SEC Strikes Down Nasdaq’s Latest Queue Jumping Proposal
We normally do not venture into the options market for market structure issues but we came across a SEC rule disapproval that we wanted to highlight. Before we get to the rule, it’s important to note that the options market has many of the same bad features as the equity market including the maker/taker model, fragmented market centers and multiple order types. Also, many of the major exchanges that have distorted the equity market are also the same players in the options market. While we have learned not to trust many of the exchange rule proposals in the equities market, the options market proposals seem to go unnoticed and do not often get challenged.
The rule change proposal that we are talking about was initiated by Nasdaq BX on February 21, 2013. Thankfully, there was one comment letter from NYSE Euronext which was extremely critical of the proposal and made the SEC pay close attention. While we are used to exchanges changing the rules to help out their high volume, high frequency clients, the audacity of the Nasdaq BX proposal stoops to new lows. Essentially, Nasdaq BX proposed a new, blatant queue jumping system that would have seriously damaged public order flow in the options market. Here is what they suggested:
“BX proposes to establish a directed order process that would permit members of BX to direct orders in listed options to a particular market maker on BX. As detailed below, a Directed Market Maker would be eligible to receive an allocated percentage of the Directed Order (40%) at all price levels at which the Directed Market Maker has a quote or order. To receive a Directed Allocation, the Directed Market Maker would be required to have quotes or orders at the National Best Bid or National Best Offer (“NBBO”) at the time of the execution of the Directed Order; the Directed Market Maker would not be required to be quoting at the NBBO at the time the Directed Order is received.”
Nasdaq BX wants to direct orders to their favorite their market makers and allow these market makers to jump the queue of public customer orders. Times must really be tough for the folks at Nasdaq because their proposal goes against everything that a fair and just market stands for. NYSE commented and clearly stated the problem of BX’s proposal to the SEC:
“NYSE Euronext noted that a Directed Market Maker that submits a quote after a public customer who has aggressively improved the NBBO would receive a Directed Allocation that the earlier-arriving public customer could potentially have completely filled.
According to NYSE Euronext, public customers would not be fully rewarded for providing an aggressive quote and thus the incentives to improve the NBBO would decrease, resulting in fewer displayed public customer orders and fewer public customers willing to improve the NBBO.”
“NYSE Euronext also notes the longstanding history of distinguishing public customers from professionals and allowing advantages to public customer orders. NYSE Euronext states its belief that BX is attempting to “turn this distinction [between a public customer and a professional] on its head” by providing preferential treatment to sophisticated professionals rather than public customers.“
The BX rebuttal to NYSE’s concerns would have been laughable if it wasn’t so sad:
“BX argues that customer priority is not mandated by the Act or the rules and regulations thereunder.”
Have they no shame? Is Nasdaq that blinded by bottom line profits that they would sacrifice customer order flow for the benefit of their HFT market makers? Thankfully, on October 25th, the SEC saw through this ridiculous scheme and shot it down. The SEC said:
“After careful consideration, the Commission does not find that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange
The Commission believes that BX’s failure to accord protection to public customer orders would result in an execution allocation that is inconsistent with Section 6(b)(5) of the Act, which requires that the rules of an exchange must designed, among other things, to protect investors. Specifically, rather than giving priority to public customer orders or placing public customers and Directed Market Makers on an equal footing, BX’s proposal would, by allowing Directed Market Maker quotes or orders to “jump” the price/time queue over previously received public customers limit orders, disadvantage public customer orders in order to give a trading benefit to Directed Market Makers in contravention of Section 6(b)(5) of the Exchange Act.”
To the SEC, we say “Bravo!”. To Nasdaq, we say “Shame on you!”.