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July 6, 2009

Flash Point

By Nina Mehta

Jamie Selway, managing director at institutional broker White Cap Trading, believes that flash orders undermine aspects of Reg NMS, including the requirement that brokers and exchanges avoid locked markets. A locked market occurs when a protected bid equals a protected offer. "Firms are locking the market by design, but not by the SEC's definition," Selway said. "The problem with the way the SEC has architected this exception to quoting requirements is that it's now a private locked market instead of a public locked market. This kludge of a half-second definition is brand new."

Direct Edge's O'Brien draws a distinction between how the information his market disseminates is seen and what Nasdaq and BATS are doing. His flashes, he said, are sent out on a different data feed than the ECN's depth-of-book feed, while Nasdaq's and BATS's flash orders are not. As a result, the latter exchanges' feeds look like they're locking the market. (Last month, both exchanges added a flag to flashed orders to identify them for subscribers.)

Jamie Selway, White Cap Trading

In Selway's view, this argument clouds the point. The point, he said, is that order messages are being broadcast at prices that, effectively, lock protected quotes. This creates an elite tier of traders with access to better-priced orders than those receiving public quotes through the securities information processors, giving flash recipients an information advantage, he said.

In its letter, SIFMA made a related point. It complained to the SEC that flash orders raise "fair access issues." A two-tiered market, SIFMA wrote, will lead to a playing field in which "some [investors are] able to pay for a non-public direct feed to trade with better-priced quotes versus those quotes that are accessible to the general public." It also said that broker-dealers unable to readily distinguish flash quotes from protected quotes could run into compliance problems with Reg NMS and their best-execution obligations, since those obligations are tied to the official NBBO.

Best Execution

Flash orders could make satisfying best-execution obligations problematic by improperly influencing routing decisions as well. Several broker-dealers told Traders Magazine that the beneficial pricing associated with flash orders creates incentives for brokers to send flow to non-NBBO markets that have flash orders. Firms whose orders are flashed pay a lower liquidity-taker fee for those executions on Direct Edge than they do for regular executions. On Nasdaq and BATS, they get a rebate instead of paying a fee. (CBSX charges the same fee for regular and flash orders.)