We All Have To Up Our Game / Take Back Our Markets

Yesterday we wrote about Direct Edge’s Route Peg order – a hidden order that gets rebated, does not “take” liquidity, and can discriminate against who it trades against. It is designed to be traded through. And it is designed to subject the order’s originator to less adverse selection – a purchase has greater chance of going higher in price, and a sale has a greater chance of going lower. It was approved by the SEC.


In July we wrote of NYSE-Arca’s PL Select order– a hidden order that also gets rebated, does not take liquidity, is designed to be traded through, and can similarly discriminate who it trades against. It was also approved by the SEC.


NASDAQ has its Supplemental Order – also a hidden order that gets rebated, and discriminates against who it can trade with. It was approved by the SEC.


In numerous other notes, we have written about order types developed by the major stock exchanges – such as Direct Edge’s Hide not Slide, BATS Post Only and Partial Post Only orders, and NASDAQ’s Supplemental Order, Post Only, and Price to Comply orders. These order types have been amended several times in rule filings as well, specifically in 2012.


These order types all have at their core the intent of helping firms maximize rebate arbitrage. They all are designed to help firms “add liquidity”, and not take it, even if their price matches up with one of your orders on the exchanges.


The stock exchanges have been steadily and stealthily tipping the scales of economic benefit so that they accrue to their largest volume customers. That the largest HFT firms have been experiencing margin and profitability compression these last few years, as investors have been voting with their feet and leaving barren and toxic equity markets, might explain HFTs increased pressure on the exchanges to help them make money. However this money comes from somewhere – it comes from all of you.


In addition the ramped up rebate arbitrage game is distorting asset pricing in the markets. The majority of order flow is not buying because they think an asset will appreciate in price, or selling because they think it will depreciate; they are simply deploying a rebate maximization module.


These latest order types take this short-sighted and capital-destructive game to a new toxic level, however. We now have markets that allow segmentation of customers, and discrimination against customers. Best bids do not trade with best offers. The most simple and important capital exchanging metric has been subverted and turned on its head with little thought to what this means for price discovery of assets, and just as importantly with little solicitation of input from long term investors.


How and why does the SEC allow this to happen? Good question – we can’t figure it out. However we do know this: they are approving these rules submitted to them by the exchanges partially because they receive no comments on them by the industry.


Allow me to go Joe Biden on you all…


Folks, you literally need to all be speaking out and commenting to the SEC when these rules hit their website. This means you have to be watching the SEC’s website. Here is the section of the SEC’s website that involves Self-Regulatory Organization Rulemaking. It is broken down by specific exchange. Click on any one of the exchange links and have fun scrolling back to see just how busy the stock exchange lawyers have been in changing your stock market. And when you see a new rule proposal, read it, understand it, get your compliance departments to understand it, and comment. If you do not do this, you are in effect saying that you trust the instincts and intentions of all the for-profit stock exchanges to do what is in your best interests, and the best interests of our markets, and the best interests of investors as opposed to hyper traders.