  unavailable temporarily.
Other participants may be critical to the overall functioning of the markets  only in the aggregate. Investors can choose to use any one of thousands of  broker-dealers registered in the United States. If one of these firms is  unable to operate, its customers may be inconvenienced or unable to trade,  but the impact on the markets as a whole may just be a lower level of  liquidity or reduced price competitiveness. But a small number of large  broker-dealers account for sizeable portions of the daily trading volume on  many exchanges and if several of these large firms are unable to operate,  the markets might not have sufficient trading volume to function in an  orderly or fair way.
section_title: Various Regulators Oversee Securities Market Participants, but Approaches and Regulatory Goals Vary
paragraphs: Several federal organizations oversee the various securities market  participants. The Securities and Exchange Commission (SEC) regulates the  stock and options exchanges and the clearing organizations for those  products. In addition, SEC regulates the broker-dealers that trade on these  markets and other participants, such as mutual funds, which are active  investors. The exchanges also have responsibilities as self-regulatory  organizations (SRO) for ensuring that their participants comply with the  securities laws and the exchanges’ own rules.
SEC or one of the depository institution regulators oversees participants in  the government securities market, but Treasury also plays a role. Treasury  issues rules pertaining to that market, but SEC or the bank regulators are  responsible for conducting examinations to ensure that these rules are  followed.
Several federal organizations have regulatory responsibilities over banks  and other depository institutions, including those active in the securities  markets. The Federal Reserve oversees bank holding companies and state- chartered banks that are members of the Federal Reserve System. The  Office of the Comptroller of the Currency (OCC) examines nationally  chartered banks.
Securities and banking regulators have different regulatory missions and  focus on different aspects of the operations of the entities they oversee.  Because banks accept customer deposits and use those funds to lend to  borrowers, banking regulators focus on the financial soundness of these  institutions to reduce the likelihood that customers will lose their deposits.
Poor economic conditions or bank mismanagement have periodically led to  extensive bank failures and customer losses in the United States. As a  result, banking and the other depository institution regulators issue  guidance and conduct examinations over a wide range of financial and  operational issues pertaining to these institutions, such as what  information security steps these institutions have taken to minimize  unauthorized access to their systems and what business continuity  capabilities they have.
In contrast, securities regulators have a different mission and focus on  other aspects of the operations of the entities they oversee. Securities  regulation in the United States arose with the goal of protecting investors  from abusive practices and ensuring that they were treated fairly. To  achieve this, SEC and the exchanges, which act as self regulatory  organizations (SRO) to oversee their broker-dealer members, focus  primarily on monitoring securities market participants to ensure that the  securities laws are not being violated; for example, restricting insider  trading or requiring companies issuing securities to completely and  accurately disclose their financial condition. As a result, few securities  regulations specifically address exchange and broker-dealer operational  issues, and securities regulators have largely considered the conduct of  such operations to be left to the business decisions of these organizations.
section_title: Telecommunications and Information Technology Are Vital to Securities Markets
paragraphs: Information technology and telecommunications are vital to the securities  markets and the banking system. Exchanges and markets rely on  information systems to match orders to buy and sell securities for millions  of trades. They also use such systems to instantaneously report trade  details to market participants in the United States and around the world.  Information systems also compile and compare trading activity and  determine all participants’ settlement obligations. The information  exchanged by these information systems is transmitted over various types  of telecommunications technology, including fiber optic cable.
Broker-dealers also make extensive use of information technology and  communications systems. These firms connect not only to the networks of  the exchanges and clearing organizations but may also be connected to the  thousands of information systems or communications networks operated  by their customers, other broker-dealers, banks, and market data vendors.  Despite widespread use of information technology to transmit data,  securities market participants are also heavily dependent on voice  communications. Broker-dealers still use telephones to receive, place, and  confirm orders. Voice or data lines transmit the information for the system  that provides instructions for personnel on exchange floors. Fedwire and  CHIPS also rely heavily on information technology and communications  networks to process payments. Fedwire’s larger bank customers have  permanent network connections to computers at each of Fedwire’s data  centers, but smaller banks connect via dial-up modem. CHIPS uses fiber- optic networks and mainframe computers to transfer funds among its 54  member banks.
section_title: Financial Organizations Manage Operations Risks by Protecting Physical and Information Security and Business Continuity Planning
paragraphs: Because financial market participants’ operations could be disrupted by  damage to their facilities, systems, or networks, they often invest in  physical and information security protection and develop business  continuity capabilities to ensure they can recover from such damage. To  reduce the risk that facilities and personnel would be harmed by  individuals or groups attempting unauthorized entry, sabotage, or other  criminal acts, market participants invest in physical security measures  such as guards or video monitoring systems. Market participants also  invest in information security measures such as firewalls, which reduce the  risk of damage from threats such as hackers or computer viruses. Finally,  participants invest in business continuity capabilities, such as backup  locations, that can further reduce the risk that damage to primary facilities  will disrupt an organization’s ability to continue operating.
section_title: Objectives, Scope, and Methodology
paragraphs: To describe the impact of the September 11, 2001, attacks on the financial  markets and the extent to which organizations had been prepared for such  events, we reviewed studies of the attacks’ impact by regulators and  private organizations. We also obtained documents and interviewed staff  from over 30 exchanges, clearing organizations, broker-dealers, banks, and  payment system processors, including organizations located in the vicinity  of the attacks and elsewhere. We toured damaged facilities and discussed  the attacks’ impact on telecommunications and power infrastructure with  three telecommunications providers (Verizon, AT&T, and WorldCom) and  Con Edison, a power provider. Finally, we discussed the actions taken to  stabilize the markets and facilitate their reopening with financial market  regulators.
To determine how financial market organizations were attempting to  reduce the risk that their operations could be disrupted, we selected 15  major financial market organizations that included many of the most active  participants, including 7 stock and options exchanges, 3 clearing and  securities processing organizations, 3 ECNs, and 2 payment system  processors. For purposes of our analysis, we also categorized these  organizations into two groups: seven whose ability to operate is critical to  the overall functioning of the financial markets and eight for whom  disruptions in their operations would have a less severe impact on the  overall markets. We made these categorizations by determining whether  viable immediate substitutes existed for the products or services the  organizations offer or whether the functions they perform were critical to  the overall markets' ability to function. To maintain the organizations’  security and the confidentiality of proprietary information, we agreed with  these organizations that we would not discuss how they were affected by  the attacks or how they were addressing their risks through physical and  information security and business continuity efforts in a way that could  identify them. However, to the extent that information about these  organizations is already publicly known, we sometimes name them in the  report.
To determine what steps these 15 organizations were taking to reduce the  risks to their operations from physical attacks, we conducted on-site  “walkthroughs” of these organizations’ primary facilities, reviewed their  security policies and procedures, and met with key officials responsible for  physical security to discuss these policies and procedures. We compared  these policies and procedures to 52 standards developed by the  Department of Justice for federal buildings. Based on these standards, we  evaluated these organizations’ physical security efforts across several key  operational elements, including measures taken to secure perimeters,  entryways, and interior areas and whether organizations had conducted  various security planning activities.
To determine what steps these 15 organizations were taking to reduce the  risks to their operations from electronic attacks, we reviewed the security  policies of the organizations we visited and reviewed documentation of  their system and network architectures and configurations. We also  compared their information security measures to those recommended for  federal organizations in the Federal Information System Controls Audit  Manual (FISCAM). Using these standards, we attempted to determine  through discussions and document reviews how these organizations had  addressed various key operational elements for information security,  including how they controlled access to their systems and detected  intrusions, what responses they made when such intrusions occurred, and  what assessments of their systems’ vulnerabilities they had performed.
To determine what steps these 15 organizations had taken to ensure they  could resume operations after an attack or other disaster, we discussed  their business continuity plans (BCP) with staff and toured their primary  facilities and the backup facilities they maintained. In addition, we  reviewed their BCPs and assessed them against practices recommended  for federal and private-sector organizations, including FISCAM, bank  regulatory guidance, and the practices recommended by the Business  Continuity Institute. Comparing these standards with the weaknesses  revealed in some financial market participants’ recovery efforts after the  September 2001 attacks, we determined how these organizations’ BCPs  addressed several key operational elements. Among the operational  elements we considered were the existence and capabilities of backup  facilities, whether the organizations had procedures to ensure the  availability of critical personnel and telecommunications, and whether they  completely tested their plans. In evaluating these organizations’ backup  facilities, we attempted to determine whether these organizations had  backup facilities that would allow them to recover from damage to their  primary sites or from damage or inaccessibility resulting from a wide-scale  disaster. We also met with staff of several major banks and securities firms  to discuss their efforts to improve BCPs. We also reviewed results of a  survey by the NASD—which oversees broker-dealer members of  NASDAQ—that reported on the business continuity capabilities of 120 of  its largest members and a random selection of 150 of approximately 4,000  remaining members.
To assess how the financial regulators were addressing physical security,  electronic security, and business continuity planning at the financial  institutions they oversee, we met with staff from SEC, the Federal Reserve,  OCC, and representatives of the Federal Financial Institutions Examination  Council. In addition, we met with NYSE and NASD staff responsible for  overseeing their members’ compliance with the securities laws. At SEC, we  also collected data on the examinations SEC had conducted of exchanges,  clearing organizations, and ECNs since 1995 and reviewed the examiners’  work program and examination reports for the 10 examinations completed  between July 2000 and August 2002. In addition, we reviewed selected SEC  and NYSE examinations of broker-dealers.
To determine how the financial markets were being addressed as part of  the United States’ critical infrastructure protection efforts, we reviewed  previously completed GAO work, met with staff from Treasury and  representatives of the Financial and Banking Information Infrastructure  Committee (FBIIC), which is undertaking efforts to ensure that critical  assets in the financial sector are protected.   We also discussed initiatives to  improve responses to future crises and improve the resiliency of the  financial sector and its critical telecommunications services with  representatives of industry trade groups, including the Bond Market  Association and the Securities Industry Association, as well as regulators,  federal telecommunications officials, telecommunications providers, and  financial market participants. The results of this work are presented in  appendix II.
We conducted our work in various U.S. cities from November 2001 to  October 2002 in accordance with generally accepted government auditing  standards.
section_title: September 11 Attacks Severely Disrupted U.S. Financial Markets
paragraphs: The terrorist attacks on September 11, 2001, resulted in significant loss of  life and extensive property and other physical damage, including damage to  the telecommunications and power infrastructure serving lower  Manhattan. Because many financial market participants were concentrated  in the area surrounding the World Trade Center, U.S. financial markets  were severely disrupted. Several key broker-dealers experienced extensive  damage, and the stock and options markets were closed for the longest  period since the 1930s. The markets for government securities and money  market instruments were also severely disrupted as several key  participants in these markets were directly affected by the attacks.  However, financial market participants, infrastructure providers, and  regulators made tremendous efforts to successfully reopen these markets  within days. Regulators also took various actions to facilitate the reopening  of the markets, including granting temporary relief from regulatory  reporting and other requirements and providing funds and issuing  securities to ensure that financial institutions could fund their operations.  The impact on the banking and payments systems was less severe, as the  primary operations of most banks and payment systems processors were  located outside of the area affected by the attacks, or because they had  fully operational backup facilities in other locations. Although many  factors affected the ability of the markets to resume operations, the attacks  also revealed limitations in many participants’ BCPs for addressing such a  widespread disaster. These factors included not having backup facilities  that were sufficiently geographically dispersed or comprehensive enough  to conduct all critical operations, unanticipated loss of  telecommunications service, and difficulties in locating staff and  transporting them to new facilities.
subsections: section_title: Attacks Caused Extensive Damage and Loss of Life and Created Difficult Conditions That Impeded Recovery Efforts
paragraphs: On September 11, 2001, two commercial jet airplanes were hijacked by  terrorists and flown into the twin towers of the World Trade Center. Within  hours, the two towers completely collapsed, resulting in the loss of four  other buildings that were part of the World Trade Center complex. As  shown in figure 2, the attacks damaged numerous structures in lower  Manhattan.
