SEC Ban on Flash Orders Coming, says Sen. Schumer

The Securities and Exchange Commission intends to ban flash orders types available on several market centers, according to New York Senator Charles Schumer.

Schumer’s office issued a statement this morning noting that SEC Chairman Mary Schapiro had assured the senator her agency would ban flash orders. "SEC Chairman Mary Schapiro informed Schumer of the imminent ban–which she said would occur as part of a larger look at dark pools and high-frequency trading–in a personal phone call late Monday," the statement said. Bloomberg was first to report news of Schumer’s statement today.

SEC Chairman Mary Schapiro, in a statement, did not directly confirm Schumer’s comment, but noted that she has asked the SEC staff "for an approach that can be quickly implemented to eliminate the inequity that results from flash orders." The statement pointed out that "Under the rule-making process, such a proposal to eliminate the ability to flash orders would need to be approved by the Commission and open to public comment."

Her statement noted that the SEC’s focus on flash orders is part of a broader review of dark pools. "Earlier this year, I asked the SEC staff to conduct an overall examination of dark pools," Shapiro said in the statement. "This included a review of flash orders by exchanges and electronic trading systems. Flash orders are orders that flash in milliseconds to only a select group of market participants which can disadvantage other investors."

Direct Edge, an electronic communications network that has offered flash order types since 2006, said in a statement: "Direct Edge hopes the SEC will do what it said it would: look into flash orders in the context of a broader review of dark liquidity." These order types are used by retail and institutional broker-dealers on Direct Edge, according to earlier statements by the William O’Brien, the firm’s CEO.

Flash orders executed on Direct Edge and BATS Exchange accounted for 2.7 percent of consolidated market volume in June. Direct Edge’s June market share was 11.9 percent, while BATS’s share was 10.7 percent.

Flash orders, offered by Nasdaq, BATS, Direct Edge and CBOE Stock Exchange, are designed to enable these market centers to execute orders within their markets when another market is quoting the industry’s best price. In flash orders offered by Nasdaq and BATS, information about the marketable order is displayed in the exchanges’ proprietary data feeds to generate orders that will meet or beat the industry’s best price. Direct Edge sends order information to a group of "enhanced liquidity providers" to generate order responses.

Over the last two weeks, flash orders have commanded a lot of attention in the financial and mainstream media. This follows a series of articles on financial websites starting the week of July 20, and a New York Times article on July 24.

On the evening of July 24, Schumer raised this controversy, which has simmered in the trading industry, to new heights when he called for the SEC to ban flash orders. If it didn’t, he said, he would introduce legislation to ban these order types.

Schumer’s statement today said "Flash orders allow sophisticated high-frequency traders to gain access to trading information before it is sent out widely to other traders. For a fee, the exchange will ‘flash’ information about buy and sell orders for just a few fractions of a second before the information is made publicly available. These traders, using super-fast computers, can then act on that early information to trade ahead of the pending orders."

It is unclear what fee Schumer’s statement refers to. All liquidity-taking equities orders in U.S. exchanges and ECNs pay a fee to remove liquidity. The only exceptions are two small markets: the Nasdaq OMX’s Boston market and one of Direct Edge’s two markets. The fee to execute against flashed orders on Nasdaq and BATS is the same as it is for non-flashed orders. On Direct Edge, firms responding to flash orders do not pay any fee. They either execute for free or receive a rebate.

Schumer’s statement also highlighted the senator’s concerns about dark pools: "It is also important to make sure flash orders aren’t just the tip of an iceberg lurking in the dark reaches of the market. There is a lot of mystery about what goes on in dark pools and in the realm of high-frequency trading generally. I am confident the SEC will be able to separate valid innovation from other practices that give certain traders an unfair advantage over others."