BATS Blames Market Rules for Mishaps
January 11, 2013
Regulatory Review
Executives at NYSE Euronext and Nasdaq OMX, the owners of the largest U.S. equity exchanges, called for a regulatory review last year. Joseph Mecane, head of U.S. equities at NYSE Euronext, said in September that the increase in venues, advances in technology and the use of increasingly complex orders warrant a coordinated assessment. Eric Noll, executive vice president and head of transaction services at Nasdaq OMX, told a U.S. Senate subcommittee last month that more testing and more coordination are needed.
Increased competition has improved technology and benefited investors, Direct Edge Chief Executive Officer William O’Brien said in June.
BATS’s error involved software written to handle the myriad order types that exchanges provide to automated-trading clients. The orders offer ways for them to optimize executions amid split-second price changes and within the strictures imposed by regulators. Among other responsibilities, venues must seek to prevent trades at prices inferior to the best levels available anywhere in the country.
Locked Market
Operators must prevent other violations, including a phenomenon known as a locked market, when a bid on one venue is the same price as the ask on another, rather than separated by a spread. Normally, a stock will be available for sale at a level a penny or more than the bid price. The maintenance of the gap, codified in rules adopted in the last decade as venues multiplied, has traditionally been viewed by regulators as a way to facilitate orderly trading.
BATS offers its users order types with price-sliding features designed to adjust to changes in the best national bid and offer while preventing markets from locking. The trades that shouldn’t have been permitted involved this type of order, Ratterman said. The company has no plans to eliminate the orders, which are often used by brokers and professionals to get the executions they seek, he said.
“The price-sliding is predominantly a reaction to the prohibition on locked markets,” Ratterman said. “It creates complexity in everybody’s systems. We’ve been advocating for some time we need an industry review of some elements” of Regulation NMS that govern locked markets, he said.
Inferior Prices
The violations also occurred in situations that programmers describe as a “race condition,” in which computers are communicating with each other in real time while adjusting to new information in the market. Computers that match orders for two BATS equity exchanges and an options venue allowed some trades to occur at prices inferior to the best available bid or offer and enabled others to violate rules for short sales, or bearish bets, the company said.
“We will most likely see more of these types of errors before investors’ disdain produces a government push to overhaul the marketplace,” Larry Peruzzi, senior equity trader at Cabrera Capital Markets LLC in Boston, wrote in an e-mail. “Maybe the old methods and dealing with people wasn’t so bad after all.”
BATS discovered the problem that involved almost 450,000 transactions on Jan. 4 through data inspections by its operations department looking for anomalies in transactions and how the exchange handles orders, Ratterman said. It informed the SEC and member firms on Jan. 9, he said.