The attacks caused extensive property damage. According to estimates by  the Securities Industry Association, the total cost of the property damages  ranges from $24 to $28 billion. According to one estimate, the damage to  structures beyond the immediate World Trade Center area extended across  16 acres. The six World Trade Center buildings that were lost accounted for  over 13 million square feet of office space, valued at $5.2 to $6.7 billion.  One of these buildings was 7 World Trade Center, which was a 46-story  office building directly to the west of the two towers. It sustained damage  as a result of the attacks, burned for several hours, and collapsed around  5:00 p.m. on September 11, 2001. An additional nine buildings containing  about 15 million square feet of office space were substantially damaged and  were expected to require extensive and lengthy repair before they could be  reoccupied. Sixteen buildings with about 10 million square feet of office  space sustained relatively minor damage and will likely be completely  reoccupied. Finally, another 400 buildings sustained damage primarily to  facades and windows. A study by an insurance industry group estimated  that the total claims for property, life, and other insurance would exceed  $40 billion. In comparison, Hurricane Andrew of 1992 caused an estimated  $15.5 billion in similar insurance claims.
The loss of life following the attacks on the World Trade Center was also  devastating with the official death toll for the September 11 attacks  reaching 2,795, as of November 2002. Because of the concentration of  financial market participants in the vicinity of the World Trade Center, a  large percentage of those killed were financial firm employees. Excluding  the 366 members of the police and fire departments and the persons on the  airplanes, the financial industry’s loss represented over 74 percent of the  total civilian casualties in the World Trade Center attacks. Four firms  accounted for about a third of the civilian casualties, and 658 were  employees of one firm—Cantor Fitzgerald, a key participant in the  government securities markets. The loss of life also exacted a heavy  psychological toll on staff that worked in the area, who both witnessed the  tragedy and lost friends or family. Representatives of several organizations  we met with told us that one of the difficulties in the aftermath of the  attacks was addressing the psychological impact of the event on staff. As a  result, individuals attempting to restore operations often had to do so  under emotionally traumatic conditions.
The dust and debris from the attacks and the subsequent collapse of the  various World Trade Center structures covered an extensive area of lower  Manhattan, up to a mile beyond the center of the attacks, as shown in figure  3.
Figures 4 and 5 include various photographs that illustrate the damage to  buildings from the towers’ collapse and from the dust and debris that  blanketed the surrounding area.
This dust and debris created serious environmental hazards that resulted in  additional damage to other facilities and hampered firms’ ability to restore  operations in the area. For example, firms with major data processing  centers could not operate computer equipment until the dust levels had  been substantially reduced because of the sensitivity of this equipment to  dust contamination. In addition, dust and other hazardous materials made  working conditions in the area difficult and hazardous. According to staff  of one of the infrastructure providers with whom we met, the entire area  near the World Trade Center was covered with a toxic dust that contained  asbestos and other hazardous materials.
Restrictions on physical access to lower Manhattan, put into place after the  attacks, also complicated efforts to restore operations. To facilitate rescue  and recovery efforts and maintain order, the mayor ordered an evacuation  of lower Manhattan, and the New York City Office of Emergency  Management restricted all pedestrian and vehicle access to most of this  area from September 11 through September 13, 2001. During this time,  access to the area was only granted to persons with the appropriate  credentials.   Federal and local law enforcement agencies also restricted  access because of the potential for additional attacks and to facilitate  investigations at the World Trade Center site. Figure 6 shows the areas with  access restrictions in the days following the attacks.
Some access restrictions were lifted beginning September 14, 2001;  however, substantial access restrictions were in place through September  18. From September 19, most of the remaining restrictions were to cordon  off the area being excavated and provide access for heavy machinery and  emergency vehicles.
section_title: Damage from Attacks Significantly Disrupted Telecommunications and Power
paragraphs: The September 11 terrorist attacks extensively damaged the  telecommunications infrastructure serving lower Manhattan, disrupting  voice and data communications services throughout the area. (We discuss  the impact of the attacks on telecommunications infrastructure and  telecommunications providers’ recovery efforts in more detail in appendix  I of this report.) Most of this damage occurred when 7 World Trade Center,  itself heavily damaged by the collapse of the twin towers, collapsed into a  major telecommunications center at 140 West Street operated by Verizon,  the major telecommunications provider for Manhattan. The collateral  damage inflicted on that Verizon central office significantly disrupted local  telecommunications services to approximately 34,000 businesses and  residences in the surrounding area, including the financial district.  Damage to the facility was compounded when water from broken mains  and fire hoses flooded cable vaults located in the basement of the building  and shorted out remaining cables that had not been directly cut by damage  and debris. As shown in figure 7, the damage to this key facility was  extensive.
Because of the damage to Verizon facilities and equipment, significant  numbers of customers lost telecommunications services for extended  periods. When Verizon’s 140 West Street central office was damaged, about  182,000 voice circuits, more than 1.6 million data circuits, almost 112,000  private branch exchange (PBX) trunks, and more than 11,000 lines serving  Internet service providers were lost. As shown in figure 8, this central  office served a large part of lower Manhattan.
The attacks also damaged other Verizon facilities and affected customers in  areas beyond that served directly from the Verizon West Street central  office. Three other Verizon switches in the World Trade Center towers and  in 7 World Trade Center were also destroyed in the attacks. Additional  services were disrupted because 140 West Street also served as a transfer  station on the Verizon network for about 2.7 million circuits carrying data  traffic that did not originate or terminate in that serving area, but that  nevertheless passed through that particular physical location. For example,  communications services provided out of the Verizon Broad Street central  office that passed through West Street were also disrupted until new  cabling could be put in place to physically carry those circuits around the  damaged facility. As a result, a total of about 4.4 million Verizon data  circuits had to be restored.
Other telecommunications carriers that serviced customers in the affected  area also experienced damage and service disruptions. For example, in 140  West Street, 30 telecommunications providers had equipment that linked  their networks to Verizon. Other firms lost even more equipment than  Verizon. For example, AT&T lost a key transmission facility that serviced  its customers in lower Manhattan and had been located in one of the World  Trade Center towers.
The attacks also caused major power outages in lower Manhattan. Con  Edison, the local power provider, lost three power substations and more  than 33 miles of cabling; total damage to the power infrastructure was  estimated at $410 million. As a result, more than 13,000 Con Edison  business customers lost power, which required them to either relocate  operations or use alternative power sources such as portable generators.
To restore telecommunications and power, service providers had to  overcome considerable challenges. Access restrictions made this work  more difficult—staff from WorldCom told us that obtaining complete  clearance through the various local, state, and federal officials, including  the National Guard, took about 2 days. In some cases, environmental and  other factors also prevented restoration efforts from beginning. According  to Verizon staff, efforts to assess the damage and begin repairs on 140 West  Street initially were delayed by concerns over the structural integrity of the  damaged facility and other nearby buildings; several times staff had to halt  assessment and repair efforts because government officials ordered  evacuations of the building.
In some cases, infrastructure providers employed innovative solutions to  restore telecommunications and power quickly. For example, these  providers placed both telecommunications and power cables that are  normally underground directly onto the streets and covered them with  temporary plastic barriers. Con Edison repair staff also had tanks of liquid  nitrogen placed on street corners so that their employees could freeze  cables, which makes them easier to cut when making repairs. To work  around the debris that blocked access to 140 West, Verizon staff ran cables  over the ground and around damaged cabling to quickly restore services.  Because of damage to the reinforced vault that previously housed the  cables at Verizon’s facility, a new cable vault was reconstructed on the first  floor, and cables were run up the side of the building to the fifth and eighth  floors, as shown in figure 9.
section_title: Attacks Severely Affected Financial Markets but Heroic Efforts Were Made to Restore Operations
paragraphs: Although the facilities of the stock and options exchanges and clearing  organizations in lower Manhattan were largely undamaged by the attacks,  many market participants were affected by the loss of telecommunications  and lack of access to lower Manhattan. As a result, many firms, including  some of the broker-dealers responsible for significant portions of the  overall securities market trading activity, were forced to relocate  operations to backup facilities and alternative locations. To resume  operations, these new facilities had to be prepared for trading and provided  with sufficient telecommunications capacity. Some firms had to have  telecommunications restored although they thought they had redundant  communications services. Regulators and market participants delayed the  opening of the stock and options market until September 17, until the key  broker-dealers responsible for large amounts of market liquidity were able  to operate and telecommunications had been tested.
subsections: section_title: Most Securities Exchanges and Market Support Organizations Were Not Directly Damaged
paragraphs: Although several securities exchanges and market support organizations  were located in the vicinity of the attacks, most did not experience direct  damage. The NYSE, Depository Trust and Clearing Corporation, Securities  Industry Automation Corporation (SIAC), International Securities  Exchange, and the Island ECN all had important facilities located in close  proximity to the World Trade Center, but none of these organizations’  facilities were damaged.   The American Stock Exchange (Amex) was the  only securities exchange that experienced incapacitating damage. Amex  was several hundred feet from the World Trade Center towers, but  sustained mostly broken windows and damage to some offices. However,  its drainage and ventilation systems were clogged by dust and debris and  the building lost power, telephones, and access to water and steam. The  loss of steam and water coupled with the inadequate drainage and  ventilation meant that Amex computer systems could not run due to a lack  of air conditioning. As a result, the Amex building was not cleared for  reoccupation until October 1, 2001, after inspectors had certified the  building as structurally sound and power and water had been fully  restored. Although the remaining exchanges were not damaged, U.S. stock  and options exchanges nationwide closed the day of the attacks and did not  reopen until September 17, 2001. However, regulators and market  participants acknowledged that if the major exchanges or clearing  organizations had sustained damage, trading in the markets would have  likely taken longer to resume.
section_title: Damage to Financial Institutions’ Facilities and Telecommunications Forced Relocations and Made Recovery Efforts Challenging
paragraphs: Although most exchanges and market support organizations were not  damaged by the attacks, several key firms with substantial operations in  the area sustained significant facilities damage. As a result of this damage  and the inability to access the area in the days following the attacks, many  financial institution participants had to relocate their operations, in some  cases using locations not envisioned by their BCPs. They then faced the  challenge of recreating their key operations and obtaining sufficient  telecommunications services at these new locations. For example, one  large broker-dealer with headquarters that had been located across from  the World Trade Center moved operations to midtown Manhattan, taking  over an entire hotel. To resume operations, firms had to obtain computers  and establish telecommunications lines in the rooms that were converted  to work spaces. Another large broker-dealer whose facilities were damaged  by the attacks attempted to reestablish hundreds of direct lines to its major  customers after relocating operations to the facilities of a recently  purchased broker-dealer subsidiary in New Jersey. The simultaneous  relocation of so many firms meant that they also had to establish  connections to the new operating locations of other organizations.  Although Verizon managers were unable to estimate how much of its  restoration work in the days following the attacks specifically addressed  such needs, they told us that considerable capacity was added to the New  Jersey area to accommodate many of the firms that relocated operations  there, including financial firms.
Restoring operations often required innovative approaches. According to  representatives of the exchanges and other financial institutions we spoke  with, throughout the crisis financial firms that are normally highly  competitive instead exhibited a high level of cooperation. In some cases,  firms offered competitors facilities and office space. For example, traders  who normally traded stocks on the Amex floor obtained space on the  trading floor of NYSE, and Amex options traders were provided space at  the Philadelphia Stock Exchange. In some cases, innovative approaches  were used by the exchanges and utilities to restore lost connectivity to  their customers. For example, technicians at the Island ECN created virtual  private network connections for those users whose services were  disrupted. Island also made some of its trading applications available to its  customers through the Internet. In another example, SIAC, which  processes trades for NYSE and the American Stock Exchange, worked  closely with its customers to reestablish their connectivity, reconfiguring  customers’ working circuits that had been used for testing or clearing and  settlement activities to instead transmit data to SIAC’s trading systems.
The Bond Market Association, the industry association representing  participants in the government and other debt markets, and the Securities  Industry Association (SIA), which represents participants in the stock  markets, played critical roles in reopening markets. Both associations  helped arrange daily conference calls with market participants and  regulators to address the steps necessary to reopen the markets. At times,  hundreds of financial industry officials were participating in these calls.  These organizations also made recommendations to regulators to provide  some relief to their members so that they could focus on restoring their  operations. For example, the Bond Market Association recommended to its  members that they extend the settlement date for government securities  trades from the day following trade date (T+1) to five days after to help  alleviate some of the difficulties that were occurring in the government  securities markets. Through a series of conference calls with major banks  and market support organizations, SIA was instrumental in helping to  develop an industrywide consensus on how to resolve operational issues  arising from the damage and destruction to lower Manhattan and how to  mitigate operational risk resulting from the destruction of physical (that is,  paper) securities, which some firms had maintained for customers.
