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.
Lenexa-based Bats agreed to a $14 million U.S. Securities and Exchange Commission penalty to resolve the case. Regulators contended that the Direct Edge markets — known as EDGA and EDGX — didn’t accurately portray procedures known as order types, which are instructions on how to handle orders to buy and sell stocks.
“These exchanges did not properly describe in their rules how their order types were functioning,” Andrew Ceresney, head of the agency’s enforcement division, said in a statement. “They also gave information about order types only to some members, including certain high-frequency trading firms that provided input about how the orders would operate.”
Bats bought Direct Edge a year ago.
In a statement, Bats said it entered into a settlement agreement with the SEC “without admitting or denying allegations, in order to put this matter behind us.”
The SEC also on Monday said it had completed its investigation into Bats exchanges for order type violations and doesn’t plan to pursue any enforcement action. Bats is the nation’s second-largest stock exchange behind the New York Stock Exchange.
A copy of the SEC action can be found here.
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 alleged that the fastest traders used the dozens of order types available at exchanges to disadvantage other investors.
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 is 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.
“I hope this settlement starts a couple of trends: that the exchanges and other execution venue will better disclose how they update 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.
Bats said it had created a reserve for the SEC settlement as part of its Direct Edge acquisition, and that the financial impact of the fine “is already reflected in its third quarter financial statement.”
The settlement came months after Bats announced Bill O’Brien, who was Direct Edge’s chief executive officer, was leaving the company.
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.