NYSE Euronext, the biggest U.S. exchange operator, will pay $5 million to resolve regulatory claims that the New York Stock Exchange violated rules by giving certain customers a head start on trading information.
The NYSE sent data through two proprietary feeds to paying customers before relaying the information to the so-called consolidated feed, which distributes trade and quote data to the public, the Securities and Exchange Commission said in an administrative order filed today. Investigators are conducting similar reviews of other exchanges, according to two people with knowledge of the probes, which aren’t public.
The SEC penalty, the first of its kind against an exchange, comes as lawmakers and regulators question whether retail investors are being harmed in an increasingly fragmented marketplace of high-speed, computer-driven trading. NYSE’s practice was discovered in the SEC’s investigation of the so-called flash crash of May 2010, in which $862 billion was erased from equity prices in 20 minutes before recovering.
“The NYSE chose ground-shipping for sending market data to the consolidated feed but used next-day air for its paying customers,” Sanjay Wadhwa, deputy chief of the SEC’s market abuse unit, said in an interview.
The practice violated Regulation NMS, which obliges exchanges to give the public fair access to market information, the SEC said. The NYSE violated SEC rules “over an extended period of time” starting in 2008 by failing to monitor the speed of its proprietary feeds compared to the consolidated feed, the agency said in its order.
The violations stemmed from technology issues in NYSE’s Open Book Ultra and PDP Quotes proprietary data feeds. According to the SEC, about 80 percent of NYSE’s trading volume is attributable to such products, which customers use to make rapid decisions through computer algorithms.
NYSE also had a software problem that made its public data feed susceptible to delays during times of high trading volume. While the exchange began to address the problem in February 2010, only about half of the relevant computer servers had been fixed by May 6, 2010, the day of the flash crash, the SEC said.
Under the stress of record trading volume that day, the servers still running on the old software experienced delays of as long as 10 seconds on quotes they processed. The average processing times for the two proprietary feeds ranged from 2 milliseconds to 16 milliseconds, the SEC said.
“The timing differentials stemmed from technology issues, not from intentional wrongdoing by the exchange or any of its personnel,” NYSE Euronext Chief Executive Officer Duncan Niederauer, said in a statement. The company, which operates exchanges in the U.S. and Europe, will “ensure that our market operates with the utmost fairness and transparency,” he said.
While the SEC has previously faulted exchanges for misconduct by employees, today’s action marks the first time the agency has fined an exchange for having faulty systems that violated securities rules.
Direct Edge Holdings LLC and two electronic exchanges it operates were faulted by the SEC last year for having weak controls that led to about $2.8 million in trading losses and a systems outage. Bats Global Markets Inc., the third-largest U.S. exchange operator, said in February that it received a request from the SEC for information on its use of order types and “communications with certain market participants.”
NYSE Euronext completed systems modifications in 2010 and 2011 that eliminated the technology issues that were the subject of the investigation, according to its statement. The company, which didn’t admit or deny wrongdoing, also agreed to hire an independent consultant to assess its compliance systems.
“How does a retail or institutional investor not think the game is rigged when you see something like this,” Joseph Saluzzi, partner and co-head of equity trading at Themis Trading LLC in Chatham, New Jersey, said in an interview. “It’s not much different from knowing what’s in earnings report a minute before everyone else.”