SEC also took actions to facilitate the successful reopening of the markets.  To allow market participants to focus primarily on resuming operations,  SEC issued rules to provide market participants temporary relief from  certain regulatory requirements. For example, SEC extended deadlines for  disclosure and reporting requirements, postponed the implementation date  for new reporting requirements, and temporarily waived some capital  regulation requirements. SEC implemented other relief measures targeted  toward stabilizing the reopened markets. For example, SEC relaxed rules  that restrict corporations from repurchasing their own shares of publicly  traded stock, and simplified registration requirements for airline and  insurance industries so that they could more easily raise capital.
section_title: Stock and Options Markets Opening Was Delayed until Sufficient Connectivity and Liquidity Existed
paragraphs: Partially because of the difficulties experienced by many firms in restoring  operations and obtaining adequate telecommunications service, the  reopening of the markets was delayed. Although thousands of broker- dealers may participate in the securities markets, staff at NYSE and  NASDAQ told us that a small number of firms account for the majority of  the trading volume on their markets. Many of those firms had critical  operations in the area affected by the attacks. For example, 7 of the top 10  broker-dealers ranked by capital had substantial operations in the World  Trade Center or the World Financial Center, across from the World Trade  Center. In the immediate aftermath of the attack, these and other firms  were either attempting to restore operations at their existing locations or at  new locations. In addition, financial market participant staff and the  financial regulators told us that their staffs did not want to return to the  affected area too soon to avoid interfering with the rescue and recovery  efforts. For example, the SEC Chairman told us that he did not want to  send 10,000 to 15,000 workers into lower Manhattan while the recovery  efforts were ongoing and living victims were still being uncovered.
Because of the considerable efforts required for broker-dealers to restore  operations, insufficient liquidity existed to open the markets during the  week of the attacks. According to regulators and exchange staff, firms able  to trade by Friday, September 14, accounted for only about 60 percent of  the market’s normal order flow. As a result, securities regulators, market  officials, and other key participants decided that, until more firms were  able to operate normally, insufficient liquidity existed in the markets.  Opening the markets with some firms but not others was also viewed as  unfair to many of the customers of the affected firms. Although  institutional clients often have relationships with multiple broker-dealers,  smaller customers and individual investors usually do not; thus, they may  not have been able to participate in the markets under these  circumstances.
In addition, connectivity between market participants and exchanges had  not been tested. For this reason, it was unclear how well the markets would  operate when trading resumed because so many critical  telecommunication connections were damaged in the attacks and had been  either repaired or replaced. Staff from the exchanges and market  participants told us that the ability to conduct connectivity testing prior to  the markets reopening was important. Many firms experienced technical  difficulties in getting the new connections they had obtained to work  consistently as telecommunication providers attempted to restore  telecommunications service. According to officials at one exchange,  restoring connections to its members was difficult because existing or  newly restored lines that were initially operational would erratically lose  their connectivity throughout the week following September 11.  Representatives of the exchanges and financial regulators with whom we  met told us that opening the markets but then having to shut them down  again because of technical difficulties would have greatly reduced investor  confidence.
Because of the need to ensure sufficient liquidity and a stable operating  environment, market participants and regulators decided to delay the  resumption of stock and options trading until Monday, September 17. This  delay allowed firms to complete their restoration efforts and use the  weekend to test connectivity with the markets and the clearing  organizations. As a result of these efforts, the stock and options markets  reopened on September 17 and traded record volumes without significant  operational difficulties.
section_title: Disruptions in Government Securities and Money Markets Severely Affected Clearance and Settlement, Liquidity, and Trade Volumes
paragraphs: The attacks also severely disrupted the markets for government securities  and money market instruments primarily because of the impact on the  broker-dealers that trade in the market and on one of the key banks that  perform clearing functions for these products. According to regulatory  officials, at the time of the attacks, eight of the nine IDBs, which provide  brokerage services to other dealers in government securities, had  operations that were severely disrupted following the attacks. The most  notable was Cantor Fitzgerald Securities, whose U.S. operations had been  located on several of the highest floors of one of the World Trade Center  towers. Because much of the trading in the government securities market  occurs early in the day, the attacks and subsequent destruction of the  towers created massive difficulties for this market. When these IDBs’  facilities were destroyed, the results of trading, including information on  which firms had purchased securities and which had sold, also were largely  lost. These trades had to be reconstructed from the records of the dealers  who had conducted trades with the IDBs that day. In addition, with the loss  of their facilities, most of the primary IDBs were not able to communicate  with the Government Securities Clearing Corporation (GSCC), which also  complicated the clearing and settlement of these trades. Staff from  financial market participants told us that reconciling some of these  transactions took weeks, and in some cases, months.
Two banks—the Bank of New York (BONY) and JP Morgan Chase—were  the primary clearing banks for government securities. Clearing banks are  essentially responsible for transferring funds and securities for their dealer  and other customers that purchase or sell government securities. For  trades cleared through GSCC, the clearing organization for these  instruments, instructs its dealer members and the clearing banks as to the  securities and associated payments to be transferred to settle its members’  net trade obligations.
As a result of the attacks, BONY and its customers experienced  telecommunications and other problems that contributed to the disruption  in the government securities market because it was the clearing bank for  many major market participants and because it maintained some of GSCC’s  settlement accounts.   BONY had to evacuate four facilities including its  primary telecommunications data center and over 8,300 staff, because they  were located near the World Trade Center.
At several of these facilities, BONY conducted processing activities as part  of clearing and settling government securities transactions on behalf of its  customers and GSCC. The communication lines between BONY and the  Fedwire systems for payment and securities transfers, as well as those  between BONY and its clients, were critical to BONY’s government  securities operations. Over these lines, BONY transmitted data with  instructions to transfer funds and securities from its Federal Reserve  accounts to those of other banks for transactions in government securities  and other instruments. BONY normally accessed its Federal Reserve  accounts from one of the lower Manhattan facilities that had to be  abandoned. In the days following the attacks, BONY had difficulties in  reestablishing its Fedwire connections and processing transactions.   In  addition, many BONY customers also had to relocate and had their own  difficulties in establishing connections to the BONY backup site. As a result  of these internal processing problems and inability to communicate with its  customers, BONY had problems determining what amounts should be  transferred on behalf of the clients for whom it performed clearing  services. For example, by September 12, 2001, over $31 billion had been  transferred to BONY’s Federal Reserve account for GSCC, but because  BONY could not access this account, it could not transfer funds to which  its clients were entitled. BONY was not able to establish connectivity with  GSCC and begin receiving and transmitting instructions for payment  transfers until September 14, 2001.
The problems at the IDBs and BONY affected the ability of many  government securities and money markets participants to settle their  trades. Before a trade can be cleared and settled, the counterparties to the  trade and the clearing banks must compare trade details by exchanging  messages to ensure that each is in agreement on the price and amount of  securities traded. To complete settlement, messages then must be  exchanged between the parties to ensure that the funds and ownership of  securities are correctly transferred. If trade information is not correct and  funds and securities are not properly transferred, the trade will be  considered a “fail.” As shown in figure 10, failed transactions increased  dramatically, rising from around $500 million per day to over $450 billion  on September 12, 2001. The level of fails also stayed high for many days  following the attacks, averaging about $100 billion daily through September  28.
The problems in the government securities markets also created liquidity  problems for firms participating in and relying on these markets to fund  their operations. Many firms, including many large broker-dealers, fund  their operations using repurchase agreements, or repos, in which one party  sells government securities to another party and agrees to repurchase  those securities on a future date at a fixed price.   Because repos are used  to finance firms’ daily operations, many of these transactions are executed  before 9:00 a.m. As a result, by the time the attacks occurred on September  11, over $500 billion in repos had been transacted. With so many IDB  records destroyed, many of the transactions could not be cleared and  settled, causing many of these transactions to fail. As a result, some firms  that relied on this market as a funding source experienced major funding  shortfalls.
Although trading government securities was officially resumed within 2  days of the attacks, overall trading activity was low for several days. For  example, as shown in figure 11, trading volumes went from around $500  billion on September 10 to as low as $9 billion on September 12, 2001.    Similarly, repo activity fell from almost $900 billion on September 10 to  $145 billion on September 13.
The attacks also disrupted the markets for commercial paper, which are  short-term securities issued by financial and other firms to raise funds.  According to clearing organization officials, the majority of commercial  paper redemptions—when the investors that originally purchased the  commercial paper have their principal returned-- that were scheduled to be  redeemed on September 11 and September 12 were not paid until  September 13. Firms that relied on these securities to fund their operations  had to obtain other sources of funding during this period.
The Federal Reserve took several actions to mitigate potential damage to  the financial system resulting from liquidity disruptions in these markets.  Banking regulatory staff told us that the attacks largely resulted in a  funding liquidity problem rather than a solvency crisis for banks. Thus, the  challenge they faced was ensuring that banks had adequate funds to meet  their financial obligations. The settlement problems also prevented broker- dealers and others from using the repo markets to fund their daily  operations. Soon after the attacks, the Federal Reserve announced that it  would remain open to help banks meet their liquidity needs. Over the next  4 days, the Federal Reserve provided about $323 billion to banks through  various means to overcome the problems resulting from unsettled  government securities trades and financial market dislocations. For  example, from September 11 through September 14, the Federal Reserve  loaned about $91 billion to banks through its discount window, in contrast  to normal lending levels of about $100 million. It also conducted securities  purchase transactions and other open market operations of about $189  billion to provide needed funds to illiquid institutions. Had these actions  not been taken, some firms unable to receive payments may not have had  sufficient liquidity to meet their other financial obligations, which could  have produced other defaults and magnified the effects of September 11  into a systemic solvency crisis.
Regulators also took action to address the failed trades resulting from the  attacks. From September 11 through September 13, the Federal Reserve  loaned $22 billion of securities from its portfolio to broker-dealers that  needed securities to complete settlements of failed trades. According to  Federal Reserve staff, the Federal Reserve subsequently reduced  restrictions on its securities lending that led to a sharp increase in  borrowings at the end of September 2001.   Treasury also played a role in  easing the failed trades and preventing a potential financial crisis by  conducting an unplanned, special issuance of 10-year notes to help address  a shortage of notes of this duration in the government securities markets.  Market participants typically use these securities as collateral for financing  or to meet settlement obligations.
To provide dollars needed by foreign institutions, the Federal Reserve also  conducted currency swaps with the Bank of Canada, the European Central  Bank, and the Bank of England. The swaps involved exchanging dollars for  the foreign currencies of these jurisdictions, with agreements to re- exchange amounts later. These temporary arrangements provided funds to  settle dollar-denominated obligations of foreign banks whose U.S.  operations were affected by the attacks.
The Federal Reserve, Federal Deposit Insurance Corporation, OCC, and the  Office of Thrift Supervision issued a joint statement after the attacks to  advise the institutions they oversee that any temporary declines in capital  would be evaluated in light of the institution’s overall financial condition.  The Federal Reserve also provided substantial amounts of currency so that  banks would be able to meet customer needs.
section_title: Impact of Attacks on the Banking and Payments Systems Was Less Severe
paragraphs: With a few exceptions, commercial banks were not as adversely affected as  broker- dealers by the attacks. Although some banks had some facilities  and operations in lower Manhattan, they were not nearly as geographically  concentrated as securities market participants. As discussed previously,  BONY was one bank with significant operations in the World Trade Center  area, but only a limited number of other large banks had any operations  that were affected. According to regulatory officials that oversee national  banks, seven of their institutions had operations in the areas affected by  the attacks.
