The Securities and Exchange Commission announced that two exchanges formerly owned by Direct Edge Holdings and since acquired by BATS Global Markets have agreed to pay a $14 million penalty — the SEC’s largest against a national securities exchange — to settle charges that their rules failed to accurately describe the order types being used on the exchanges.
This case against the EDGA Exchange and EDGX Exchange is the SEC’s first principally focusing on stock exchange order types, according to the SEC’s statement on Monday.
An important category of an exchange’s rules is the operation of its order types — which the SEC defines as “the primary means by which market participants communicate their instructions for the handling of their orders to the exchange” — so that its members and all other participants in trading on an exchange can understand the terms and conditions under which trading is conducted.
From the time EDGA Exchange and EDGX Exchange began operating as registered exchanges in 2010 until late 2014 (when they finally updated their rules and obtained Commission approval for the changes), the two exchanges were supposed to be processing orders using a single “displayed price sliding process” according to their rules. And, according to the SEC, exchanges and other self-regulatory organizations are required under federal securities laws to obtain commission approval for rules governing order types and operate in compliance with their own set of rules as approved by the SEC.
However, rather than the stated single displayed price sliding process, the two exchanges were actually offering three variations of “price sliding” order types: “hide not slide,” “price adjust” and “single re-price,” which were not completely and accurately described in their rules.
“These exchanges did not properly describe in their rules how their order types were functioning,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement, in a statement. “They also gave information about order types only to some members, including certain high-frequency trading firms that provided input about how the orders would operate. Exchanges must ensure that their order types are described accurately in their rules and communications to all members.”
As Ceresney stated, the SEC’s investigation found that the exchanges separately disclosed information about how those order types operated to some but not all of their members.
According to the SEC’s order instituting a settled administrative proceeding, the EDGA and EDGX exchanges provided complete and accurate information about the order types to only some members, including certain high-frequency trading firms that Direct Edge also solicited for input about how the “hide not slide” order type should operate. Direct Edge originally developed this order type following a request from one of the firms. “Although the exchanges provided information about the ‘hide not slide’ order type in technical specifications made available to all members,” according to an SEC statement, “those technical specifications did not contain fully accurate information. This created a significant risk that not all market participants would understand how these order types operated.”
Without admitting or denying the SEC’s findings, EDGA and EDGX agreed to accept a censure, pay the $14 million penalty, and cease and desist from committing these violations. According to the SEC, EDGA and EDGX also agreed to comply with various undertakings, including a requirement that they develop new policies and procedures relating to order types.
This is the SEC’s second enforcement action against the Direct Edge exchanges. In October 2011, the commission sanctioned EDGA Exchange, EDGX Exchange and their affiliated routing broker Direct Edge ECN LLC for violations of U.S. securities laws arising out of weak internal controls that resulted in millions of dollars in trading losses and a systems outage. At this time, the SEC ordered remedial measures in connection with two systems incidents occurring in November 2010 and April 2011.
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