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July 6, 2009

Flash Point

By Nina Mehta

Nasdaq and BATS launched their flash order types partly because of Direct Edge's gain in matched market share in recent months. In May, the ECN's market share was 12.2 percent, compared with less than 7 percent in December. Nasdaq's share in May was 19.8 percent, while BATS's was 10.2 percent. Another reason for these latest flash order types, according to market participants, may have been Direct Edge's regulatory filing, in May, to convert its two ECN markets into exchanges. Becoming an exchange could give Direct Edge a market-share boost.

Nasdaq implemented flash orders to compete with Direct Edge. "This gets us on a level playing field with the competition," said Brian Hyndman, senior vice president for Nasdaq transaction services. "This benefits our customers, and client demand drove us to introduce this order type."

For BATS, offering flash orders, which it calls BOLT orders, was also a business decision. "We're going down the path we are because the SEC has said it's legal," said Joe Ratterman, CEO of BATS. "If they authorize other firms to employ similar programs, BATS doesn't want to be left at a disadvantage [based on] market structures other venues may use."

NYSE Euronext, despite frowning on flash orders, may wind up joining the party. Joe Mecane, executive vice president for U.S. markets at the company, notes that if the SEC allows these flash order types to stand, NYSE Arca would probably convert an existing order type into a flash-type interaction, and would look to more broadly disseminate that information. "If the SEC is implicitly allowing private access to information, we'll need to do it to be competitive," he said. NYSE Euronext may decide to offer flash orders on the NYSE as well, Mecane said. Nasdaq, for its part, is implementing a flash-type order this month on Nasdaq OMX BX, its Boston equities market.

In the Lurch

The primary argument against flash orders is that they create private markets and are therefore a step back for market structure. "These programs are creating a private locked market for a small group of participants, and they are holding up the execution process for that marketable order," Mecane said. He added that the Big Board operator isn't against dark pools, competition or innovative business models. "Our issue is that this creates a tiered market," he said.

Market maker GETCO told the SEC that by creating a two-tiered market, flash orders give professionals receiving the flashes a leg up over other investors. Non-public quotes could also "negatively affect the broader market, including retail investors who rely on the NBBO to ensure that their orders obtain the best, reasonably available price," the firm said. GETCO argued that flash orders, like dark liquidity that executes at the NBBO, also leave limit orders that established the best price in the lurch.