The Return of Haim Bodek
Do you remember Haim Bodek? We first wrote about Haim back in October 2012 in a post titled “Who is Haim Bodek?”. Haim was the first whistleblower to expose how a major stock exchange (Direct Edge) created an order type (Hide Not Slide) that provided HFT firms with unfair advantages that propelled them to the exchanges’ best prices at investors’ expense. Back in 2012, the financial media was all over this story and market structure savvy journalists like Scott Patterson were able to shine a light on these shady exchange practices. Scott’s article “How “Hide Not Slide” Orders Work” was a virtual blueprint in how unsuspecting investors were getting ripped off by HFT traders who were armed with Direct Edge’s special order type. Direct Edge was subsequently fined $14 million by the SEC for failing to properly describe order types.
Haim has been relatively quiet for the past few years (at least publicly) but he has just resurfaced as the whistleblower in the latest SEC case against the NYSE. Last week, we wrote about the details of this case and how the NYSE was fined $14 million by the SEC for five serious violations. Haim Bodek was the whistleblower for the most serious – in our view – of these five violations in which the NYSE failed to state that pegging interest orders created the possibility of detection of prices of non-displayed depth liquidity.
We were outraged by the facts of this case and were sure that the financial media would cover the case similar to how they did back in 2012 with the Hide Not Slide scandal. But you know what we heard from the press? Crickets. Hardly a word was written. The WSJ covered the story in a very small article buried deep in the B section of the print edition which highlighted the case as “trading malfunctions”.
We felt that the contribution of Haim Bodek and his team has been overlooked so we reached out to Haim to get some more details about how he once again caught a major stock exchange with their hand in the cookie jar.
Haim told us that he thought everything in this case was the investigated very methodically and thoroughly by the SEC and that this case should encourage more whistleblowers to have confidence in the regulators’ readiness to pursue solid cases against key players in securities markets. Haim first learned of the NYSE pegging interest problem when a trader who had encountered it firsthand approached Haim for his assistance with solving this bug-like puzzle. In 2013, the trader (who remains anonymous) confronted the NYSE with a complaint that his non-displayed orders might be shadowed by other orders which would peg to the non-displayed order. The trader suspected this was occurring because he was placing non-marketable orders in illiquid securities and monitoring subsequent trading activity. Despite repeated interactions of the trader with NYSE, the exchange shockingly declined to fix the problem and concluded, as noted in the SEC order, that “the system had operated according to specifications.”
Culminating in a whistleblower complaint submitted to the SEC, Haim worked with the trader and formed a research team that included his long-standing counsel Shayne Stevenson of Hagens Berman LLP and Stanislav Dolgopolov who is the chief regulatory officer of Decimus Capital Markets. This team quickly put together the details of the case and realized that NYSE had created an order type that would allow pegging interest (PI) orders to peg to non-displayed interest. Haim’s team established that the shadowing was accomplished by the entry of thousands of pegged orders which went through floor broker pipes and used the pegging interest (PI) order type. These orders were placed by customers of the floor brokers and were non-bona fide orders that acted as a type of radar to identify non-displayed orders.
In November 2014, NYSE filed a rule proposal, which was later withdrawn, to explain that the “next available best-priced interest” to which PIs could peg included non-displayed orders. However, in March 2015, NYSE realized – with some pressure being exerted by the SEC – that they had a problem and decided to stop the information leakage by changing the order type to peg to only displayed interest through another (quickly approved) rule proposal.
Haim Bodek’s team was responsible for alerting the SEC to what was going on at the NYSE. He initially didn’t think that the complaint would result in a significant fine because it was so deep in the weeds of market structure and likely to disappear through technical housecleaning. But Haim was elated to see the SEC dig into the case and (as he assumes) reject whatever efforts were assuredly made by NYSE to try convincing the regulators it had done nothing wrong.
However, Haim was disappointed that the financial press did not take time to cover this story and bring to light what a major exchange was doing to investors. He wonders what has happened to the reporters like Scott Patterson. This is Haim’s fourth whistleblower case contributing to a significant monetary penalty imposed by the SEC. In fact, Haim has played a role in both of the record-tying SEC fines against securities exchanges, and he wants the world to know that, if you put together the right team, you can help correct bad behavior by working with the regulators even if that behavior is being perpetrated by a major exchange. While whistleblowers do get a share of SEC fines, the work they do is not easy. There are thousands of whistleblower complaints filed with the SEC every year, and very few ever get to collect a reward. Haim Bodek and his team performed a public service, and we as investors should all be thankful to them.