For the second time since Christmas, a major U.S. stock exchange operator has announced discrepancies in how its computer systems price and prioritize complex trade orders routed through the exchange.
Direct Edge, which operates the EDGA Exchange and the EDGX Exchange, disclosed in a Dec. 28 trading notice and a Jan. 11 update that it had discovered two separate discrepancies that may have led to poor pricing for some customers.
The company said it fixed one of its computational problems in time for trading January 14. The other won’t be fixed until “on or about February 15.”
The discrepancies were in how orders were being prioritized on its two platforms and were in violation of Direct Edge’s own order priority rules, the exchange said. Not disclosed is how or when the discrepancies came to light or how many trades were affected in each case. Also not known is how much money might have been lost by customers due to these discrepancies.
“We don’t have any comment outside the trading notice,” said Direct Edge spokesman James Gorman, in an email message.
Last week, BATS Global Markets Inc., like Direct Edge an upstart rival to the New York Stock Exchange and the Nasdaq Stock Market, announced it had found anomalies in its trading systems that allowed some trades to occur at prices less than the best available bid or offer price. BATS also said it had discovered violations of short-sale rules. BATS estimated its customers lost more than $420,000 because of rule violations.
“This is infuriating,” said Eric Hunsader, chief executive of Nanex, a Chicago-based developer of streaming market data technology. “It’s like they don’t even look at their code.”
Much of the problem lies in the overly-complex and fragmented nature of the exchange market, and how each of the 13 exchanges only looks out for themselves, Hunsader said. “No one is looking over the market as a whole, and there’s no incentive to play nice.”
The first discrepancy discovered and reported by Direct Edge involved Intermarket Sweep Orders (ISOs) that were “permissibly” locking the National Best Bid and Offer (NBBO) on the EDGA Exchange, as well as EDGA-Only sell orders that were ranked on the EDGA Book at the locking price.
Direct Edge found that once these orders locked in the NBBO price, certain other sell orders were being placed ahead of them even if those orders arrived after the price-lock was established.
Direct Edge said this discrepancy had been occurring since August 2011. In its January 11 update, Direct Edge confirmed it had “successfully tested and implemented system changes on EDGA to ensure orders are assigned priority precisely as set forth” in the company’s order priority rules. Those changes went into effect on Jan. 14, the company said.
The second discrepancy discovered and reported by Direct Edge in the Dec. 28 trading notice, involved the exchanges’ Matching Engine and crossed-market, odd-lot orders or other non-displayed orders that may not have been executed in the most price-efficient manner, possibly resulting in losses for customers.
Direct Edge said this discrepancy may have occurred on either EDGA or EDGX and had been affecting the system since the time both exchanges were launched in July 2010.
Direct Edge said in the December notice that its second discrepancy should be fixed by Feb. 4, however, in its follow-up notice, the company pushed that date back to Feb. 15. Direct Edge said in the later notice that “[t]he additional time will be used for further testing of the system change prior to implementation.”
The issue with BATS and Direct Edge comes at a time when traders, regulators and market observers are growing more concerned about the complexity of “unique order type combinations” that provide buy or sell instructions, as well as the efficiency of the order prioritizing systems and pricing mechanisms used by the myriad exchanges that buy and sell securities on a daily basis. Indeed, these system discrepancy disclosures have occurred following a period that has seen breakdowns on U.S. exchanges, rapid-fire trading mishaps, and the infamous Flash Crash, all which have raised red flags on the integrity of the nation’s electronic trading infrastructure.
“These announcements don’t leave me with a lot of confidence that this will be the last of them,” Nanex’s Hunsader said.
Daily volume on Direct Edge’s two exchanges in 2012 averaged 724.1 million shares, according to the Securities Industry and Financial Markets Association.
Daily volume at BATS’ two exchanges was 759.0 million. Volume at Nasdaq’s three exchanges totaled 1.7 billion shares a day; and NYSE’s three exchanges came in at 1.4 billion, by SIFMA’s tally.
