NYSE Euronext’s $5 million penalty over rule violations for giving certain customers trading data before the public delivers a fresh blow to the reputation of securities exchanges.
The New York Stock Exchange sent data through two proprietary feeds to paying customers before relaying the information to the so-called consolidated feed, which sells trade and quote data to the public, the Securities and Exchange Commission said in an administrative order filed yesterday. Investigators are conducting similar reviews of other exchanges, according to two people with knowledge of the probes, which aren’t public.
The SEC action follows the Nasdaq Stock Market’s flubbed initial public offering of Facebook Inc. in May and Bats Global Markets Inc.’s withdrawal of its IPO after a technology glitch in March, both of which undercut investor confidence that exchanges are in command of their technology systems. The agency is considering a new rule to mandate that exchanges and possibly brokers employ adequate automated systems to operate their markets and related platforms, according to Dave Shillman, an executive in the SEC’s trading and markets division.
“The overall reputation of exchanges has taken a bit of a battering in the last few months,” Sang Lee, managing partner at research firm Aite Group LLC in Boston, said in an interview. “Something like this certainly doesn’t help. At the end of the day, exchanges are supposed to be unbiased, providing market services fairly to all participants.”
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. The 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 flouted 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 disparity in data dissemination ranged from single-digit milliseconds to multiple seconds, the SEC said.
“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 an earnings report a minute before everyone else.”
The violations stemmed from technology advantages that benefited NYSE’s Open Book Ultra and PDP Quotes proprietary data feeds. One information stream used a faster path to get data to customers while another operated independently of the system that sent data to the public feed. According to the SEC, about 80 percent of the NYSE’s trading volume is attributable to proprietary products, which customers use to make rapid decisions through computer algorithms.
The 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. During two five-minute periods starting at 2:40 p.m. New York time, the average delays for quotes were 3.7 seconds and 5.3 seconds, while the average processing time for the two proprietary data feeds were less than 2 milliseconds and 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.
U.S. securities exchanges aren’t allowed to release data about trades and their best bids and offers to clients faster than they send it to the organizations that collect and disseminate it publicly. Exchanges earn money from the sale of subscriptions to proprietary and public data feeds.
Still, proprietary market data from an exchange enables high-frequency and other clients to get transaction-related information faster than the public since the content doesn’t have to be collected from all venues trading the securities and aggregated. The data may also include information that’s not public, such as the number of shares available at different prices. Exchanges share the revenue they receive collectively from the public feeds.
NYSE Euronext received $193 million for the sale of cash equities market data last year, according to a regulatory filing. That segment includes the sale of public data in the U.S. and some of the data revenue generated in Europe. It doesn’t include proprietary U.S. market data.
As part of the SEC’s focus on high-speed automated trading, the commission plans to boost requirements for exchanges by converting and expanding its automated review policy program into an “enforceable rule,” Shillman, associate director of the trading and markets division, said on Sept. 13 at a conference in New York. The rule may extend beyond trading systems to “market data provision, routing services, issuer services and the like,” he said.
While the SEC has previously faulted exchanges for misconduct by employees, yesterday’s action marks the first time the agency has fined an exchange for having inadequate 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.
“As investors and traders we need to understand that information is being distributed fairly and equally to the market,” Larry Tabb, chief executive officer of research firm Tabb Group LLC in New York, said in an interview. “Depending upon the investment style of different investors, the time delay may not be material, but we can’t have a market where structural inequalities present the optics that one class of investors has an advantage over another.”