Banning Marketable Flash Orders
Open Meeting of the Securities and Exchange Commission
Sept. 17, 2009
The Securities and Exchange Commission voted to propose a rule amendment that would ban flash orders. A flash order enables a person who has not publicly displayed a quote to see orders less than a second before the public is given an opportunity to trade with those orders. That momentary head-start in the trading arena could produce inequities in the markets and create disincentives to display quotes.
How Does It All Work?
Placing an Order. . .
When an investor wants to buy shares in a company he or she may contact a broker to place an order. If the investor is seeking to buy, say 100 shares of XYZ Company at the current best quoted price of $10 per share, then the broker may route that buy order to a stock exchange.
The stock exchange, in turn, determines whether it has any market participants who have publicly displayed an interest in selling at the $10 price. Such a public display would appear in the widely available pricing information for the stock that is known as the consolidated quotation data stream. If the exchange does have an interested seller, the order is executed and a transaction has occurred.
If, however, the stock exchange does not have a market participant on its exchange willing to sell at the best quoted price of $10, then the exchange cannot simply execute the order at an inferior price. To execute the order for the buyer, the exchange is obligated to search other exchanges or markets. This is required under a rule known as Regulation NMS.
Flashing an Order. . .
An order to buy is "flashed" by the exchange that received the order when the exchange has determined it has no willing seller at the best quoted price. Rather than seeking out a seller in a competing exchange or market, the exchange "flashes" the order to certain of its participants. By doing this, the exchange is able to seek out willing sellers on its market who may have decided not to publicly display their sell price.
Using high-speed technology, potential sellers that receive the flash can see the buy order and, within a fraction of a second, respond with their own order to execute against the flashed order. The time periods vary in length, but generally are one second or less.
If there is no response to the flashed order, the exchange generally will route orders away to execute against the best-priced quotations on other markets.
Typically a flash order is a "marketable" order - either:
- an order to buy that is immediately executable at the price of the national best offer (the best quoted price to sell), or
- an order to sell that is immediately executable at the price of the national best bid (the best quoted price to buy).
How Is It That Flash Orders Are Allowed?
Currently, flash orders are permitted as result of an exception to Rule 602 of Regulation NMS that excepts these orders from requirements that apply generally to other orders.
As a result, flash orders are not required to be included in the consolidated quotation data stream and are not subject to restrictions that such flash orders would otherwise violate, namely a restriction on locking and crossing quotations. The exception in Rule 602 that permits flash orders was originally adopted in 1978 to accommodate certain quotations of traders on the floors of exchanges prior to the general use of automated trading.
What Are The Concerns Associated With Flash Orders?
The Commission is concerned that the Rule 602 exception is no longer necessary or appropriate in today's highly automated trading environment.
Among other things, the flashing of order information outside of the consolidated quotation data stream could lead to a two-tiered market in which the public does not have fair access to information about the best available prices for a security that is available to some market participants. Flash orders also may detract from the incentives for market participants to display their trading interest publicly.
What is the Proposed Rule?
The Commission voted to propose the elimination of the flash order exception from Rule 602. If adopted, the proposed amendment would effectively prohibit all markets, including equity exchanges, options exchanges, and alternative trading systems, from displaying marketable flash orders.
The proposal seeks public comment and data on a broad range of issues relating to flash orders, including the costs and benefits associated with the proposal. It also seeks comment on whether the use of flash orders in the options markets should be evaluated differently than their use in the equity markets.