At the core of the NYSE Rulebook are the underlying notions of just and equitable principles of trade and sound business practices. The rules are designed to prevent fraudulent or manipulative acts and practices, and provide a means by which NYSE Regulation can take appropriate disciplinary actions against its membership when rule violations occur.
By Tom Lauricella and Jenny Strasburg
Regulators are scrutinizing what some in the stock market are calling "quote stuffing," trading in which unusually large numbers of orders to buy or sell stocks are placed in a fraction of a second, only to be canceled almost immediately.
The Securities and Exchange Commission has begun looking into whether the practice is putting some investors at a disadvantage by distorting stock prices, according to people familiar with the matter. The SEC is looking at what role, if any, quote stuffing played in the May 6 "flash crash," when the Dow Jones Industrial Average collapsed 700 points in minutes, the people say.
Traders say the phenomenon of huge bursts of orders flooding stocks and then getting canceled has risen with the growth of high-speed computerized trading in recent years.
In addition, the SEC is looking into another practice in which large numbers of orders are placed. In these cases, what's unusual is that the orders are priced in increments as small as one-tenth of a cent and far away from the actual price at which a stock is trading, says a person familiar with the line of inquiry.
The SEC is seeking to learn whether such orders, known as "sub-penny pricing," are used to manipulate the market, this person says, which would be illegal. At issue is whether the practice could artificially torpedo stocks' prices or help make it appear that there is more trading volume in a stock than there really is, allowing sellers to profit when demand for the stock appears elevated. The agency has identified about half a dozen investment firms to question regarding "sub-penny" orders, this person says, and the inquiry is expected to take months to complete. The firms identified aren't necessarily suspected of wrongdoing, and it is unclear whether there will be a formal investigation. An SEC spokesman declined to comment on the inquiry.
These issues are among the latest to have emerged as stock trading has become dominated by super-fast computer systems used by hedge funds. At the same time, the once-clubby world of a handful of stock exchanges has evolved into many more decentralized, loosely connected, high-speed electronic trading networks.
The transformation of the stock market has some benefits for investors, of course, including some lower costs. And some say greater volume of canceled orders is a natural consequence of high-speed markets, where traders constantly troll across exchanges for the best price.
But the risks of high-speed crashes became clear during the so-called flash crash. And as the questions being asked about quote-stuffing suggest, the combination of powerful computers and fragmented stock markets may have opened the door to new trading tactics that regulators are finding hard to track and police.
Issues surrounding canceled orders have gained exposure in recent weeks since Nanex LLC, a stock-data provider, published data showing large swaths of canceled orders on May 6 and also identified other examples taking place before and since.
For example, on Aug. 17, from the start of stock trading at 9:30 a.m. until just after 9:51, there were, on average, 38 orders every second to buy or sell shares of Abbott Labs through the New York Stock Exchange, according to Nanex.
Then, in the span of one second, 10,704 orders hit Abbott and in the next second, another 5,483. And all but 14 of those combined orders were canceled within one second, according to data from Nanex.
On Wednesday, "quote stuffing" appeared to have played a role in bogging down trading of one of the most widely traded stocks, the SPDR Sand P 500 exchange traded fund, according to Nanex
"There are dozens, sometimes hundreds of these occurring every day," says Eric Hunsader, one of the founders of Nanex, who theorizes that distortions caused by "quote stuffing" were so large on May 6 that they helped destabilize the market.
Nanex has shared data with regulators. SEC officials have held conference calls to discuss Nanex data and theories, say people familiar with the matter. Issues related to high-volume cancellations could be part of the agency's report on causes of the flash crash, say people close to the matter. The report is expected to be released within the next month.
Nasdaq OMX executives have discussed cancellation volumes as part of overall transaction-monitoring, in part because canceled orders take up computer power and therefore cost money, say people familiar with the matter.
During the past year, Nasdaq officials have examined whether the exchange should charge customers for "excessive cancellations," one person says. But in an electronic trading world, it's difficult to draw the line between orders canceled in the normal course of business and excessive cancellations, let alone orders placed and canceled for potentially improper reasons, the person says.
Some in the market suspect the flood of orders is the result of high-frequency traders attempting to profit from tiny discrepancies in stock prices. They say waves of orders slow down electronic stock-trading networks or otherwise distort stock prices, creating profit opportunity to buy or sell at artificially high or low prices.
Others say the canceled orders are above board, reflecting either legitimate behavior by traders in search of profitable trades, basic market-making, where broker-dealers constantly provide quotes for potential trades and then cancel, or computer programs gone awry.
One thing is clear, say traders and regulators: An eye-popping number of the stock quotes entered in the U.S. market's exchange system are canceled.
For example, on Feb. 18, trading volume on the Nasdaq exchange totaled about 1.247 billion shares, according to data compiled by T3 Capital Management, a New York hedge fund. However, over the course of the same day traders submitted offers to buy or sell stock for roughly 89.704 billion shares. In other words, only 1% of the orders posted on Nasdaq actually traded.
While a portion of cancellations are part of the natural course of trading, Sean Hendelman, chief executive officer at T3, says he believes most of these canceled stock quotes are from traders loading up a stock's computerized order book with essentially fake bids and offers.
Mr. Hendelman, whose firm employs other high-frequency trading tactics, says the practice creates an inaccurate picture of the true supply and demand for a stock. "People are relying on the [stock quote data] and the data is not real," he says.
Nanex scrutinized trading of Procter & Gamble shares on April 28, a week before the flash crash, and found that a burst of orders were sent to the NYSE shortly before 11:48 and quickly canceled. Soon after, the NYSE quote reporting system temporarily fell several seconds behind that of the Consolidated Quote System, which brings together quote feeds from stock exchanges such as Nasdaq and BATS Global Markets.
That in turn was followed by a flurry of trades where P&G shares were bought at the lower, up-to-date prices published by BATS, and sold at higher NYSE quotes that weren't as recent—a profit opportunity.
No comments:
Post a Comment