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The U.S. stock market lost a measure of trust with traders after computer malfunctions sent the Dow Jones Industrial Average plummeting 178 points in one minute yesterday.

"The system should be able to handle the capacity when you have high-volume days," said Thomas Garcia, head of trading at Thornburg Investment Management, which oversees about $34 billion in Santa Fe, New Mexico. "If I was making decisions based off of bad data, then yeah, I have a huge problem with that."

Dow Jones & Co. said its computers were responsible for the sudden nosedive in the 30-stock benchmark about an hour before markets closed because they failed to keep up with trades. The New York Stock Exchange said separately that it experienced "intermittent delays" in prices. Nasdaq Stock Market Inc. reported slower distribution of some market data. Together the two markets handle almost 90 percent of all shares that trade in the U.S., the world's biggest equity market.

Some NYSE floor brokers resorted to pen and paper to complete trades, while others scrambled to keep up with orders after an overnight sell-off in Chinese stocks spread globally and sparked the biggest U.S. rout in four years. The 3.3 billion shares that traded on the Nasdaq was the most in almost five years. Some 2.4 billion shares traded at the NYSE, the highest volume since June.

It was the busiest day on record at the Chicago Board Options Exchange, the largest U.S. options market. Some 6.8 million contracts changed hands, eclipsing the previous record of 5.8 million reached in May 2006, according to the exchange.

Backup System

"The extraordinary heavy trading volume caused a delay in our Dow Jones Industrial Average data," said Sybille Reitz, a spokeswoman at New York-based Dow Jones, which created the price-weighted benchmark in 1896. "As we identified the problem we switched over to a backup system and the result was a rapid catch up in the public value for the Dow."

Dow Jones alerted stock, futures and options exchanges that rely on the average "pretty early" after noticing the problem, Reitz said. "We switch back and forth between data servers all the time for maintenance reasons, but have never had a delay like this in the reporting of the index," she said.

Bloomberg LP, the parent of Bloomberg News, competes with Dow Jones to provide financial news and information. A chart of the Dow average shows a steady decline until 2:59 p.m., when the line heads straight down as the backup servers at Dow Jones kicked in, tabulating trades done earlier in the day.

`The Dam Broke'

Michael Driscoll, a trader at Bear Stearns Cos., noted that the Dow average was down about 300 points when he turned away from the chart to take a phone call just before 3 p.m. in New York. By the time he looked up again, the losses had almost doubled.

"When the dam broke, that's when we saw the market go from down 250 to down 550 literally in a couple of seconds," said Driscoll, senior managing director at New York-based Bear Stearns.

The sudden plunge fueled a wave of new orders that overwhelmed systems at stock exchanges in the final hour of trading. Warren Meyers, a managing director at NYSE brokerage Walter J. Dowd Inc., started scribbling trades on paper after the delays made it impossible to determine the fate of an electronic order. He ended up with more shares than he wanted. The debacle reminded many traders how captive the market has become to computers.

Price of Speed

"I noticed some problems early in the day, but after 3 p.m. it was floor-wide," Meyers said. "People want speed and they want the anonymity of electronic trading, but when the markets get roiled they look to humans to handle trades efficiently and we weren't able to do that. It's frightening when you're in the New York Stock Exchange and you can't trade."

Just last March, the 214-year-old New York Stock Exchange embraced electronic trading with the purchase of Archipelago Holdings Inc. It's now acquiring Paris-based Euronext NV, a $12.5 billion trans-Atlantic deal that involves the integration of stock markets on an unprecedented scale.

The Dow ended up declining 416.02, or 3.3 percent, to 12,216.24, the biggest slide since March 2003. At the day's low, which followed the malfunction at Dow Jones, the average was down 546.2 points. The last time it fell as much was Sept. 17, 2001, the first trading day after terrorists destroyed the World Trade Center in downtown New York, killing more than 2,700 people.

The CBOE SPX Volatility Index, an indicator known as the VIX that measures the perceived risk of stock-market swings, rose 64 percent -- the most ever.

Declined Extended

The market drop started in China, where the Shanghai and Shenzhen 300 Index tumbled 9.2 percent yesterday, wiping out $107.8 billion of market value. Indexes in Europe then declined more than 2 percent. Today, stocks in Japan and Hong Kong fell, while the Shanghai index gained 3.5 percent. U.S. stock indexes are indicated to open higher.

Still, Bruce Bartlett, director of growth equity investments at Lord Abbett & Co. in Jersey City, New Jersey, said the reports of data problems at the exchanges concerned him more than the market's decline.

"It's not particularly scary in the context of the 1987 crash," said Bartlett. "A lot of it's really going to bear on what happened on the floor of the exchange."

New market rules next month may cause recurring problems at the exchanges, said Joe Rosen, who until April was a managing director of trading technology at the NYSE. Regulation National Market System, commonly known as Reg NMS, takes effect March 5, forcing brokers and exchanges to route orders to the market with the best price available for automatic execution.

`Wake-Up Call'

"This is a foreboding of what's going to happen when you have the quotes flickering and orders getting routed here and there," said Rosen, president of brokerage consultant RKA Inc. "This is a wake-up call."

Some investors took advantage of yesterday's rout to buy stocks. Bartlett said Lord Abbett added to positions in some technology stocks. Benjamin Wallace, who helps oversee $650 million at Grimes & Co. in Westborough, Massachusetts, asked his trader to buy shares of Progressive Corp., Novartis AG and Chesapeake Energy Corp. at about 3 p.m. New York time.

"Things started to accelerate and prices were interesting," Wallace said. "As long as the real catalyst is this issue in China, it's short-term."

Jim Russell, an equity strategist at Fifth Third Asset Management, a Cincinnati money manager that oversees $21.8 billion, said he's reluctant to increase stock holdings until the markets stabilize.

Freight Train

"While a couple of stocks are starting reach a point where they're starting to look attractive, we aren't going to step in front of what could be a freight train," he said.

For Kenneth Polcari, a managing director at ICAP Plc's equities unit, the question isn't whether stocks were poised for an extended slump after four straight years of gains. It's how quickly stocks bounce back. "The technology issues created some anxiety, which exacerbated the market's move," said Polcari, an NYSE broker for more than 25 years. "The institutional investor understands that the market had to take a breather."

With reporting by Christine Harper and Bradley Keoun in New York. Editor: Erik Schatzker.

To contact the reporters on this story:
Edgar Ortega in New York at 212-617-2592 or ebarrales@bloomberg.net; Eric Martin in New York at +1-212-617-5383 or emartin21@bloomberg.net.

To contact the editor responsible for this story:
Erik Schatzker at 212-617-3849 or eschatzker@bloomberg.net.