Flash orders now a populist issue?

Flash orders have been a pretty big issue in the industry over the last year. We've certainly weighed in on the debate about these orders and on hi-frequency trading in general. But these rather arcane issues have exploded into a big, public issue as of late. Thanks in part to a front-page New York Times article about high-frequency trading in general--"it is suddenly one of the most talked-about and mysterious forces in the markets." 

The article jumped headlong into the issue of whether flash orders might be giving some hi-fi traders an advantage. The article riled up Sen. Charles Schumer, from New York, who went public with his concerns, prompting lots of coverage. He couched the debate in populist terms. "The integrity of our capital markets is being compromised by the ability of some insiders to view order information before it is available to the entire market," Schumer said in a letter Friday to SEC Chairman Mary Schapiro. This allows them "to profit from that information at the expense of other investors." 

Flash order are basically a new order type that are routed to specific firms just before they hit the public market. Direct Edge pioneered the idea, and still defends it. More recently, the Nasdaq and BATS have launched such orders. The CBOE also offers this order type. 

Flash orders generally work like this: A market center gets an order to buy that would otherwise be routed to the broad public market, part of the NBBO process. Instead, they disclose the order to some customers as a bid at the same price as the national best offer. Flash orders are displayed for up to 500 milliseconds. Most flash orders are displayed for much less. But that brief glimpse gives some hi-fi customers an advantage and allows the market center another shot at consummating the trade. Volume is the name of the game. Flash trades account for about 4 percent of volume now. But that could easily go higher. 

Critics contend that this arrangement essentially amounts to a private market and that it creates an uneven playing field and violates the idea of determining a best bid and offer via the interplay of all trade orders. The NYSE is staunch opponent of flash orders. One executive, at a recent conference, charged that Direct Edge's Enhanced Liquidity Provider was akin in "to the advance look at orders that NYSE specialists used to get. That practice was seen as giving specialists unfair advantages over other market participants, and potentially disadvantaging order senders." A Direct Edge executive shot back: "That's slander." Traders magazine says the panel discussion "almost ended in fisticuffs."  

Direct Edge, which pioneered the practice, opposes the ban proposed by Schumer. 

The issue may have to be decided by the SEC. The agency has ruled that any order being displayed for 500 milliseconds or less are exempt from Quote Rule, or Rule 602, in Regulation NMS. That rule requires market centers to make their best bids and offers through orders available publicly. There are exceptions for orders that are immediately executed or canceled. But the speed with which the market moves has advanced tremendously. There was a day when 500 milliseconds seemed like a short time. - Jim