Corporate & Securities Law

By Jim Hamilton

In a letter to SEC Chair Mary Schapiro, Senator Charles Schumer (D-NY) urged the Commission to ban the practice of flash trading that gives advance knowledge of stock orders to certain traders or he would consider introducing legislation to ban the practice in connection with optional pre-routing programs in order to ensure that trading in the capital markets is fair and transparent for all market participants. In his view, market integrity is being compromised by the ability of some insiders to view order information before it is available to the entire market and use electronic trading strategies to profit from that information at the expense of other investors.

Flash trading is a type of high-frequency trading, a technique that has gained attention recently for contributing to the spike in trading volume and, according to critics, increased volatility on U.S. exchanges. According to one industry estimate, high frequency trading accounted for $21 billion in profits in 2008.

Sen. Schumer?s concerns regard special programs offered by exchanges such as NASDAQ and BATS, as well as an electronic trading platform called DirectEdge. Each of these marketplaces currently allow sophisticated high-frequency traders to gain access to trading information before it is sent out widely to other traders. For a fee, the exchange will flash information about buy and sell orders for just a few fractions of a second before the information is made publicly available.

Specifically, he asked the SEC to prohibit the use of flash orders in connection with optional display periods currently permitted by DirectEdge?s Expedited Liquidity Program, NASDAQ?s Flash order program and BATS?s Bolt Optional Liquidity Program. Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public, he said, allowing those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity.

The practice can influence the pricing of stocks, experts say.
While conceding that pre-routing programs can benefit markets by providing additional liquidity, the senior Banking Committee member observed that this kind of unfair access seriously compromises the integrity of the markets and creates a two-tiered system under which a privileged group of insiders receives preferential treatment, depriving others of a fair price for their transactions. If allowed to continue, he warned, these practices will undermine the confidence of ordinary investors, and drive them away from the capital markets

Full post as published by Jim Hamilton's World of Securities Regulation on August 01, 2009 (boomark / email).