Nasdaq Hackers Another Blow to Investor Confidence

News that computer hackers had infiltrated the operator of the Nasdaq Stock Exchange is the latest blow for Wall Street as it works to repair an image with investors and traders dented by last year's "flash crash."

Nasdaq OMX Group said on Saturday that it found "suspicious files" on its U.S. computer servers, but said there was no evidence hackers had accessed or acquired customer information or that its trading platforms were compromised.

The news comes as flows into U.S. equity mutual funds show signs of recovering after years of outflows following the financial crisis and the debilitating experience of the "flash crash" last May that sent U.S. indexes plunging.

"There have been a number of events over the last few years that have damaged investor confidence and this could certainly be another one," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.

Just last week, an unexplained hour-long glitch locked the prices of two key indexes -- the widely followed Nasdaq Composite and the Nasdaq 100.

Given that about 21 percent of all U.S. cash equity trading was matched on one of Nasdaq OMX's exchanges last year -- second only to Big Board parent NYSE Euronext -- the integrity of its marketplace is closely aligned with the smooth functioning of U.S. markets in general.

The timing is poor as a stocks rally from last year has started to draw retail investors back into equities and away from bond funds.

The last three weeks of January saw back-to-back inflows into domestic equity mutual funds amounting to $10.3 billion, the longest streak of inflows in 1-1/2 years, according to data from the Investment Company Institute.

Individual traders also returned in force to U.S. equity markets in January, helping drive volumes to their highest levels since the "flash crash" last May.

Daily trading among retailers, including active "day traders" who drive much of the volume, jumped some 25% from December to January, Sandler O'Neill analyst Richard Repetto wrote in a note estimating market activity.

Although this event in itself is unlikely to have an impact on that trend, maintaining confidence is key at a time when regulators are concerned about the stability of the electronic marketplace and many retail investors believe the odds are against them.

"In general, investors have become increasingly concerned about some of the movements in the market ... and things like this just serve to undermine confidence," said Rick Meckler, president of investment firm LibertyView Capital Management in New York.

Meckler said Nasdaq needed to release more information about the security breach.

"Just entering a system is a lot different from using a system to profit from it," he said. "That distinction is yet to be made."

Jim Awad, Managing Director at Zephyr Management New York, said investors were reserving judgment until Nasdaq released more information.

"People are nervous that there was a hacking but until they know who it was and what the motive was I don't think they will take it tremendously seriously," he said.

Nasdaq OMX said the suspicious files were found in a Web application called Directors Desk. The FBI and outside forensic companies helped conduct an investigation, which is continuing with the help of securities regulators.

Sang Lee, a managing partner specializing in market structure at Boston-based consultant Aite Group, said the lapse would be unlikely to see brokerages move to alternative trading venues at this stage.

"It appears that the break-in happened in an area which seems to be a very minor part of their overall business," he said. "I would not equate this to hackers going after the transaction business, for example."

The majority of trading in the United States is now done electronically and the market is competitive and fragmented.

"I think the ultimate fallout from this could be a wake-up call for all of the exchanges and financial services firms to carefully reassess their security policy," said Lee.