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July 6, 2009

Flash Point

By Nina Mehta

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All four markets with flash orders treat these orders in a similar way. If they get a marketable buy order, for instance, that would otherwise be routed to a market quoting at the NBBO, they flash the order to some or all of their participants as a bid at the same price as the national best offer. Exactly who sees the flash, how that information is conveyed and the duration of the flash vary by market. The maximum allowable time for a flash is 500 milliseconds, or half a second, although most of the markets flash routable orders for under 30 milliseconds.

NYSE Euronext's anti-flash tirade didn't end with the SIFMA conference. The exchange operator, along with market-making firm GETCO and SIFMA, weighed in on the Nasdaq and BATS flash order types with formal letters to the Securities and Exchange Commission. NYSE and SIFMA urged the SEC to abrogate the Nasdaq rule filing and reject BATS's filing. All three pushed the SEC to study the potential impact of flash orders on the marketplace before deciding whether to give them free rein.

NYSE and GETCO charged that markets with flash orders were essentially running private markets of quotes for select participants that competed with the public quote stream. With Nasdaq and BATS rolling out new order types to combat Direct Edge, the upshot, in their view, was bad market structure and probably eventual harm to investors.

These firms and SIFMA argued that flash order types call into question some of the basic tenets of the equities market structure. In various combinations, they claimed that the effort to keep flow in-house undermines the concept of a quotation, impairs the meaningfulness of the NBBO, jeopardizes liquidity provision by hurting liquidity providers quoting at the NBBO, and potentially upsets the pursuit of best execution.

The Quote Rule

The SEC is carefully tracking the flash issue. David Shillman, an associate director at the Commission's Division of Trading and Markets, said at the SIFMA conference that flash orders lasting less than 500 milliseconds fall within an exception to the Quote Rule, or Rule 602, in Regulation NMS. The Quote Rule requires all market centers to publicly disseminate their best bids and offers through the securities information processors. The exception is for orders that are immediately executed or canceled.

Joe Mecane, NYSE Euronext

However, the SEC's thinking on this issue isn't settled and may be re-examined, Shillman said. "It's an open question as to whether the Quote Rule should be modified, whether it is really necessary to have that [exception] in the electronic world," he told the SIFMA crowd.