Even The Stock Exchanges Are Confused About Their Own Order Types
The complexity of orders in the equity market is now even confusing the exchanges that have created these orders. We are referring to last week’s approval by the SEC of a change to the NYSE Arca PL Select Order type. You may recall that we wrote about this order type last year. The NYSE Arca PL Select order type is a hidden order entered on Arca which is designed not to trade with contra-side orders that are either ISO, IOC or are larger than the size of the PL Select order. At the time, we questioned why an exchange would want to roll out an order type which was discriminatory and designed not to trade. The SEC approved the order type last year even though institutional investors like T Rowe Price also expressed their concerns about the fairness of the order.
Well, here is where the story gets interesting. On September 21, 2012, NYSE Arca implemented the PL Select Order. Apparently, the developers of this order didn’t quite work through all the details and consequences of the order. Specifically, the PL Select Order was preventing ALO (Add Liquidity Only) orders from being entered on the Arca book. On December 7, 2012, NYSE Arca filed to amend their PL Select order:
“Based on the few weeks of experience with the new order type, the Exchange has identified an unintended business consequence in connection with the fact that PL Select Orders do not interact with incoming orders that are larger than the size of the PL Select Order. Specifically, in limited situations, the existence of a PL Select Order may prevent certain incoming opposite side interest from posting to the Arca Book.”
Wow, an unintended consequence of an overly complex and discriminatory order – who could have ever imagined that? We think it would have been reasonable and prudent for an exchange that discovers a flaw in an order type to simply voluntarily remove that order type from their system. But that is not what NYSE Arca did. They just went back to the SEC and asked to remove one feature of the order:
“The Exchange proposes to amend NYSE Arca Equities Rule 7.31(h)(7) to permit PL Select Orders to interact with incoming orders larger than the size of the PL Select Order.”
And what did the SEC do in response to this request:
“Based on the Exchange’s statements, the Commission believes that removing the restriction on PL Select Order as proposed and thereby allowing ALO Orders to post to the Arca Book, as intended, NYSE Arca should help to ensure that trading interest is able to interact on its market in an efficient manner. Accordingly, the Commission believes that the proposed rule change is consistent with Section 6(b)(5) of the Act.”
Approved. Of course, why would we expect the SEC to come back and request the entire removal of the flawed and controversial PL Select order? That would have been too difficult. It’s much easier to just approve these requests.
When will this insanity of adding controversial and complex order types stop? This was a perfect opportunity for the SEC to step in and highlight the dangers of a flawed order type and its unintended consequences. They could have used this as an opportunity for order type reform. But they once again chose to take the easy road and side with the exchanges.