An Open Letter to the SEC’s Investor Advocate


In February 2014, the SEC named Rick Fleming to be the first head of the agency’s Office of the Investor Advocate. Today, we have penned an open letter to Mr. Fleming concerning recent stock exchange rule proposals.

Dear. Mr. Fleming,

We have been encouraged by some of your recent comments about the role of a stock exchange.  In particular, on October 16, 2015  you stated :

“In considering a proposed change to an exchange rule, the Commission publishes the proposed amendment for public comment. However, given the volume of rule filings, it is difficult for the public to keep track of them all, and few individual investors, if any, typically submit comments for Commission consideration.

The Commission maintains a thorough review process for exchange filings, and the Commission staff carefully scrutinizes each filing under the federal securities laws. However, given the general lack of awareness of such filings among investors, the exchanges may have come to expect little scrutiny from investors of their routine proposals. Those days are now over.”

Also, last week in a speech titled “The Falling Leaves of the Buttonwood Tree” you spoke about the lack of comment letters received by the SEC concerning exchange rule filings.  You stated that in 2015, exchanges filed 1,050 proposed rule changes and the SEC received a total of only 38 comment letters on these changes.  In that same speech, you spoke about the conflict that now exists with for-profit exchanges and their self-regulatory function:

More broadly, in an age of for-profit exchanges, where exchanges have an inherent conflict between the interests of investors and their own bottom lines, it may be time again for the Commission to confront the larger question of whether it makes sense for a for-profit business to be entrusted with the regulatory responsibilities of an SRO. Based upon the evidence I’ve seen so far, I believe investors have cause for concern.”

​Over the past few years, we have consistently pointed out many conflicts that exist at the for-profit exchanges and have often published our findings on our blog and in our book “Broken Markets”.  For example, in 2010, we published a white paper titled “Data Theft on Wall Street” which exposed that some stock exchanges were leaking confidential information on hidden orders through their private data feeds.  After our paper was published, many institutional investors expressed outrage and were able to get the exchanges to change this practice.  Unfortunately, we continue to find more and more examples of conflicted behavior by the exchanges in these SEC rule filings.

Here is the latest example of another source of information leakage that we discovered in an exchange rule filing:

On February 19th, 2016, the Direct Edge Stock Exchange (which is owned by Bats) filed a “Proposed Rule Change to Rule 11.6, Definitions, to Amend the Operation of Orders with a Non-Displayed Instruction and Orders with Reserve Quantity”

Essentially, this rule change is detailing how Direct Edge was posting displayed orders to other trading centers that were supposed to be non-displayed.  The filing states:

“Non-Displayed is an instruction the User may attach to an order stating that the order is not to be displayed by the System on the EDGX Book. A Reserve Quantity is the portion of an order that includes a Non-Displayed instruction in which a portion of that order is also displayed on the EDGX Book. Both the portion of the order with a Displayed instruction and the Reserve Quantity are available for execution against incoming orders. Under the Post to Away routing option, the remainder of an order that was previously routed away and returned to the Exchange may be re-routed to and post on the order book of a destination on the System routing table as specified by the User.

Currently, orders with a Non-Displayed instruction or Reserve Quantity that are routed to an away Trading Center pursuant to the Post to Away routing option are routed as fully displayed orders. The Exchange proposes to include a Non-Displayed instruction or to include a Reserve Quantity on orders routed to an away Trading Center. The Exchange believes doing so is consistent with the original intent of the order, to be Non-Displayed or to include a Reserve Quantity.”

The problem seems to occur when a client selects the “Post to Away” strategy which is a routing strategy that posts liquidity to another exchange.  Rather than posting an order as a non-displayed order, the trading center that received the order from Direct Edge posted the entire order as a displayed order.   In the filing, Direct Edge states that this rule proposal will become effective immediately.  We agree that Direct Edge should make this change immediately but we are more concerned about the potential damage that the “Post to Away” strategy might have caused to their clients.  Is anybody at the SEC going to track down the amount of times Direct Edge displayed the entire size of an order?  Is the SEC able to quantify the damage that this exposure could have cost the investor who posted the order?

If we hadn’t seen this proposal, would the SEC simply have approved it and moved on?

As the SEC’s Investor Advocate, we trust that your office will follow up on this latest Direct Edge proposal and find out if any investors were harmed.  In the meantime, we’ll continue to do our job and highlight the exchange rule filings which we think can harm investors.


Your friends at Themis Trading