by Bill Singer
On Sept. 14, 2012, the Securities and Exchange Commission announced an historic regulatory action resulting in the implementation of an order against the New York Stock Exchange for compliance failures that gave certain customers an improper head start on trading information. The NYSE and its parent company NYSE Euronext settled the charges pursuant to a $5 million penalty and various undertakings. This is the first SEC financial penalty against an exchange. In the Matter of New York Stock Exchange LLC, and NYSE Euronext, Respondents (Order Instituting Administrative And Cease-And-Desist Proceedings Pursuant To Sections 19(H)(1) OoAnd 21c Of The Securities Exchange Act Of 1934, Making Findings And Imposing Sanctions And A Cease-And-Desist Order, 1934 Act Release 67857 / Admin. Proc. 3-15023, September 14, 2012).
The Order found that the NYSE violated Rule 603(a) of Regulation NMS and the record retention provisions of Section 17(a)(1) of the Securities Exchange Act and Rule 17a-1, and NYSE Euronext, which supplied the personnel responsible for these systems and compliance, caused the violations. The NYSE and NYSE Euronext agreed to a settlement without admitting or denying the SEC’s findings. The Order Censured the NYSE, imposed a $5 million penalty, and required both the NYSE and NYSE Euronext to cease and desist from committing or causing these violations. Further, the NYSE and NYSE Euronext are required to retain an independent consultant to conduct a comprehensive review of their market data delivery systems to ensure that they comply with Rule 603(a).
Bill Singer
The Order alleged that the NYSE violated Regulation NMS (“National Market System”),which seeks to ensure that the public has fair access to current market information about the best displayed prices for stocks and trades that have occurred. The NYSE was charged with violating Reg NMS when, starting in 2008, it transmitted data through two of its proprietary feeds starting before sending data to the consolidated feeds. Such conduct resulted in preferential treatment for those receiving the early data, even though such an advantage is measured in milliseconds. Given the high-frequency trading parameters of today’s markets, such seemingly minuscule timeframes do result in substantial and meaningful advantages.
As set forth in the Order (footnotes omitted):
Accordingly, exchanges are required to send their best-priced quotations (or “quotes”) and trade reports to be included in the consolidated feeds. Exchanges also are permitted to distribute customized market data products directly to customers. However, to preserve the integrity of the consolidated feeds, a Commission rule—Rule 603(a) of Regulation NMS—requires that exchanges distribute market data on terms that are “fair and reasonable” and “not unreasonably discriminatory.” This rule prohibits an exchange from releasing data relating to quotes and trades to its customers through proprietary feeds before it sends its quotes and trade reports for inclusion in the consolidated feeds.
The disparities in data transmissions that Rule 603(a) prohibits can have important consequences that risk undermining investor confidence and interfering with the efficiency of the markets. For example, a delay in the release of data to the consolidated feeds in contrast to the proprietary feeds can cause an investor relying on the consolidated feeds to make a trading decision based on a potentially stale picture of current market conditions. An exchange’s delay in sending its quotes to the consolidated feeds also can cause inefficient execution decisions at other market centers and, under some circumstances, create the appearance of a “crossed” national best bid and offer (“NBBO”), which occurs when the best bid exceeds the best offer. The appearance of a crossed NBBO can cause both uncertainty and the risk of a trade being executed at worse than the best available price.
The NYSE earns revenue from selling market data through proprietary data feeds and the two NYSE proprietary data feeds cited in the Order were
An internal NYSE system architecture gave one of the data feeds a faster path to customers than the path used to send data to the consolidated feed. Also there was a software issue in the internal NYSE system that sent data to the consolidated feed. Accordingly, such preferential practices violated Rule 603(a) of SEC Regulation NMS.
As to the conduct of NYSE’s compliance department in monitoring such practices, the Order found that this critical first-line of regulatory defense was largely missing-in-action and not involved in important technology decisions, including the design, implementation, and operation of NYSE’s market data systems.
Further, the Order asserted that under Rule 603(a) the NYSE was required to retain computer files about its transmission of market data, including the times that NYSE sent data to be included in the consolidated feed, but that said files were not archived, thus hamstringing the NYSE’s ability to determine when it experienced delays sending data and calculate the length of delays when they occurred.
Bill Singer‘s Comment
On the heels of the recent Knight Capital implosion, the Facebook / NASDAQ IPO debacle, the MF Global vanishing act, and assorted missteps and miscues by Morgan Stanley Smith Barney, JP Morgan, and other iconic Wall Streetparticipants, we now have the cherry atop the rotting cake: the venerable New York Stock Exchange can’t seem to figure out how to run a fair casino.
I could go on and on with this but how about I just leave you with this classic scene from the movie Casablanca:
Rick: How can you close me up? On what grounds?
Captain Renault: I’m shocked, shocked to find that gambling is going on in here! [a croupier hands Renault his winnings]
Croupier: Your winnings, sir.
Captain Renault: Oh, thank you very much. Everybody out at once!