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SEC to Ban Flash Trades of U.S. Stocks, Schumer Says (Update3)
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By Edgar Ortega and Jesse Westbrook
Aug. 4 (Bloomberg) -- The U.S. Securities and Exchange Commission will
seek to ban flash trades that give some brokerages an advance look at
orders, Senator Charles Schumer said, citing a conversation with SEC
Chairman Mary Schapiro.
Schapiro assured Schumer in a phone call yesterday that the agency
plans to ban the practice, according to a statement from his office.
In a separate release, Schapiro said she has asked her staff to draft
rules that “quickly eliminate the inequity” that flash orders cause.
“It’s preferencing one group over another, and that’s not the way
markets should work,” said Michael Panzner, author of “The New Laws of
the Stock Market Jungle” who once traded for George Soros’s hedge
fund. “It certainly on its face seems unfair and up until now was
against the spirit, now perhaps against the actual rules, of fair
play.”
A ban would reverse decisions since at least 2004, when the SEC first
approved the systems at the Boston Options Exchange. Nasdaq OMX Group
Inc., Bats Global Markets, Direct Edge Holdings LLC and the CBOE Stock
Exchange give information to their clients about orders for a fraction
of a second before the trades are routed to rival platforms. The
technique is meant to give investors another opportunity to complete a
transaction.
Schumer told the SEC in a July 24 letter to halt flash orders, saying
he would propose legislation barring them if the agency didn’t act.
NYSE Euronext, the world’s largest owner of stock exchanges, as well
as brokerages Morgan Stanley and Getco LLC have said the practice may
result in investors getting worse prices.
30 to 90 Days
Schapiro said any proposal to ban the transactions would require
approval from SEC commissioners and public comment. SEC rulemaking is
usually a two-step process. The agency’s staff proposes a regulation,
and commissioners vote to solicit public feedback for between 30 and
90 days. Once the comment period ends, commissioners vote on whether
to make the rule binding. The SEC can speed up the process by issuing
temporary rules.
“These issues are very complex and not widely understood,” said
Lawrence Harris, a former SEC chief economist who is now a business
professor at the University of Southern California in Los Angeles.
“The consequence is that, occasionally, even experts will make
mistakes. Fortunately, the SEC has mechanisms to revisit decisions
that after the fact appear to be made with too much haste.”
Private Markets
Nasdaq and Bats said last week they support an industrywide ban on
flash orders. In a July 27 letter, Nasdaq Chief Executive Officer
Robert Greifeld urged the SEC to examine alternative systems that
don’t publicly display their orders to investors. The SEC should
examine whether the information in the flash trade is readily
accessible and clearly identifiable to brokers who have to execute
trades at the best price, Bats CEO Joe Ratterman said in a July 7
newsletter to clients.
Flash orders represented 2.4 percent of the shares traded in the U.S.
in June, according to the New York brokerage Rosenblatt Securities
Inc. At Direct Edge, which handles most of the flash volume, revenue
from its Enhanced Liquidity Provider program has helped it cut other
trading fees and more than double its market share since November.
A ban would help Direct Edge’s rivals, particularly NYSE Euronext,
Raymond James Financial Inc. analyst Patrick O’Shaughnessy wrote in a
July 27 report to clients.
NYSE Euronext, the only one of the top four U.S. exchanges that
doesn’t use flash orders, added 2 percent to $27.31 at 1:48 p.m. in
New York. Nasdaq shares rose 0.2 percent to $21.51.
Traders Yelling
Flash systems trace their roots as far back as 1978 to efforts by
exchanges to electronically replicate how a trader might yell an order
to floor brokers before entering it into the system that displays all
bids and offers. Markets have evolved since the days of floor brokers’
dominance, with computer algorithms now buying and selling shares
1,000 times faster than the blink of an eye.
“This is a relatively old concept. However, the electronification of
it makes it more dangerous than it used to be,” Sean O’Malley, a
former lawyer at the SEC’s division of trading and markets who is now
a partner at Goodwin Procter LLP in New York. “Computer-based trading
is going to be able to do things in a split second that no human could
have done. That’s something that the SEC probably hadn’t thought about
as much until this year.”
70% of Trading
The proposal may be a sign regulators are moving to stricter oversight
of so-called high-frequency trading, in which brokerages using
advanced computers execute thousands of transactions in a second.
Those strategies may account for 70 percent of trading volume,
according to O’Shaughnessy.
While flash orders make up a small fraction of high-speed
transactions, they have drawn the most criticism from investors and
traders. Goldman Sachs Group Inc. released a statement today in light
of the “complex landscape” surrounding high-frequency trading, saying
the strategy accounted for less than 1 percent of its revenue and that
it doesn’t use flash programs in executing client agency orders.
“Unfortunately, flash trading gives a bad name to high- frequency
trading,” said Irene Aldridge, author of “High- Frequency Trading: A
Practical Guide to Algorithmic Strategies and Trading Systems.” “Most
high-frequency trading has nothing to do with flash orders, so it’s
going to continue as business as usual.”
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