Most payment system operations continued with minimal disruption. The  Federal Reserve Bank of New York (FRBNY) manages the Federal  Reserve’s Fedwire securities and payments transfer systems. Although the  FRBNY sustained damage to some telecommunications lines, Fedwire  continued processing transactions without interruption because the actual  facilities that process the transactions are not located in lower Manhattan.  However, Federal Reserve officials noted that some banks experienced  problems connecting to Fedwire because of the widespread damage to  telecommunications systems. Over 30 banks lost connectivity to Fedwire  because their data first went to the FRBNY facility in lower Manhattan  before being transmitted to Fedwire’s system’s processing facility outside  the area. However, most were able to reestablish connections through dial- up backup systems and some began reporting transfer amounts manually  using voice lines. Federal Reserve officials noted that normal volumes for  manually reported transactions were about $200–$400 million daily, but  from September 11 through September 13, 2001, banks conducted about  $151 billion in manually reported transactions. A major private-sector  payments system, CHIPS, also continued to function without operational  disruptions, although 19 of its members temporarily lost connectivity with  CHIPs in the aftermath of the attacks and had to reconnect from backup  facilities.
Retail payments systems, including check clearing and automated clearing  house transactions, generally continued to operate. However, the  grounding of air transportation did complicate and delay some check  clearing, since both the Federal Reserve and private providers rely on  overnight air delivery to transport checks between banks in which they are  deposited and banks from which they are drawn. Federal Reserve officials  said they were able to arrange truck transportation between some check  clearing offices until they were able to gain approval for their chartered air  transportation to resume several days later. According to Federal Reserve  staff, transporting checks by ground slowed processing and could not  connect all offices across the country. The staff said that the Federal  Reserve continued to credit the value of deposits to banks even when it  could not present checks and debit the accounts of paying banks. This  additional liquidity —normally less than $1 billion—peaked at over $47  billion on September 13, 2001.
section_title: Attacks Revealed Limitations in Financial Market Participants’ Business Continuity Capabilities
paragraphs: The terrorist attacks revealed that limits that existed in market  participants’ business continuity capabilities at the time of the attacks.  Based on our discussions with market participants, regulators, industry  associations and others, the BCPs of many organizations had been too  limited in scope to address the type of disaster that occurred. Instead,  BCPs had procedures to address disruptions affecting a single facility such  as power outages or fires at one building. For example, a 1999 SEC  examination report of a large broker-dealer that we reviewed noted that in  the event of an emergency this firm’s BCP called for staff to move just one- tenth of a mile to another facility. By not planning for wide-scale events,  many organizations had not invested in backup facilities that could  accommodate key aspects of their operations, including several of the large  broker-dealers with primary operations located near the World Trade  Center that had to recreate their trading operations at new locations.  Similarly, NYSE and several of the other exchanges did not have backup  facilities at the time of the attacks from which they could conduct trading.
The attacks also illustrated that some market participants’ backup facilities  were too close to their primary operations. For example, although BONY  had several backup facilities for critical functions located several miles  from the attacks, the bank also backed up some critical processes at  facilities that were only blocks away. According to clearing organization  and regulatory staff, one of the IDBs with facilities located in one of the  destroyed towers of the World Trade Center had depended on backup  facilities in the other tower.
Additionally, firms’ BCPs did not adequately take into account all necessary  equipment and other resources needed to resume operations as completely  and rapidly as possible. For example, firms that occupied backup facilities  or other temporary space found that they lacked sufficient space for all  critical staff or did not have all the equipment needed to conduct their  operations. Others found that their backup sites did not have the most  current versions of the software and systems that they use, which caused  some restoration problems. Some firms had contracted with third-party  vendors for facilities and equipment to conduct operations during  emergencies, but because so many firms were disrupted by the attacks,  some of these facilities were overbooked, and firms had to find other  locations in which to resume operations.
Organizations also learned that their BCPs would have to better address  human capital issues. For example, some firms had difficulties in locating  key staff in the confusion after the attacks. Others found that staff were not  able to reach their backup locations as quickly as their plans had  envisioned due to the closure of public transit systems, bridges, and roads.  Other firms had not planned for the effects of the trauma and grief on their  staff and had to provide access to counseling for those that were  overwhelmed by the events.
The attacks also revealed the need to improve some market participants’  business continuity capabilities for telecommunications. According to  broker-dealers and regulator staff with whom we spoke, some firms found  that after relocating their operations, they learned that their backup  locations connected to the primary sites of the organizations critical to  their operations but not to these organizations’ backup sites. Some  financial firms that did not have damaged physical facilities nonetheless  learned that their supporting telecommunications services were not as  diverse and redundant as they expected. Diversity involves establishing  different physical routes in and out of a building, and using different  equipment along those routes if a disaster or other form of interference  adversely affects one route. Redundancy involves having extra capacity  available, generally from more than one source, and also incorporates  aspects of diversity. Therefore, users that rely on telecommunications  services to support important applications try to ensure that those services  use facilities that are diverse and redundant so that no single point in the  communications path can cause all services to fail. Ensuring that carriers  actually maintain physically redundant and diverse telecommunications  services has been a longstanding concern within the financial industry. For  example, the President’s National Security Telecommunications Advisory  Committee in December 1997 reported, “despite assurances about diverse  networks from the carriers, a consistent concern among the financial  services industry was the trustworthiness of their telecommunications  diversity arrangements.”
This concern was validated following the September 11 attacks when firms  that thought they had achieved redundancy in their communications  systems learned that their network services were still disrupted. According  to regulators and financial market participants with whom we spoke, some  firms that made arrangements with multiple service providers to obtain  redundant service discovered that the lines used by their providers were  not diverse because they routed through the same Verizon switching  facility. Other firms that had mapped out their communications lines to  ensure that their lines flowed through physically diverse paths at the time  those services were first acquired found that their service providers had  rerouted some of those lines over time without their knowledge,  eliminating that assurance of diversity in the process.
section_title: Observations
paragraphs: The attacks demonstrated that the ability of U.S. financial markets to  remain operational after disasters depends to a great extent on the  preparedness of not only the exchanges and clearing organizations but also  the major broker-dealers and banks that participate in these markets. The  various financial markets were severely affected and the stock and options  exchanges were closed in the days following the attacks for various  reasons, including the need to conduct rescue operations. However, the  markets also remained closed because of the time required for several  major broker-dealers that normally provide the bulk of the liquidity for  trading in the stock, options, and government securities markets to become  operational. Although the attacks were of a nature and magnitude beyond  that previously imagined, they revealed the need to address limitations in  the business continuity capabilities of many organizations and to mitigate  the concentration of critical operations in a limited geographic area. Many  organizations will have to further assess how vulnerable their operations  are to disruptions and determine what capabilities they will need to  increase the likelihood of being able to resume operations after such  events.
section_title: Financial Market Participants Have Taken Actions to Reduce Risks of Disruption, but Some Limitations Remain
paragraphs: Since the attacks, exchanges, clearing organizations, ECNs, and payment  system processors implemented various physical and information security  measures and business continuity capabilities to reduce the risk that their  operations would be disrupted by attacks, but some organizations  continued to have limitations in their preparedness that increases their risk  of disruption. With threats to the financial markets potentially increasing,  organizations must choose how best to use their resources to reduce risks  by investing in protection against physical and electronic attacks for  facilities, personnel, and information systems and developing capabilities  for continuing operations. To reduce the risk of operations disruptions, the  15 financial market organizations—including the 7 critical ones—we  reviewed in 2002 had taken many steps since the attacks to protect their  physical facilities or information systems from attacks and had developed  plans for recovering from such disruptions. However, at the time we  conducted our review, 9 of the 15 organizations, including 2 we considered  critical to the functioning of the financial markets, had not taken steps to  ensure that they would have the staff necessary to conduct their critical  operations if the staff at their primary site were incapacitated—including 8  organizations that also had physical vulnerabilities at their primary sites.  Ten of the 15 organizations, including 4 of the critical organizations, also  faced increased risk of being unable to operate after a wide-scale  disruption because they either lacked backup facilities or had backup  facilities near their primary sites. Finally, although many of the 15  organizations had attempted to reduce their risks by testing some of their  risk reduction measures, only 3 were testing their physical security  measures, only 8 had recently assessed the vulnerabilities of their key  information systems, and only 7 had fully tested their BCPs.
subsections: section_title: In Climate of Increasing Risk, Organizations Often Have to Choose How to Best Use Resources
paragraphs: Faced with varying and potentially increasing threats that could disrupt  their operations, organizations must make choices about how to best use  their resources to both protect their facilities and systems and develop  business continuity capabilities. September 11, 2001, illustrated that such  attacks can have a large-scale impact on market participants. Law  enforcement and other government officials are concerned that public and  private sectors important to the U.S. economy, including the financial  markets, may be increasingly targeted by hostile entities that may have  increasing abilities to conduct such attacks. For example, the leader of the  al Qaeda organization was quoted as urging that attacks be carried out  against the “pillars of the economy” of the United States. Press accounts of  captured al Qaeda documents indicated that members of this organization  may be increasing their awareness and knowledge of electronic security  techniques and how to compromise and damage information networks and  systems, although the extent to which they could successfully conduct  sophisticated attacks has been subject to debate. A recent report on U.S.  foreign relations also notes that some foreign countries are accelerating  their efforts to be able to attack U.S. civilian communications systems and  networks used by institutions important to the U.S. economy, including  those operated by stock exchanges.
The physical threats that individual organizations could reasonably be  expected to face vary by type and likelihood of occurrence. For example,  events around the world demonstrate that individuals carrying explosive  devices near or inside facilities can be a common threat. More powerful  explosive attacks by vehicle are less common but still have been used to  devastating effect in recent years. Other less likely, but potentially  devastating, physical threats include attacks involving biological or  chemical agents such as the anthrax letter mailings that occurred in the  United States in 2001 and the release of a nerve agent in the Tokyo subway  in 1995.
Faced with the potential for such attacks, organizations can choose to  invest in a range of physical security protection measures to help manage  their risks. The Department of Justice has developed standards that  identify measures for protecting federal buildings from physical threats.  To reduce the likelihood of incurring damage from individuals or  explosives, organizations can physically secure perimeters by controlling  vehicle movement around a facility, using video monitoring cameras,  increasing lighting, and installing barriers. Organizations can also prevent  unauthorized persons or dangerous devices from entering their facilities by  screening people and objects, restricting lobby access, and only allowing  employees or authorized visitors inside. Organizations could also take  steps to prevent biological or chemical agents from contaminating facilities  by opening and inspecting mail and deliveries off-site. To protect sensitive  data, equipment, and personnel, organizations can also take steps to secure  facility interiors by using employee and visitor identification systems and  restricting access to critical equipment and utilities such as power and  telecommunications equipment.
Organizations can also reduce the risk of operations disruptions by  investing in measures to protect information systems. Information system  threats include hackers, who are individuals or groups attempting to gain  unauthorized access to networks or systems to steal, alter, or destroy  information. Another threat—known as a denial of service attack— involves flooding a system with messages that consume its resources and  prevent authorized users from accessing it. Information systems can also  be disrupted by computer viruses that damage data directly or degrade  system performance by taking over system resources. Information security  guidance used for reviews of federal organizations recommend that  organizations develop policies and procedures that cover all major systems  and facilities and outline the duties of those responsible for security.   To  prevent unauthorized access to networks and information systems,  organizations can identify and authenticate users by using software and  hardware techniques such as passwords, firewalls, and other filtering  devices. Organizations can also use monitoring systems to detect  unauthorized attempts to gain access to networks and information systems  and develop response capabilities for electronic attacks or breaches.
Investing in business continuity capabilities is another way that  organizations can reduce the risk that their operations will be disrupted.  According to guidance used by private organizations and financial  regulators, developing a sound BCP requires organizations to determine  which departments, business units, or functions are critical to operations.  The organizations should then prepare a BCP that identifies capabilities  that have to be in place, resources required, and procedures to be followed  for the organization to resume operations. Such capabilities can include  backup facilities equipped with the information technology hardware and  software that the organization needs to conduct operations. Alternatively,  organizations can replace physical locations or processes, such as trading  floors, with electronic systems that perform the same core functions. Many  organizations active in the financial markets are critically dependent on  telecommunications services for transmitting the data or voice traffic  necessary to operate. As a result, organizations would have to identify their  critical telecommunications needs and take steps to ensure that services  needed to support critical operations will be available after a disaster.  Finally, BCP guidance such as FISCAM, which provides standards for  audits of federal information systems, also recommends that organizations  have backup staff that can implement BCP procedures. To the extent that  an organization’s ability to resume operations depends on the availability of  staff with specific expertise, the organization has to maintain staff capable  of conducting its critical functions elsewhere.
