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July 1, 2011

SEC Bogged Down on Options Rules

By Peter Chapman

The Securities and Exchange Commission is unlikely to take action any time soon on two of the most important outstanding rule proposals affecting the options industry.

According to Heather Seidel, an associate director in the SEC's Division of Trading and Markets, the regulator is scrutinizing proposals that would ban so-called "flash" orders and cap exchange fees, but is not even close to ruling on them.

Heather Seidel

Seidel, who spoke at this year's Options Industry Conference, cited the regulator's workload as the reason for the holdup. "The Commission and the staff have a lot on our plates now and in the foreseeable future," she said. "I don't know that there will be any action on those proposals in the near future."

(Both the SEC and the Commodity Futures Trading Commission are struggling under the weight of converting the historic Dodd-Frank legislation into rules.)

Flash orders are unexecuted orders that exchanges "flash" to anonymous traders in hopes of a fill before routing them on to competitor exchanges. The SEC first proposed a ban on the practice in September 2009. It received several comments on both sides of the debate. In July 2010, still undecided, the regulator asked the public for more input, especially regarding the effect of a ban on the options industry. The comment period ended in August 2010, but the SEC never ruled. While the practice has largely faded away in the stock market, flashing still occurs at options exchanges.

Inextricably linked to the flash order debate is another SEC rule proposal that would cap exchange access fees in the options market. In April 2010, the SEC proposed capping the fees exchanges charge to trade in their markets at 30 cents per contract. Such a cap could make a ban on flash orders more acceptable to some brokers. Currently, flashing saves them money over routing if the destination is a more expensive exchange. A fee cap could reduce any such routing expenses.

"We support flash orders as a mechanism to control execution costs, particularly if you route out to an exchange that charges a high take fee," Marty Mannion, chief operating officer at Citadel Securities, said at OIC. "But the elimination of flash orders would be palatable if you also had a fee cap."

Mike West, a vice president in the transaction services group at Nasdaq OMX, on the other hand, prefers a ban. "We think flash should go in options," he said at OIC. "Better prices should be routed to. Exchanges offer functionality for an order not to be routed. If people don't want their orders to be routed, they should mark them 'do not route.'"

Seidel said a Commission ruling could go in any of three directions: (a) adopt as proposed, (b) adopt with modifications or (c) don't adopt. The attorney has spent about a dozen years working for the SEC, winning the SEC's Jay Manning Award for excellence in 2006. She intemittently worked in the legal department of Morgan Stanley and at the law firm of Wilmer, Hale and Dorr. Seidel was promoted to associate director at the SEC last October. With David Shillman, she directs the Division of Trading and Markets' Office of Market Supervision, which oversees stock and option markets.


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