SEC Reviewing "Hide Not Slide" and Other Order Types

Discussion in 'Wall St. News' started by Options12, Apr 8, 2012.

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    By Jean Eaglesham, Jenny Strasburg and Scott Patterson


    U.S. securities regulators are conducting a wide-ranging investigation into the complex relationships between rapid-fire trading firms and stock exchanges, according to the official overseeing some 20 probes into computerized trading.

    The inquiry into ownership and other ties is part of a broader probe into whether high-speed traders have unfair advantages over other investors, according to people familiar with the matter.

    "We're interested in understanding the ownership structure and history" of the firms, said Daniel Hawke, head of the Securities and Exchange Commission's market-abuse enforcement unit, in an interview. "How the firm got started, who was behind it and who wrote the [computer] code that might be at issue."

    One such area under SEC scrutiny is the use of routing and trading instructions, known as order types. Many investors use relatively simple order types, such as limit orders, which specify a price at which an investor is willing to buy or sell a stock.

    But exchanges also offer more sophisticated order types commonly used by rapid-fire traders that could potentially give them an edge over other investors, according to industry experts. Some allow computer-driven traders to hide orders and prevent them from routing to other exchanges, where the traders may have less control over the order execution.

    One order type, called "Hide Not Slide" and offered by the exchange operator Direct Edge Holdings LLC, is among those being scrutinized by the SEC, according to people familiar with the matter. The agency is also looking at a similar order type offered by computerized stock exchange BATS Global Markets Inc., the people said.

    Other exchanges also offer order types that share similar characteristics. Representatives of Direct Edge and BATS declined to comment.

    The SEC is examining whether such order types unfairly allow high-speed traders to jump ahead of other investors in an exchange's "order book," or the queue of buy and sell orders that are typically ranked by price and when they were received, according to people familiar with the matter.

    Another area of focus for the SEC are the rebates some traders earn from exchanges even as other investors pay fees to complete trades, say people familiar with exchange operations and the SEC probes.

    The SEC stepped up its scrutiny of these high-speed trading firms and exchanges after the May 6, 2010 "flash crash," when computerized trading triggered a 9% selloff within minutes.

    Some aspects of the SEC's inquiry are tied to at least one whistleblower, according to people familiar with the matter.

    One of the most prominent investigations involves BATS, which last month pulled its initial public offering after halting trading due to what it described as a software glitch. On the morning BATS shares began trading, The Wall Street Journal disclosed details of the SEC's investigation into whether superfast-trading firms have exploited their links to BATS and other exchanges to gain an unfair advantage over other investors.

    Hawke, who supervises the SEC's regional operations in Philadelphia, declined to comment on the specifics of any ongoing investigations, including the probe into BATS.

    The SEC's scrutiny doesn't imply that the agency believes the close relationships are an indicator of fraudulent conduct. None of the firms involved in the SEC investigation has been accused of wrongdoing.

    The probes won't necessarily result in any enforcement action. But if regulators determine that conduct harms some investors, the agency could seek to change existing rules, Hawke said.

    Computerized stock trading now accounts for two-thirds or more of all trading volume, experts say. The move has come amid overlapping relationships among trading firms and exchanges and the technology platforms that drive them. A number of individuals who worked on the technology systems at exchanges have taken jobs at computer-trading firms, raising questions about whether the firms are on a level playing field.

    The SEC probe involving BATS is looking at the trading activities of two of the Lenexa, Kansas, exchange's owners, high-frequency trading firms Tradebot Systems Inc. and Getco LLC, the Journal reported last month.

    Dave Cummings, Tradebot's founder, is also the founder and a current director of BATS. More than a decade ago, he wrote the original trading software code first used by both Getco and Tradebot, according to people familiar with the matter.

    Cummings said that he designed software for both Tradebot and Getco but the two companies are "completely separate" now. "It has been a decade or more since there has been any kind of direct work done together," he said. A Getco spokeswoman declined to comment.

    The flow of rebate payments is an area of interest in the BATS inquiry, say people familiar with the matter.

    According to a regulatory filing tied to its IPO, BATS in 2009 paid 51% of such rebates to a single firm, which it described as "an affiliate of one of our strategic investors." The filing doesn't give the firm's name.

    -By Jean Eaglesham, Jenny Strasburg and Scott Patterson, The Wall Street Journal;