Given that most organizations have limited resources, effectively managing  the risk of operations disruptions involves making trade-offs between  investing in protection of facilities, personnel, and systems or development  of business continuity capabilities. For example, organizations must weigh  the expected costs of operations disruptions against the expected cost of  implementing security protections, developing facilities, or implementing  other business continuity capabilities to ensure that they would be able to  resume operations after a disaster. Risk management guidance directs  organizations to identify how costly various types of temporary or  extended outages or disruptions would be to parts or all of their  operations. Such costs stem not only from revenues actually lost during the  outage, but also from potential lost income because of damage to the  organization’s reputation stemming from its inability to resume operations.  In addition to estimating the potential costs of disruptions, organizations  are advised to identify potential threats that could cause such disruptions  and estimate the likelihood of these events. By quantifying the costs and  probabilities of occurrence of various disruptions, an organization can then  better evaluate the amount and how to allocate the resources that it should  expend on either implementing particular protection measures or attaining  various business continuity capabilities. For example, an organization  whose primary site is located in a highly trafficked, public area may have  limited ability to reduce all of its physical security risks. However, such an  organization could reduce the risk of its operations being disrupted by  having a backup facility manned by staff capable of supporting its critical  operations or by cross-training other staff.
section_title: All Financial Market Organizations Were Taking Steps to Reduce the Risks of Operations Disruptions
paragraphs: The 15 exchanges, clearing organizations, ECNs, and payment system  processors we reviewed in 2002 had invested in various physical and  information protections and business continuity capabilities to reduce the  risk that their operations would be disrupted. Each of these 15  organizations had implemented physical security measures to protect  facilities and personnel. To establish or increase perimeter security, some  organizations had erected physical barriers around their facilities such as  concrete barriers, large flowerpots, or boulders. To reduce the likelihood  that its operations would be disrupted by vehicle-borne explosives, one  organization had closed off streets adjacent to its building and had guards  inspect all vehicles entering the perimeter. Some organizations were also  using electronic surveillance to monitor their facilities, with some  organizations having 24-hour closed circuit monitoring by armed guards.  Others had guards patrolling both the interior and exterior of their facilities  on a 24-hour basis. In addition, all of these organizations had taken  measures to protect the security of their interiors. For example, the  organizations required employee identification, electronic proximity cards,  or visitor screening.
All 15 organizations had taken measures to reduce the risk that electronic  threats would disrupt their operations. The securities markets already use  networks and information systems that reduce their vulnerability to  external intrusion in several ways. First, the securities exchanges and  clearing organizations have established private networks that transmit  traffic only to and from their members’ systems, which are therefore more  secure than the Internet or public telephone networks. Second, traffic on  the exchange and clearing organization networks uses proprietary message  protocols or formats, which are less vulnerable to the insertion of  malicious messages or computer viruses. Although rendering the securities  market networks generally less vulnerable, these features do not  completely protect them and the prominence of securities market  participants’ role in the U.S. economy means that their networks are more  likely to be targeted for electronic attack than some other sectors. The 15  organizations we reviewed in 2002 had generally implemented the elements  of a sound information security program, including policies and procedures  and access controls. Thirteen of the 15 organizations were also using  intrusion detection systems, and the remaining 2 had plans to implement or  were considering implementing such systems. All 15 of the organizations  also had procedures that they would implement in the event of systems  breaches, although the comprehensiveness of the incident response  procedures varied. For example, 2 organizations’ incident response plans  involved shutting down any breached systems, but lacked documented  procedures for taking further actions such as gathering evidence on the  source of the breach.
Developing business continuity capabilities is another way to reduce the  risk of operations disruptions, and all 15 of the organizations we reviewed  in 2002 had plans for continuing operations. These plans had a variety of  contingency measures to facilitate the resumption of operations. For  example, 11 organizations had backup facilities to which their staff could  relocate if disruptions occurred at the primary facility. One of these  organizations had three fully equipped and staffed facilities that could  independently absorb all operations in an emergency or disruption. In  some cases, organizations did not have backup facilities that could  accommodate their operations but had taken steps to ensure that key  business functions could be transferred to other organizations. For  example, staff at one exchange that lacked a backup facility said that most  of the products it traded were already traded on other exchanges, so  trading of those products would continue if its primary site was not  available. In addition, this exchange has had discussions with other  exchanges about transferring trading of proprietary products to the other  exchanges in an emergency situation. These organizations all had  inventoried critical telecommunications and had made arrangements to  ensure that they would continue to have service if primary lines were  damaged.
section_title: Some Financial Organizations Had Preparedness Limitations That Increased Their Risk of an Operations Disruption
paragraphs: Although all 15 organizations we reviewed had taken steps to address  physical and electronic threats and had BCPs to respond to disruptive  events, but at the time of our review many had limitations in their  preparedness that increased the risk of an operations disruption. Nine of  the 15 organizations, including 2 critical organizations, were at greater risk  of experiencing an operations disruption because their BCPs did not  address how they would recover if a physical attack on their primary  facility left a large percentage of their staff incapacitated. Although 5 of  these 9 organizations had backup facilities, they did not maintain staff  outside of their primary facility that could conduct all their critical  operations. Eight of the 9 organizations also had physical security  vulnerabilities at their primary sites that they either had not or could not  mitigate. For example, these organizations were unable to control  vehicular traffic around their facilities and thus were more exposed to  damage than those that did have such controls.
Most of the organizations we reviewed also had faced increased risk that  their operations would be disrupted by a wide-scale disaster. As of August  2002, all 7 of the critical organizations we reviewed had backup facilities,  including 3 whose facilities were hundreds of miles from their primary  facilities. For example, 1 organization had two data centers located about  500 miles apart, each capable of conducting the organization’s full scope of  operations in the event that one site failed. The organization also has a  third site that can take over the processing needed for daily operations on a  next-day basis. However, the backup facilities of the other four  organizations were located 2 to 5 miles from their primary sites. If a wide- scale disaster caused damage or made a region greater than these distances  inaccessible, these 4 organizations would be at greater risk for not being  able to resume operations promptly.
Many of the other 8 organizations also had faced increased risk that their  operations would be disrupted by wide-scale disasters. At the time we  conducted our review, 2 of the 8 organizations had backup facilities that  were hundreds of miles from their primary operations. The remaining 6  organizations faced increased risk of being disrupted by a wide-scale  disaster because 4 lacked backup facilities, while 2 organizations had  backup facilities that were located 4 to 10 miles from their primary  operations facilities. Of the 4 organizations that lacked a backup facility,  one had begun constructing a facility near its primary site.
Four of the organizations that lacked regionally dispersed backup facilities  told us that they had begun efforts to become capable of conducting their  operations at locations many miles from their current primary and backup  sites. For example, NYSE has announced that it is exploring the possibility  of creating a second active trading floor some miles from its current  location. In contrast to the backup trading location NYSE built in the  months following the attack, which would only be active should its current  primary facility become unusable, the exchange plans to move the trading  of some securities currently traded at its primary site to this new facility  and have both sites active each trading day. However, if the primary site  were damaged, the new site would be equipped to be capable of conducting  all trading. In December 2002, NYSE staff told us that they were still  evaluating the creation of this second active trading floor.
For the organizations that lacked backup facilities, cost was the primary  obstacle to establishing such capabilities. For example, staff at one  organization told us that creating a backup location for its operations  would cost about $25 million, or as much as 25 percent of the organization’s  total annual revenue. Officials at the 3 organizations without backup sites  noted that the products and services they provide to the markets are largely  duplicated by other organizations, so their inability to operate would have  minimal impact on the overall market’s ability to function.
Although cost can be a limiting factor, financial market organizations have  some options for creating backup locations that could be cost-effective. At  least one of the organizations we reviewed has created the capability of  conducting its trading operations at a site that is currently used for  administrative functions. By having a dual-use facility, the organization has  saved the cost of creating a completely separate backup facility. This  option also would seem well suited to broker-dealers, banks, and other  financial institutions because they frequently maintain customer service  call centers that have large numbers of staff that could potentially be  equipped with all or some of the systems and equipment needed for the  firm’s trading or clearing activities.
subsections: section_title: Some Financial Market Organizations Not Fully Testing Security Measures or Business Continuity Capabilities
paragraphs: Organizations can also minimize operations risk by testing their physical  and information security measures and business continuity plans, but we  found the 15 exchanges, clearing organizations, ECNs, and payment system  processors were not fully testing all these areas. In the case of physical  security, such assessments can include attempting to infiltrate a building or  other key facility such as a data processing center or assessing the integrity  of automated intrusion detection systems. In the case of information  security, such assessments can involve attempts to access internal systems  or data from outside the organization’s network or by using software  programs that identify, probe, and test systems for known vulnerabilities.  For both physical and information security, these assessments can be done  by the organization’s own staff, its internal auditors, or by outside  organizations, such as security or consulting firms.
The extent to which the 15 exchanges, clearing organizations, ECNs, and  payment system providers that we reviewed had tested their physical  security measures varied. Only 3 of the 7 critical financial organizations  routinely tested their physical security; the tests included efforts to gain  unauthorized access to facilities or smuggle fake weapons into buildings.
None of the remaining 8 organizations routinely tested the physical security  of their facilities.
To test their information security measures, all 7 of the critical  organizations had assessed network and systems vulnerabilities. We  considered an organization’s assessment current if it had occurred within  the 2 years prior to our visit, because system changes over time can create  security weaknesses, and advances in hacking tools can create new means  of penetrating systems. According to the assessments provided to us by  the 7 critical organizations, all had performed vulnerability assessments of  the information security controls they implemented over some of their key  trading or clearing systems within the last 2 years. However, these tests  were not usually done in these organizations’ operating environment but  instead were done on test systems or during nontrading hours. Seven of the  remaining 8 organizations we reviewed also had not generally had  vulnerability assessments of their key trading or clearing networks  performed with the 2 years prior to our review. However, in the last 2 years,  all 15 organizations had some form of vulnerability assessments performed  for their corporate or administrative systems, which they use to manage  their organization or operate their informational Web sites.
Most of the 7 organizations critical to overall market functioning were  conducting regular tests of their business continuity capabilities. Based on  our review, 5 of the 7 critical organizations had conducted tests of all  systems and procedures critical to business continuity. However, these  tests were not usually done in these organizations’ real-time environments.  Staff at one organization told us that they have not recently conducted live  trading from their backup site because of the risks, expense, and difficulty  involved. Instead, some tested their capabilities by switching over to  alternate facilities for operations simulations on nontrading days. One  organization tested all components critical to their operations separately  and over time, but it had not tested all aspects simultaneously. Of the 8  other financial market organizations we reviewed, only 2 had conducted  regular BCP tests. One organization, however, had an extensive disaster  recovery testing regimen that involved using three different scenarios:  simulating a disaster at the primary site and running its systems and  network from the backup site; simulating a disaster at the backup site and  running the systems and network from the primary site; and running its  systems and network from the consoles at the backup site with no staff in  the control room at the primary site.
