Bats Global Markets Inc. (BATS), the exchange operator preparing for an initial public offering, got a request from the U.S. Securities and Exchange Commission for information on the types of orders customers use on its venues.
The request from the SEC’s enforcement division, disclosed in a regulatory filing yesterday on the IPO, sought information about how order types have evolved at the third-largest owner of U.S. equity exchanges by volume. Bats said regulators asked for documents “related to the development, modification and use of order types, and our communications with certain market participants,” including some of Bats’ owners.
Bats and exchanges such as Nasdaq Stock Market and NYSE Arca offer multiple order types so traders can tailor transactions based on price moves or other conditions. Some of them give users control over when and how they execute a trade request while others allow firms to keep their place in line for orders or avoid routing to other venues. NYSE Euronext (NYX), which owns NYSE Arca, and Nasdaq OMX Group Inc. (NDAQ) are in New York.
“Order types are designed to incent different behavior in the market such as providing liquidity,” according to Adam Honore, research director at Boston-based Aite Group LLC, who said he had no specific knowledge of the SEC’s inquiry. “It may have to do with participant incentivization and whether or not all of that has been fair and equitable.”
The SEC asked for information on Lenexa, Kansas-based Bats’ information-technology systems and trading strategies, the filing said. Randy Williams, a spokesman for Bats, declined to comment. John Nester, an SEC spokesman, declined to provide further details.
The request is part of a broader probe of relationships between exchanges and some electronic trading firms, the Wall Street Journal reported today, citing people familiar with the matter that it didn’t identify.
Bats also said in the filing that its board approved a $100 million dividend for current shareholders the day before the IPO. Bats operates two U.S. equities markets, an options exchange and two European trading venues and is owned by a group of brokers including Morgan Stanley (MS) and Citigroup Inc. in New York and Chicago-based Getco LLC.
The company disclosed in the filing that its cash-and-stock purchase of Chi-X Europe Ltd. in November had a fair value of about $304 million.
Bats Versus LSE
The deal gave Bats a second alternative trading venue in Europe and a total market share of more than 23 percent of equity trading in the region, according to data it compiles. The London Stock Exchange Group Plc (LSE)’s two exchanges and Turquoise, which it owns in partnership with banks and brokers, have 24 percent. Bats said it intends to register as a European exchange this year.
Bats plans to enter at least two new markets by the end of 2014, the filing said. It’s considering an expansion into U.S. Treasuries, foreign exchange and U.S. futures, and may enter Canada and Brazil, according to the document. The company previously said it’s exploring the possibility of creating a Brazilian exchange with Claritas Investments, a Sao Paulo-based asset manager.
The number of U.S. stock and options exchanges has risen to 13 and nine, respectively. One way they try to differentiate themselves and win orders is with pricing plans. So-called maker-taker pricing, in which an exchange charges some firms to trade and gives rebates to those providing orders, is mainly used to compensate market makers and providers of bids and offers. Traders who execute against those orders pay a fee.
Exchanges using this pricing may also seek more business from firms by employing tiers for fees and rebates based on the amount of trading they conduct. The levels push brokers to consolidate orders on a particular venue to get the better pricing or use other securities firms to benefit from their ability to meet the volume requirements. Exchanges may tailor the conditions for better pricing to certain types of firms.
In May 2010, Bats changed a service customers used to hide the number of shares they were trying to buy or sell to provide additional anonymity. Chief Executive Officer Joe Ratterman said at the time that the exchange received “inquiries about our data feeds” from firms concerned about whether order IDs were disseminated on its data feeds and what type of information that conveyed to recipients.
‘Are They Aware?’
SEC Chairman Mary Schapiro said in a speech in September 2010 that competition among exchanges, alternative venues and brokers operating their own trading systems to match buy and sell requests had produced an array of different order types and proprietary data feeds. The electronic message streams offer information quicker than so-called consolidated data feeds, which aggregate trades or quotes from multiple markets. They may also provide information that’s not available publicly.
“Are they aware of potential conflicts of interest that could cause their orders to be handled in ways that may not be consistent with their best interests?” Schapiro asked about investors such as asset managers. “And, even if they are aware, is there a way for investors to effectively protect themselves by, for example, masking their strategies?”
Additional Bats owners include Bank of America Corp., Credit Suisse Group AG, Deutsche Bank AG, Instinet Holdings Inc.; JPMorgan Chase & Co.; the estate of Lehman Brothers Holdings Inc., Lime Brokerage Holdings LLC and Tradebot Systems Inc. Tradebot Chairman Dave Cummings founded Bats in 2005.
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