interesting comments of Mr. Bright of Bright trading! http://www.sec.gov/comments/s7-02-10/s70210.shtml Lets voice our opinion on HF scum robots and such! Excellent response from Bright trading: http://www.sec.gov/comments/s7-02-10/s70210-63.pdf Robert W. Cook Director, Division of Trading and Markets Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-1090 Re: Meeting with Bright Trading, LLC on Equity Market Structure Dear Mr. Cook: We appreciate the opportunity to provide our comments, and address the Division of Trading and Markets, on File No. S7-02-10, the Commissionâs Concept Release on Equity Market Structure. We commend the Commission for taking the initiative to evaluate the current equity market structure. Bright Trading, LLC is one of the largest professional stock trading firms in the United States with hundreds of traders trading from offices and connected remotely from their homes. Bright has been registered in the US as a broker dealer with the Securities and Exchange Commission since 1992 and is also a member of the Chicago Stock Exchange. Bright is in the business solely for trading its own membersâ accounts and does not solicit nor accept orders from customers. All transactions are executed through our clearing broker, Goldman Sachs Execution and Clearing. In order to become a trader at Bright, each individual must become a Class B member of the limited liability company and must successfully complete the Series 7 general securities representative qualification examination as well as be registered with the Chicago Stock Exchange. Bright Trading has noticed a number of changes in the equity market structure over the past few years. While some of these changes have benefited the overall markets, other changes have raised significant concerns for us. We have outlined a number of our concerns with the current market structure below. Underlying Problem: Undisplayed Trading Centers Compromising the NBBO through Sub-Penny Trading Sub-pennying An abusive strategy that has been occurring with increased frequency is a practice called âsub_ pennyingâ. It is the practice of a market participant stepping in front of a displayed limit order by a fraction of a cent. The explicit purpose of this strategy is to preempt the NBBO. Evidence: Appendix A, B, C, D, E, F, G, H, I. SEC rule 612 prohibits market participants from displaying orders in a sub-penny increment. Most broker-dealers will not even accept these sub-penny orders from their customers. Broker-Dealer Internalization However under SEC Rule 612, broker-dealers themselves are allowed to provide âprice improvementâ to their customers. When an investor places a market order from their retail brokerage account, their broker-dealer routes this order to their OTC market maker. The market maker then decides if they want to trade against their customer, by taking the opposite side of the order. If the market maker believes they can make money by trading against their customer, they will fill the order from their own inventory. In this case, the market order never makes it to the public exchange. This practice is known as broker-dealer internalization. Statistics from the Commissionâs Concept Release on Equity Market Structure, state that 17.5% of all trades are internalized by broker-dealers. A more alarming statistic from page 21 of the release states that, âa review of the order routing disclosures required by Rule 606 of Regulation NMS of eight broker-dealers with significant retail customer accounts reveals that nearly 100% of their customer market orders are routed to OTC market makers.â This means that almost every single market order placed in these retail brokerage accounts, is checked by the broker_ dealerâs OTC market maker to decide if they can make money by trading against their customer. They can legally trade against their customers as long as they match or beat the National Best Bid and Offer (âNBBOâ). Nominal Price Improvement Broker-dealers will often beat the NBBO, by a nominal amount, often as little as 1/100th of a penny. This gives them justification for internalizing the trade, because they saved their customer a fraction of a cent. But this savings does not justify the cost to the true liquidity provider that was left unfilled. To put this into perspective, consider a stock offered at $25.00 on the public exchange, the best posted ask price. An investor buying 100 shares of this stock would pay $2,500.00. When the broker-dealer internalizes the fill, and beats the NBBO by 1/100ths of a penny, the investor only pays $2,499.99, a savings of 1 cent. This nominal price improvement of 1 cent, does not justify the unquantifiable loss of the lost trading opportunity, to the person who was publicly offering the stock at $25.00. This person, the true liquidity provider, is left holding the stock. Evidence: Appendix J. Dark Pools Being Used To Hide in Front of the NBBO If the broker-dealer decides to pass on the opportunity to trade against its customer, the order is routed to the exchange. Many broker dealers use smart routers that check âdark poolsâ of liquidity for a better price. A dark pool is an execution venue that provides liquidity, but does not provide public quotations. In other words, it is a place where a trader can place hidden orders. Algorithmic programs can place hidden orders that automatically sub-penny the NBBO. This can be easily done by pegging the order to the NBBO, with a sub-penny offset. For example, the NBBO offer from the above example was $25.00. An algorithmic program can be created to peg a sell short order to the NBBO offer with a -.0001 offset, and be sent to a dark pool. Even though the public NBBO offer is $25.00, the algorithm has a hidden sell short order at $24.9999. If the public offer were to move down to $24.99, the algorithmic program automatically adjusts its offer to $24.9899. In essence, the algorithmic program is always hiding in front of the NBBO. This sub-penny order does not violate SEC rule 612, because the $24.9899 order is not displayed. A market order that was sent via the smart router searches out the better price and is executed at the hidden $24.9999 price. Again, the displayed liquidity provider is not filled. Evidence: Appendix H, Appendix I. Discouraging Liquidity Providers The only time the displayed order on the NBBO is filled from an incoming retail market order, is when the OTC market maker of the broker-dealer passes on the chance to trade against its customerâs order, and there are no undisplayed orders hiding in dark pools in front of the NBBO order. As a result the only retail orders getting through to the publicly displayed NBBO, are the orders that the first two market participants have passed on. If the first two participants have passed on the opportunity to trade against the order, there is a good chance that the incoming market order is on the right side of the market (in the short-term). Hence, the only NBBO orders that are filled are those that are more likely wrong (in the short-term). The displayed liquidity provider is âsub-penniedâ when theyâre right, filled when theyâre wrong. As liquidity providers become discouraged, they will place fewer passive limit orders in the short term and ultimately leave the trading markets. This will lead to less depth in the market and larger spreads, both increasing the cost to investors in the long term. Algorithmic systems being used to Preempt NBBO in displayed market centers Another predatory practice that is extremely prevalent in our current market structure, is displayed âpennyingâ, where an algorithmic system automatically steps in front of a displayed order by a full cent. The reason for this practice, is to be first in line for execution. While this practice is an annoyance to active investors, and active traders, it is not as damaging as the âsub_ pennyingâ that goes on in the undisplayed market centers. This is a predatory practice that is extremely prevalent in thinner issues, as the typical bid-ask spreads are much wider than 1 cent. This problem does not exist in the most actively traded issues. This could however become a serious problem, if the public exchanges are allowed to quote in sub-pennies as well. Sub-Pennies for Everyone â Not the Answer The public exchanges have recently disclosed their interest to quote in sub-pennies. They need a level playing field to compete with the undisplayed market centers (broker-dealer internalization, and dark pools), so they are proposing a move to displayed quotes in 1/10th of a penny increments. This is simply not the answer to the sub-pennying issues.