Organizations also discovered the benefits of conducting such tests. For  example, because of lessons learned through testing, one organization  learned vital information about the capabilities of third-party applications,  identified the need to configure certain in-house applications to work at the  recovery site, installed needed peripheral equipment at the backup site,  placed technical documentation regarding third-party application  installation procedures at the backup site, and increased instruction on  how to get to the backup site if normal transportation routes were  unavailable. An official at this organization told us that with every test, they  expected to learn something about the performance of their BCP and  identify ways to improve it.
section_title: Observations
paragraphs: The exchanges, clearing organizations, ECNs, and payment system  providers that we reviewed had all taken various steps to reduce the risk  that their operations would be disrupted by physical or electronic attacks.  In general, the organizations we considered more critical to the overall  ability of the markets to function had implemented the most  comprehensive physical and information security measures and BCPs.  However, limitations in some organizations’ preparedness appeared to  increase the risks that their operations could be disrupted because they  had physical security vulnerabilities not mitigated with business continuity  capabilities. The extent to which these organizations had also reduced the  risk posed by a wide-scale disruption also varied. Because the importance  of these organizations’ operations to the overall markets varies, regulators  are faced with the challenge of determining the extent to which these  organizations should take additional actions to address these limitations to  reduce risks to the overall markets.
section_title: Financial Market Regulators Lack Recovery Goals for Trading and Could Strengthen Their Operations Risk Oversight
paragraphs: Although banking and securities regulators have begun to take steps to  prevent future disasters from causing widespread payment defaults, they  have not taken important actions that would better ensure that trading in  critical U.S. financial markets could resume smoothly and in a timely  manner after a major disaster. The three regulators for major market  participants, the Federal Reserve, OCC, and SEC are working jointly with  market participants to develop recovery goals and sound business  continuity practices that will apply to a limited number of financial market  organizations to ensure that these entities can clear and settle transactions  and meet their financial obligations after future disasters. However, the  regulators’ recovery goals and sound practices do not extend to  organizations’ trading activities or to the stock exchanges. The regulators  also had not developed complete strategies that identify where trading  could be resumed or which organizations would have to be ready to  conduct trading if a major exchange or multiple broker-dealers were  unlikely to be operational for an extended period. Individually, these three  regulators have overseen operations risks in the past. SEC has a program— the Automation Review Policy (ARP)—for reviewing exchanges and  clearing organizations efforts to reduce operations risks, but this program  faces several limitations. Compliance with the program is voluntary, and  some organizations have not always implemented important ARP  recommendations. In addition, market participants raised concerns over  the inexperience and insufficient technical expertise of SEC staff, and the  resources committed to the program limit the frequency of examinations.  Lacking specific requirements in the securities laws, SEC has not generally  examined operations risk measures in place at broker-dealers. The Federal  Reserve and OCC are tasked with overseeing the safety and soundness of  banks’ operations and had issued and were updating guidance that covered  information system security and business continuity planning. They also  reported annually examining information security and business continuity  at the entities they oversee, but these reviews did not generally assess  banks’ measures against physical attacks.
subsections: section_title: Regulators Are Developing Recovery Goals and Sound Business Continuity Practices for Clearing Functions but Not for Trading Activities
paragraphs: Treasury and the financial regulators have various initiatives under way to  improve the financial markets’ ability to respond to future crises (we  discuss these in app. II) and assess how well the critical assets of the  financial sector are being protected. As part of these initiatives, certain  financial market regulators have begun to identify business continuity  goals for the clearing and settling organizations for government and  corporate securities. On August 30, 2002, the Federal Reserve, OCC, SEC,  and the New York State Banking Department issued the Draft Interagency  White Paper on Sound Practices to Strengthen the Resilience of the U.S.  Financial System. The paper presents sound practices to better ensure  that clearance and settlement organizations will be able to resume  operations promptly after a wide-scale, regional disruption. The paper  proposes these organizations adopt certain practices such as   identifying the activities they perform that support these critical   developing plans to recover these activities on the same business day;  and  having out-of-region resources sufficient to recover these operations  that are not dependent on the same labor pool or transportation,  telecommunications, water, and power.
The regulators plan to apply the sound practices to a limited number of  financial market organizations whose inability to perform certain critical  functions could result in a systemic crisis that threatens the stability of the  financial markets. If these organizations were unable to sufficiently recover  and meet their financial obligations, other market participants could  similarly default on their obligations and create liquidity or credit  problems. According to the white paper, the sound practices apply to “core  clearing and settlement organizations,” which include market utilities that  clear and settle transactions on behalf of market participants and the two  clearing banks in the government securities market. In addition, the  regulators expect firms that play significant roles in these critical financial  markets also to comply with sound practices that are somewhat less  rigorous. The white paper indicates that probably 15 to 20 banks and 5 to 10  broker-dealers have volume or value of activity in these markets sufficient  to present a systemic risk if they were unable to recover their clearing  functions and settle all their transactions by the end of the business day.
The regulators also sought comment on the appropriate scope and  application of the white paper, including whether they should address the  duration of disruption that should be planned for, the geographic  concentration of backup sites, and the minimum distance between primary  and backup facilities. After considering the comments they receive, the  regulators intend to issue a final version in 2003 of the white paper that will  present the practices to be adopted by clearance and settlement  organizations for these markets.
Based on our analysis of the comment letters that have been sent to the  regulators as of December 2002, market participants and other  commenters have raised concerns over the feasibility and cost of the  practices advocated by the white paper. The organizations that have  commented on the paper include banks, broker-dealers, industry  associations, information technology companies and consultants, and  many of these organizations complimented the regulators for focusing  attention on a critical area. However, many commenters have urged the  regulators to ensure that any practices issued balance the cost of  implementing improved business continuity capabilities against the  likelihood of various types of disruptions occurring. For example, a joint  letter from seven broker-dealers and banks stated that requiring  organizations to make costly changes to meet remote possibilities is not  practical. Other commenters urged regulators not to mandate minimum  distances between primary sites and backup locations for several reasons.  For example, some commenters noted that beyond certain distances, firms  cannot simultaneously process data at both locations, which the regulators  acknowledged could be between 60 to 100 kilometers. Rather than specify  a minimum distance, others stated that the practices should provide  criteria that firms should consider in determining where to locate their  backup facilities. One broker-dealer commented that it had chosen the  locations of its two operating sites to minimize the likelihood that both  would be affected by the same disaster or disruption. It noted that its two  sites were served by separate water treatment plants and power grids and  different telecommunication facilities support each. A third commonly  cited concern was that the regulators should implement the practices as  guidelines, rather than rules. For example, one industry association stated,  “Regulators should not impose prescriptive requirements, unless  absolutely necessary, in order to enhance the firms’ ability to remain  competitive in the global market.”
Ensuring that organizations recover their clearing functions would help  ensure that settlement failures do not create a broader financial crisis, but  regulators have not begun a similar effort to develop recovery goals and  business continuity practices to ensure that trading activities can resume  promptly in various financial markets. Trading activities are important to  the U.S. economy because they facilitate many important economic  functions, including providing means to productively invest savings and  allowing businesses to fund operations. The securities markets also allow  companies to raise capital for new ventures. Ensuring that trading  activities resume in a smooth and timely manner would appear to be a  regulatory goal for SEC, which is specifically charged with maintaining fair  and orderly markets. However, Treasury and SEC staff told us that the  white paper practices would be applied to clearing functions because such  activities are concentrated in single entities for some markets or in very  few organizations for others, and thus pose a greater potential for  disruption. In contrast, they did not include trading activities or  organizations that conduct only trading functions, such as the securities  exchanges, because these activities are performed by many organizations  that could substitute for each other. For example, SEC staff said that if one  of the exchanges was unable to operate, other exchanges or the ECNs  could trade their products. Similarly, they said that individual broker- dealers are not critical to the markets because others firms can perform  their roles.
Although regulators have begun to determine which organizations are  critical for accomplishing clearing functions, identifying the organizations  that would have to be ready for trading in U.S. financial markets to resume  within a given period of time is also important. If key market participants  are not identified and do not adopt sound business continuity practices, the  markets may not have sufficient liquidity for fair and orderly trading. For  example, in the past when NYSE experienced operations disruptions, the  regional exchanges usually have also chosen to suspend trading until NYSE  could resume. SEC staff have also previously told us that the regional  exchanges may not have sufficient processing capacity to process the full  volume usually traded on NYSE. If the primary exchanges are not  operational, trading could be transferred to the ECNs, but regulators have  not assessed whether such organizations have sufficient capacity to  conduct such trading or whether other operational issues would hinder  such trading.
SEC has begun efforts to develop a strategy for resuming stock trading for  some exchanges, but the plan is not yet complete and does not address all  exchanges and all securities. To provide some assurance that stock trading  could resume if either NYSE or NASDAQ was unable to operate after a  disaster, SEC has asked these exchanges to take steps to ensure their  information systems can conduct transactions in the securities that the  other organization normally trades. SEC staff told us each organization will  have to ensure that its systems can properly process the varying number of  characters in the symbols that each uses to represent securities. However,  as of December 2002, SEC had not identified the specific capabilities that  the exchanges should implement. For example, NASDAQ staff said that  various alternatives are being proposed for conducting this trading and  each would involve varying amounts of system changes or processing  capacity considerations. In addition, although each exchange trades  thousands of securities, NYSE staff told us that they are proposing to  accommodate only the top 250 securities, and the remainder of NASDAQ’s  securities, which have smaller trading volumes, would have to be traded by  the ECNs or other markets. NASDAQ staff said they planned to trade all  NYSE securities if necessary. NYSE staff also said that their members have  been asked to ensure that the systems used to route orders to NYSE be  ready to accept NASDAQ securities by June 2003. Furthermore, although  some testing is under way, neither exchange has completely tested its  ability to trade the other’s securities. Strategies for other exchanges and  products also have not been developed.
As noted in chapter 2 of this report, trading was not resumed in U.S. stock  and options markets after the attacks until several key broker-dealers were  able to sufficiently recover their operations. Resuming operations after  disruptions can be challenging because large broker-dealers’ trading  operations can require thousands of staff and telecommunications lines. In  some cases, organizations that may not appear critical to the markets in  ordinary circumstances could become so if a disaster affects other  participants more severely. For example, in the days following the attacks,  one of the IDBs that previously had not been one of the most active firms  was one of the few firms able to resume trading promptly.
section_title: Program, Staff, and Resource Issues Hamper SEC Oversight of Market Participants’ Operations Risks
paragraphs: Lacking specific requirements under the securities laws, SEC uses a  voluntary program to oversee exchange, clearing organization, and ECN  information systems operations. U.S. securities laws, rules, and regulations  primarily seek to ensure that investors are protected. For example,  securities laws require that companies issuing securities disclose material  financial information, and SRO rules require broker-dealers to determine  the suitability of products before recommending them to their customers.  The regulations did not generally contain specific requirements applicable  to physical or information system security measures or business continuity  capabilities. However, as part of its charge to ensure fair and orderly  markets and to address information system and operational problems  experienced by some markets during the 1980s, SEC created a voluntary  program—ARP—that covered information technology issues at the  exchanges, clearing organizations and, eventually, ECNs. SEC’s 1989 ARP  statement called for the exchanges and clearing organizations to establish  comprehensive planning and assessment programs to test system  capacities, develop contingency protocols and backup facilities,  periodically assess the vulnerability of their information systems to  external or internal threats, and report the results to SEC. SEC issued an  additional ARP statement in 1991 that called for exchanges and clearing  organizations to obtain independent reviews—done by external  organizations or internal auditors—of their general controls in several  information system areas.
subsections: section_title: SEC ARP Reviews Address Some Operations Risks but Some Key Recommendations Not Addressed
paragraphs: SEC’s ARP staff conducted examinations of exchanges, clearing  organizations, and ECNs that addressed their information security and  business continuity. The examinations are based on ARP policy statements  that cover information system security, business continuity planning, and  physical security at data and information systems centers, but do not  address how organizations should protect their entire operations from  physical attacks. SEC’s ARP program staff explained that they analyze the  risks faced by each organization to determine which are the most  important to review. As a result, the staff is not expected to review every  issue specific to the information systems or operations of each exchange,  clearing organization, and ECN during each examination. We found that  SEC ARP staff were reviewing important operations risks at the  organizations they examined. Based on our review of the 10 most recent  ARP examinations completed between January 2001 and July 2002, 9  covered information system security policies and procedures, and 7  examinations covered business continuity planning. Only one  examination—done after the September 11, 2001, attacks—included  descriptions of the overall physical security improvements. SEC ARP staff  told us that telecommunications resiliency was a part of normal  examinations, but none of the examination reports we reviewed  specifically discussed these organizations’ business continuity measures  for ensuring that their telecommunications services would be available  after disasters. However, ARP staff said that all of these operations risk  issues would be addressed as part of future reviews.
