Bats Pays $14 Million Settling Claims Markets Obscured Rules

Bats Global Markets Inc. is paying a record fine to settle allegations that two stock exchanges it bought last year obfuscated a central part of how their trading system worked.

Bats agreed to a $14 million U.S. Securities and Exchange Commission penalty to resolve the case, which contended that the Direct Edge markets didn’t accurately portray procedures known as order types, which are instructions on how to handle orders to buy and sell stocks.

“This is a serious violation with serious implications,” Andrew Ceresney, head of the Washington-based agency’s enforcement division, said on a call with reporters on Monday afternoon. “The idea here is that if you’re going to have order types, you need to specifically, completely and accurately disclose the nature of those order types.”

The settlement -- which surpassed the $10 million fine against Nasdaq OMX Group Inc. for its mishandling of Facebook Inc.’s initial public offering -- followed an SEC inquiry begun several years ago into key facets of modern markets, including order types. Critics including Haim Bodek, a former Goldman Sachs Group Inc. trader, alleged that the fastest traders used the dozens of order types available at exchanges to disadvantage other investors.

‘Quite Impressed’

“I was quite impressed by the level of sophistication the SEC took towards this case,” Bodek said in a phone interview today. “It’s completely knowledgeable about the intricacies of the market. I’d be very surprised if that competency that they’ve shown was just limited to just this one case.”

Order types are electronic instructions for trading shares that have become a flashpoint in the debate around high-frequency trading. Where in the past humans matched requests to buy and sell stocks, transactions are now usually filled by computers that critics contend are poorly understood by anyone but the most sophisticated traders.

“The SEC does not allege that there was anything inherently inappropriate about the order type functionality,” Bats said in a statement. “Rather, the SEC alleged that the price sliding functionality was not completely and accurately disclosed in Direct Edge’s rules.”

Among the concerns raised regarding order types is that their interactions are so complex that they effectively allow high-frequency firms to flout market rules that mandate investors receive the best price for stock they’re trying to buy and sell. As a result, questions about how orders can be used to jump in line at exchanges, or gauge the intent of other traders, have received greater scrutiny from regulators.

No Enforcement Action

The SEC also today said it had completed its investigation into Bats exchanges for order type violations and doesn’t plan to pursue any enforcement action.

“I hope this settlement starts a couple of trends: that the exchanges and other execution venues will better disclose how they update their rules and that the SEC will actually bring real enforcement cases,” said Dave Lauer, the president of consulting firm Kor Group LLC. Lauer added that it’s “disappointing” that Bats wasn’t required to admit wrongdoing. “It’s a good start, but we have a long ways to go to restore fair and efficient markets,” he said.

The settlement came months after Bats announced Bill O’Brien, who was Direct Edge’s chief executive officer, was leaving the company. Bats bought Direct Edge a year ago.

O’Brien’s five months as president of Bats included an appearance debating author Michael Lewis and IEX Group Inc.’s Brad Katsuyama on CNBC. Lewis’s book, “Flash Boys,” dubbed Katsuyama a hero for combating alleged unfairness in trading and accused exchanges and high-speed traders of rigging the stock market.

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