• Sluggish data cited as potential harm to brokers’ clients
  • Potential bombshell tucked into footnote of Finra notice

Brokers have been put on notice: treat your customers’ orders as well as you treat your own.

The Financial Industry Regulatory Authority, Wall Street’s self-regulator, recently said firms using the fastest, most expansive price databases for their own stock trading must also use those so-called direct feeds when handling client orders. That means they can’t just rely on the decades-old repository known as the SIP -- which gives a slower view of trading that critics say exposes investors to predators.

The new guidance from Finra foreshadows a stepped-up effort by the regulator to police whether brokers are fulfilling their duty to give client orders the best possible execution. Michael Lewis’s 2014 book “Flash Boys” argued that high-frequency traders armed with powerful computers can exploit fraction-of-a-second time lags between the direct feeds and SIP to trade ahead of slower-moving investors.

“‘Flash Boys’ raised the question in everybody’s mind as to whether or not the SIP is the right way to go,” said Lee Schneider, an attorney at Debevoise & Plimpton in New York and former general counsel of brokerage Convergex Group LLC. “Finra is setting themselves up to bring enforcement cases on best execution with this guidance.”

Backbone of Trading

These feeds serve as the backbone of trading in the U.S. equities market, providing the mechanism for determining how much stocks cost at any given moment. Critics see an uneven playing field that’s made the business of trading stocks unfair for many.

The SIP -- which stands for securities information processor -- consolidates prices from the 11 U.S. stock exchanges and dozens of alternative venues to produce snapshots of the market. It’s been the benchmark for U.S. stock prices since the 1970s. But because it takes time to collect and collate the information from each market, the SIP ends up giving a slower view of trading than the feeds exchanges offer.

Because of that, the most sophisticated traders subscribe to the direct feeds from each exchange, generating their own analysis of the market. Doing so gives a more up-to-date picture of trading than using the SIP.

In the U.S. stock market, brokers are supposed to send trades to whatever exchange has the best price at the moment. In its new instructions, Finra described how brokers should go about determining what the best price is.

Footnote 12

“A firm that regularly accesses proprietary data feeds, in addition to the consolidated SIP feed, for its proprietary trading, would be expected to also be using these data feeds to determine the best market under prevailing market conditions when handling customer orders to meet its best execution obligations,” according to footnote 12 of the Finra regulatory notice released in November.

Even before Finra’s public guidance, brokers were grappling with the shortcomings of the SIP. Earlier this year, Bloomberg News reported that Goldman Sachs Group Inc. was upgrading its Sigma X dark pool to use direct exchange feeds as the primary source of price data. Sigma X had been using the SIP.

Finra’s guidance will be a wake-up call for some brokers that have traditionally looked to the consolidated tape to judge whether a customer got the best price for their trade, said John Standerfer, chief technology officer of S3 Matching Technologies in Austin, Texas.

‘Everything Is Good’

“If you’re a firm that has the proprietary feeds, you can no longer execute and say, ‘Hey, I got you guys the SIP price, everything is good,’ which is how a lot of things have historically worked,” said Standerfer, whose firm helps brokers measure how well trades are executed.

Not every firm will need to buy the exchanges’ faster price feeds, Finra spokeswoman Nancy Condon said. Brokers who only use the consolidated tape don’t need to purchase the direct feeds, she said. “You can’t use an exchange feed to place your own orders and then a different feed for customers,” Condon said.

Finra’s notice comes as brokers and exchanges wage a years-long legal battle over the cost of market-data feeds, which generate hundreds of millions of dollars in revenue annually for stock exchanges. Brokers have sought to overturn the U.S. Securities and Exchange Commission’s determination that prices are competitive, seeking evidence that would show exchanges enjoy a monopoly on the sale of the information.

Finra’s statement on the faster feeds shows that exchanges don’t face any competitive restraint on market-data prices, the Securities Industry and Financial Markets Association said on Nov. 25 in a filing with the SEC. The Finra notice elevates the importance of direct feeds and keeps brokers at the mercy of exchanges on the price of their market data, Sifma said. (Bloomberg LP, the parent company of Bloomberg News, is a Sifma member and is involved in the case.)

‘Captive Customers’

Exchanges may “have more captive customers” for their direct feeds as a result of Finra’s notice, said Jamil Nazarali, head of execution services at Citadel Securities, one of Sifma’s member brokers.

NYSE Group, a unit of Intercontinental Exchange Inc. that operates three equity markets including the New York Stock Exchange, and Nasdaq Inc. sent their own filing to the SEC, saying that Sifma’s reading of the Finra guidance was incorrect. It said Sifma’s letter was “based on mischaracterizations of the Finra notice” and tried to divert attention away from the competitive pricing of market data.

Peter Gau, a spokesman for Nasdaq, said the company’s policy is not to comment on pending litigation. Sara Cohen, a spokeswoman for NYSE, declined to comment.

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