Although SEC’s voluntary ARP program provides some assurance that  securities markets are being operated soundly, some of the organizations  subject to ARP have not taken action on some important  recommendations.   Since its inception, ARP program staff  recommendations have prompted numerous improvements in the  operations of exchanges, clearing organizations, and ECNs. ARP staff also  reviewed exchange and clearing organization readiness for the Year 2000  date change and decimal trading, and market participants implemented  both industrywide initiatives successfully. However, because the ARP  program was not implemented under SEC’s rulemaking authority,  compliance with the ARP guidance is voluntary. Although SEC staff said  that they were satisfied with the cooperation they received from the  organizations covered by the ARP program, in some cases, organizations  did not take actions to correct significant weaknesses ARP staff identified.  For example, as we reported in 2001, three organizations had not  established backup facilities, which SEC ARP staff had raised as significant  weaknesses. Our report noted, “Securities trading in the United States  could be severely limited if a terrorist attack or a natural disaster damaged  one of these exchange’s trading floor.” In addition, for years, SEC’s ARP  staff raised concerns and made recommendations relating to inadequacies  in NASDAQ’s capacity planning efforts, and NASDAQ’s weaknesses in this  area delayed the entire industry’s transition to decimal pricing for several  months. NASDAQ staff told us they have implemented systems with  sufficient capacity, and SEC staff said they are continuing to monitor the  performance of these systems. We also reported that exchanges and  clearing organizations sometimes failed to submit notifications to SEC  regarding systems changes and outages as expected under the ARP policy  statement, and we again saw this issue being cited in 2 of 10 recent ARP  examination reports we reviewed.
ARP staff continue to find significant operational weaknesses at the  organizations they oversee. In the 10 examinations we reviewed, SEC staff  found weaknesses at all 9 organizations and made 74 recommendations for  improvement. We compared these weaknesses to the operational elements  we used in our analysis of financial market organizations (as discussed in  ch. 3 of this report). Our analysis showed that the ARP staff made at least  22 recommendations to address significant weaknesses in the 9  organizations’ physical or information system security or business  continuity planning efforts—including 10 recommendations to address  significant weaknesses at organizations critical to the functioning of the  markets. For example, in an examination conducted in 2000, ARP staff  found that personnel at one exchange did not have consistent information  system security practices across the organization and lacked a centrally  administered, consolidated information system security policy. In  addition, although SEC recommends that organizations subject to ARP  have vulnerability assessments performed on their information systems,  ARP staff found that this exchange had not assessed its information  systems. In three other reviews, the ARP staff found that the organizations  had not complied with ARP policy expectations to fully test their  contingency plans. ARP staff noted other significant weaknesses, including  inadequate BCPs or backup facilities. ARP staff said that they considered  all the recommendations they make to be significant, including the 74  recommendations made in these 10 reports. These recommendations will  remain open until the next time the ARP staff review the organization and  can assess whether they have been acted upon.
Because the ARP program was established through a policy statement and  compliance is voluntary, SEC lacks specific rules that it can use to gain  improved responsiveness to recommendations to the exchanges and  clearing organizations subject to APP.  SEC staff explained that they chose  not to use a rule to implement ARP because rules can become obsolete and  having voluntary guidance provides them with flexibility. SEC staff also  told us that an organization’s failure to follow ARP expectations could  represent a violation of the general requirement that exchanges maintain  the ability to operate, and therefore they could take action under that  authority. However, they noted that the use of such authority is rare.  However, SEC has issued a rule requiring the most active ECNs to comply  with all the ARP program’s standards. In 1998, SEC issued a regulation that  subjected alternative trading systems such as ECNs to increased regulatory  scrutiny because of their increasing importance to U.S. securities markets.  Included in this regulation was a rule that required ECNs whose trading  volumes exceeded certain thresholds to comply with the same practices as  those contained in the ARP policy statements.   In its explanation of the  regulation, SEC noted that its ARP guidelines are intended to ensure that  short-term cost cutting by registered exchanges does not jeopardize the  operation of the securities markets, and therefore it was extending these  requirements to the ECNs because of their potential to disrupt the  securities markets.
We previously recommended that SEC develop formal criteria for assessing  exchange and clearing organization cooperation with the ARP program and  perform an assessment to determine whether the voluntary status of the  ARP program is appropriate. Although they were generally satisfied with  the level of cooperation, SEC staff told us that they were reviewing the  extent to which exchanges and clearing organizations complied with the  ARP program and planned to submit the analysis to SEC commissioners in  2003. In addition to possibly changing the status of the program for the 22  exchanges and clearing organizations subject to ARP, SEC staff also told us  that they were considering the need to extend the ARP program to those  broker-dealers for whom it would be appropriate to adopt the sound  business continuity practices that will result from the joint regulatory white  paper.
subsections: section_title: SEC ARP Program Faces Resource and Staff Limitations
paragraphs: Limited resources and challenges in retaining experienced ARP staff have  affected SEC’s ability to oversee an increasing number of organizations and  more technically complex market operations. Along with industrywide  initiatives discussed earlier, ARP staff workload has expanded to cover 32  organizations with more complex technology and communications  networks. However, SEC has problems retaining qualified staff, and market  participants have raised concerns about the experience and expertise of  ARP staff. As SEC has experienced considerable staff losses overall, the  ARP program also has had high turnover. As of October 2002, ARP had 10  staff, but SEC staff told us that staff levels had fluctuated and had been as  low as 4 in some years. As a result, some ARP program staff had limited  experience, with 4 of the 10 current staff having less than 3.5 years’  experience, including 3 with less than 2 years’ experience. During our work  on SEC resource issues in 2001, market participants and former SEC staff  raised concerns that the level of resources and staff expertise SEC has  committed to review technology issues is inadequate to address complex  market participant operations. For example, officials from several market  participants we interviewed in 2001 told us that high turnover resulted in  inexperienced SEC staff, who lacked in-depth knowledge, doing reviews of  their organizations. SEC staff told us that they continue to emphasize  training for their staff to ensure that they have the proper expertise to  conduct effective reviews.
Resource limitations also affect the frequency of ARP reviews. With current  staffing levels, SEC staff said that they are able to conduct examinations of  only about 7 of the 32 organizations they oversee as part of the ARP  program each year. Although standards for federal organizations’  information systems require security reviews to be performed at least once  every 3 years, these standards recommend that reviews of high-risk  systems or those undergoing significant systems modifications be done  more frequently. Although our analysis of SEC ARP examination data  found that SEC had conducted recent reviews of almost all the  organizations we considered critical to the financial markets, long periods  of time often elapsed between ARP examinations of these organizations.  Between September 1999 and September 2002, SEC examined 6 of the 7  critical organizations under its purview. However, as shown in figure 12,  the intervals between the most recent examinations exceeded 3 years for 5  of the 7 critical organizations, including an organization that was not  reviewed during this period.
Our analysis of ARP report data showed that the intervals between reviews  of critical organizations averaged 39 months, with the shortest interval  being 12 months and the longest 72 months. Since September 1999, the SEC  ARP staff had reviewed 7 of the 8 less critical exchanges, clearing  organizations, and ECNs that we visited during this review. However, SEC  staff told us that the ARP program also may be tasked with reviewing the  extent to which broker-dealers important to clearing and trading in U.S.  securities markets are adhering to sound business continuity practices.  Such an expansion in the ARP program staff’s workload would likely  further reduce the ability of the SEC staff to frequently review all the  important organizations under its authority.
section_title: Increased Appropriations Could Provide SEC an Opportunity to Improve ARP Program Resources
paragraphs: The potential increase in SEC’s appropriations could provide the agency an  opportunity to increase the level and quality of the resources it has  committed to the ARP program. The Sarbanes-Oxley Act of 2002, which  mandated various accounting reforms, also authorized increased  appropriations for SEC for fiscal year 2003. Specifically, the act  authorized $776 million in 2003, an increase of about 51 percent over the  nearly $514 million SEC received for fiscal year 2002. The act directs SEC  to devote $103 million of the newly authorized amount to personnel and  $108 million to information technology. If appropriated, these additional  funds could allow SEC to increase resources devoted to the ARP program.  Increased staffing levels also could allow SEC to conduct more frequent  examinations and better ensure that significant weaknesses are identified  and addressed in a timely manner. The additional resources could also be  used to increase the technical expertise of its staff, further enhancing SEC’s  ability to review complex information technology issues.
section_title: SEC and SROs Generally Did Not Review Physical and Information System Security and Business Continuity at Broker- Dealers
paragraphs: SEC and the securities market SROs generally have not examined broker- dealers’ physical and information system security and business continuity  efforts, but planned to increase their focus on these issues in the future.  SEC’s Office of Compliance Inspections and Examinations (OCIE)  examines broker-dealers, mutual funds, and other securities market  participants. However, for the most part, OCIE examinations focus on  broker-dealers’ compliance with the securities laws and not on physical  and electronic security and business continuity, which these laws do not  generally address. After some broker-dealers that specialized in on-line  trading experienced systems outages, OCIE staff told us that they began  addressing information system capacity, security, and contingency  capabilities at these firms. SEC predicated its reviews of these issues on  the fact that these firms, as a condition of conducting a securities business,  would need to have sufficient operational capacity to enter, execute, and  settle orders, and deliver funds and securities promptly and accurately. In  addition, the Gramm-Leach-Bliley Act (GLBA) required SEC to establish  standards for the entities it oversees to safeguard the privacy and integrity  of customer information and prevent unauthorized disclosure. As a result,  in some reviews done since July 2001, OCIE staff discussed the controls  and policies that firms have implemented to protect customer information  from unauthorized access. However, SEC OCIE staff acknowledged that  their expertise in these areas is limited. OCIE staff told us that few of the  approximately 600 examiners they employ had information technology  backgrounds. During the work we conducted for our report on SEC’s  staffing and workload, staff at several broker-dealers told us that the SEC  staff that review their firms lacked adequate technology expertise.
SROs also generally have not addressed these issues at broker-dealers.  Under U.S. securities laws, exchanges acting as SROs have direct  responsibility for overseeing their broker-dealer members. NYSE and  NASD together oversee the majority of broker-dealers in the United  States. According to officials at these two SROs, staff as often as annually  conduct examinations to review adherence with capital requirements and  other securities regulations. However, staff at both organizations  acknowledged that, in the past, their oversight generally did not focus on  how members conducted their operations from physical or information  systems security or business continuity perspectives. Representatives of  the SROs told us they plan to include aspects of these issues in future  reviews. For example, they plan to examine their members’ information  system security to ensure compliance with GLBA customer information  protection provisions.
NYSE and NASD plan to focus on business continuity issues in future  reviews because, in August 2002, both submitted similar rules for SEC  approval that will require all of their members to establish BCPs. The areas  the plans are to address include the following:  backup for books and records,  procedures for resuming operations of critical systems,  alternate means for communicating with the members’ staff and their   regulatory reporting and communications with regulators.
NYSE and NASD officials told us that once these rules were adopted, their  staff would include these matters in the scope of their examinations after  allowing sufficient time for firms to develop the required BCPs.
section_title: Bank Regulators Have Authority to Oversee Operational Risk
paragraphs: As part of their mandate to oversee banks’ safety and soundness, the  banking regulators, including the Federal Reserve and OCC, issued  guidance that directs depository institutions or banks to address potential  operations risks with physical and information system security and  business continuity measures. The guidance includes recommended steps  that banks should take to reduce the risk of operations disruptions from  physical or electronic attacks and for recovering from such events with  business continuity capabilities. For example, in 1996 these regulators  jointly issued a handbook on information systems, which calls for banks to  conduct an analysis of their risks and implement measures to reduce  them. Banks were also to have access controls for their systems and  programs. Regarding physical security, the banking regulators expect  banks to ensure the safety of assets and to physically protect data centers  used for information systems processing. For example, the Federal  Reserve’s guidance directs banks to take security steps to protect cash and  vaults and ensure that bank facilities are protected from theft. The banking  regulators’ joint 1996 handbook discussed measures to secure data centers  and information system assets. However, the bank regulators’ guidance did  not specifically address measures to protect facilities from terrorist or  other physical attacks. Regarding business continuity, the joint handbook  expects banks to have plans addressing all critical services and operations  necessary to minimize disruptions in service and financial losses and  ensure timely resumption of operations in a disaster. Banks also were to  identify the critical components of their telecommunications networks and  assess whether they were subject to single points of failure that could  occur, for example, by having all lines routed to a single central switching  office, and to identify alternate routes and implement redundancy.
The Federal Reserve and OCC, in conjunction with the other depository  regulators, are also developing expanded guidance on physical and  electronic security and business continuity planning. They are planning to  issue separate handbooks on information system security and business  continuity in early 2003. Bank regulatory staff provided us with a draft of  the information system security guidance, which expects banks to have  programs that include security policies, access controls, and intrusion  monitoring; vulnerability assessments; and incident response capabilities.  The draft guidance also covers physical security from an overall facility  perspective and suggests that banks use appropriate controls to restrict or  prevent unauthorized access and prevent damage from environmental  contaminants. Banks will also be instructed to assess their exposure risks  for fire and water damage, explosives, or other threats arising from  location, building configuration, or neighboring entities. According to bank  regulatory staff, they are also currently drafting a separate guidance  handbook addressing business continuity issues.
subsections: section_title: Bank Regulators Reported Reviewing Operations Risks but Not Banks’ Measures Against Physical Attacks
paragraphs: Bank regulators reported regularly examining how banks are addressing  physical and information system security and business continuity issues.  The Federal Reserve and OCC oversee over 3,100 institutions combined,  including the largest U.S. banks, and are required to examine most  institutions annually. At the end of fiscal year 2002, the Federal Reserve  had over 1,200 examiners and OCC over 1,700. As part of these staff, the  agencies each had between 70 and 110 examiners that specialized in  reviewing information systems issues. Using a risk-based approach, these  regulators’ examiners tailor their examinations to the institution’s unique  risk profile. As a result, some areas would receive attention every year, but  others would be examined only periodically. Staff at the Federal Reserve  and OCC told us that their examiners consider how their institutions are  managing operations risks and review these when appropriate. For  example, Federal Reserve staff told us that under their risk-based  examination approach, information security is considered as part of each  examination, particularly since regulations implementing section 501(b) of  GLBA require that the regulators assess how financial institutions protect  customer information. They said that the extent to which information  security is reviewed at each institution can vary, with less detailed reviews  generally done at institutions not heavily reliant on information technology.
They also said that business recovery issues were addressed in most  examinations. Both Federal Reserve and OCC staff told us that physical  security was considered as part of information security in reviewing  protections at data centers. Both regulators also expect banks’ internal  auditors to review physical security for vault and facilities protection.  However, the focus of these reviews has not generally been on the extent to  which banks are protected from terrorist or other physical attacks. In light  of the September 2001 attacks, these regulators stated that their scrutiny of  physical and information system security and business continuity policies  and procedures would be reviewed even more extensively in future  examinations. Because we did not review bank examinations as part of our  review, we were unable to independently determine how often and how  extensively these two bank regulatory agencies reviewed information  security and business continuity at the entities they oversee.
section_title: Conclusions
paragraphs: Financial market regulators have begun to develop goals and a strategy for  resuming operations along with sound business continuity practices for a  limited number of organizations that conduct clearing functions. The  business continuity practices that result from this effort will likely address  several important areas, including geographic separation between primary  and backup locations and the need to ensure that organizations have  provisions for separate staff and telecommunications services needed to  conduct critical operations at backup locations. If successfully  implemented, these sound practices should better ensure that clearing in  critical U.S. financial markets could resume and settlement would be  completed after a disaster, potentially avoiding a harmful systemic crisis.
However, trading on the markets for corporate securities, government  securities, and money market instruments is also vitally important to the  economy, and the United States deserves similar assurance that trading  activities would also be able to resume when appropriate and without  excessive delay. The U.S. economy has demonstrated that it can withstand  short periods during which markets are not trading. After some events  occur, having markets closed for some time could be appropriate to allow  for disaster recovery and reduce market overreaction. However, long  delays in reopening the markets could also be harmful to the economy.  Without trading, investors lack the ability to accurately value their  securities and would be unable to adjust their holdings. The attacks  demonstrated that the ability of markets to recover could depend on the  extent to which market participants have made sound investments in  business continuity capabilities. Without identifying strategies for recovery,  determining the sound practices needed to implement these strategies, and  identifying the organizations that would conduct trading under these  strategies, the risk that markets may not be able to resume trading in a fair  and orderly fashion and without excessive delays is increased. Goals and  strategies for recovering trading activities could be based on likely disaster  scenarios that identify the organizations that could be used to conduct  trading in the event that other organizations were unable to recover within  a reasonable time. These would provide market participants with  information to make better decisions about how to improve their  operations and provide regulators with sound criteria for ensuring that  trading on U.S. markets could resume when appropriate.
Strategies for resuming trading could involve identifying which markets  would assume the trading activities of others or identifying other venues  such as ECNs in which trading could occur. To be viable, these strategies  would also have to identify whether any operational changes at these  organizations would be necessary to allow this trading to occur. Although  SEC has begun efforts to ensure that trading can be transferred between  NYSE and NASDAQ, these efforts are not complete and not all securities  are covered. Because of the risk of operational difficulties resulting from  large-scale transfers of securities trading to organizations that normally do  not conduct such activities, testing the various scenarios would likely  reduce such problems and ensure that the envisioned strategies are viable.
Expanding the organizations that would be required to implement sound  business continuity practices beyond those important for clearing would  better ensure that those organizations needed for the resumption of  smooth and timely trading would have developed the necessary business  continuity capabilities. As discussed in chapter 3, exchanges, clearing  organizations, and ECNs we reviewed had taken many steps to reduce the  risks that they would be disrupted by physical or electronic attacks and  have mitigated risk through business continuity planning. However, some  organizations still had limitations in their business continuity measures  that increased the risk that their operations would be disrupted, including  organizations that might need to trade if the major exchanges were unable  to resume operations. In addition, the attacks demonstrated that  organizations that were not previously considered critical to the markets’  functioning could greatly increase in importance following a disaster.  Therefore, identifying all potential organizations that could become  important to resuming trading and ensuring they implement sound  business practices would increase the likelihood of U.S financial markets  being able to recover from future disasters. Given that the importance of  different organizations to the overall markets varies, any recovery goals  and business continuity practices that are developed could similarly vary  their expectations for different market participants but with the ultimate  goal of better ensuring that organizations take reasonable, prudent steps in  advance of any future disasters. For example, broker-dealers could be  expected to take steps to ensure that their customer records are backed up  frequently and that these backup records are maintained at considerable  distance from the firms’ primary sites. This would allow customers to  transfer their accounts to other broker-dealers if the firm through which  they usually conduct trading is not operational after a major disaster.
Given the increased threats demonstrated by the September 11 attacks and  the need to ensure that key financial market organizations are following  sound practices, securities and banking regulators’ oversight programs are  important mechanisms for ensuring that U.S financial markets are resilient.  However, SEC’s ARP program—which oversees the key clearing  organizations and exchanges and may be used to oversee additional  organizations’ adherence to the white paper on sound practices—currently  faces several limitations. Because it is a voluntary program, SEC lacks  leverage to assure that market participants implement important  recommended improvements. An ARP program that draws its authority  from an issued rule could provide SEC additional assurance that exchanges  and clearing organizations adhere to important ARP recommendations and  any new guidance developed jointly with other regulators. To preserve the  flexibility that SEC staff see as a strength of the current ARP program, the  rule would not have to mandate specific actions but could instead require  that the exchanges and clearing organizations engage in activities  consistent with the practices and tenets of the ARP policy statements. This  would provide SEC staff with the ability to adjust their expectations for the  organizations subject to ARP as technology and industry best practices  evolve while providing clear regulatory authority to require prudent actions  when necessary. SEC already requires ECNs to comply with ARP guidance;  extending the rule to the exchanges and clearing organizations would place  them on similar legal footing.
Additional staff, including those with technology backgrounds, could better  ensure the effectiveness of the ARP program’s oversight. SEC could  conduct more frequent examinations, as envisioned by federal information  technology standards, and more effectively review complex, large-scale  technology operations in place at the exchanges, ECNs, and clearing  organizations. If the ARP program must also begin reviewing the extent to  which broker-dealers important to clearing and trading in U.S. securities  markets are adhering to sound business continuity practices, additional  staff resources would likely be necessary to prevent further erosion in the  ability of the SEC staff to oversee all the important organizations under its  authority. The increased appropriations authorized in the Sarbanes-Oxley  Act, if received, would present SEC a clear opportunity to enhance its  technological resources, including the ARP program, without affecting  other important initiatives.
section_title: Recommendations
paragraphs: So that trading in U.S. financial markets can resume after future  disruptions in as timely a manner as appropriate, we recommend that the  Chairman, SEC, work with industry to   develop goals and strategies to resume trading in securities;  determine sound business continuity practices that organizations would  need to implement to meet these goals;  identify the organizations, including broker-dealers, that would likely  need to operate for the markets to resume trading and ensure that these  entities implement sound business continuity practices that at a  minimum allow investors to readily access their cash and securities; and  test trading resumption strategies to better assure their success.
In addition, to improve the effectiveness of the SEC’s ARP program and the  preparedness of securities trading and clearing organizations for future  disasters, we recommend that the Chairman, SEC, take the following  actions:  Issue a rule requiring that the exchanges and clearing organizations  engage in activities consistent with the operational practices and other  tenets of the ARP program; and  If sufficient funding is available, expand the level of staffing and  resources committed to the ARP program.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from the heads, or their  designees, of the Federal Reserve, OCC, Treasury, and SEC. The Federal  Reserve and SEC provided written comments, which appear in appendixes  III and IV, respectively. The Federal Reserve, OCC, and SEC also provided  technical comments, which we incorporated as appropriate.
SEC generally agreed with the report and the goals of its recommendations.  The letter from SEC’s Market Regulation Division Director noted that SEC  has been working with market participants to strengthen their resiliency  and that the SEC staff agreed that the financial markets should be prepared  to resume trading in a timely, fair, and orderly fashion following a  catastrophe, which is the goal of our recommendations that SEC work with  the industry to develop business continuity goals, strategies, and practices.  SEC’s letter expressed a concern that this recommendation expects SEC to  ensure that broker-dealers implement business continuity practices that  would allow trading activities to resume after a disaster. The SEC staff  noted that broker-dealers are not required to conduct trading or provide  liquidity to markets. Instead this would be a business decision on the part  of these firms. However, SEC’s letter noted that broker-dealers are required  to be able to ensure that any completed trades are cleared and settled and  that customers have access to the funds and securities in their accounts as  soon as is physically possible. SEC’s letter stated that the BCP expectations  for these firms must reflect these considerations.
We agree with SEC that the business continuity practices they develop with  broker-dealers should reflect that the extent to which these firms’ BCPs  address trading activities is a business decision on the part of a firm’s  management. In addition, SEC would need to take into account the  business continuity capabilities implemented by broker-dealers that  normally provide significant order flow and liquidity to the markets when it  works with the exchanges and other market participants to develop goals  and strategies for recovering from various disaster scenarios. To the extent  that many of these major broker-dealers may be unable to conduct their  normal volume trading in the event of some potential disasters without  extended delays, the intent of our recommendation is that SEC develop  strategies that would allow U.S. securities markets to resume trading, when  appropriate, through other broker-dealers such as regional firms that are  less affected by the disaster. However, to ensure that such trading is orderly  and fair to all investors, SEC will have to ensure that broker-dealers’  business continuity measures at a minimum are adequate to allow prompt  transfers of customer funds and securities to other firms so that the  customers of firms unable to resume trading are not disadvantaged.
Regarding our recommendations to ensure that SEC’s ARP program has  sufficient legal authority and resources to be an effective oversight  mechanism over exchanges, clearing organizations, and ECNs, SEC’s  Market Regulation Division Director stated that they will continue to assess  whether rulemaking is appropriate. In addition, the letter stated that, if the  agency receives additional funding, they will consider recommending to  the Chairman that ARP staffing and resources be increased.
SEC’s letter also commented that physical security beyond the protection  of information technology resources was not envisioned as a component of  ARP when the program was initiated. They indicated that they may need  additional resources and expertise to broaden their examinations to  include more on this issue.
In the letter from the Federal Reserve’s Staff Director for Management, he  noted that the Federal Reserve is working to improve the resilience of the  financial system by cooperating with banking and securities regulators to  develop sound practices to reduce the system effects of wide-scale  disruptions. They are also working with the other banking regulators to  expand the guidance for banks on information security and business  continuity.