February 1, 2016
The issue of how various markets and exchanges open at 9:30 is an important one. The proposed change to avoid a biased or erronous opening due to an inadvertent or mistaken submission of a pre-open order and price is a reasonable change by NASDAQ. However, it raises two broader issues related to the Equity Market Structure Advisory Commission discussion of the April 24 volatility and flash crash in SPY and some major stocks.
The first issue is, who has access to and information about pre-market bidding and imbalances. If, as on Aug 24, there were signs of a lower market opening, and orders reflecting reduced prices and desires to sell various securities and ETPs such as SPY, those market participants who have or had early access to pre-market messages about orders, prices, and imbalances being used to establish the opening cross of prices and transactions may have, according to some, the ability to front-run or arbitrage other market participants. How can the Commission assure that pre-market activity is either available to all, or to only those who have no financial ability to profit from such pre=market information That is, should pre-market price setting information be restricted somehow to parties who will only use it for an intial transaction and not for their own proprietary trading.
The second issue is, if, instead of a mistaken or inadvertent price, pre-market information provided by a party is intended to bias or affect the opening price under what circumstances does such activity become prohibited by anti-manipulation provisions of the Securities and Exchange Act. As a corollary, what records or messages are available to establish who did what in terms of pre=market quotes and prices, and what subsequent trading did those partiess engage in. The Commission should make clear that any manipulation of pre-market bids, prices, sizes or other participation in the pre-market opening cross which is intended to falsely represent market conditions and activity is just as illegal as market manipulation during the hours of market activity.
Given the proliferation of exchanges, ATS, NMS, brokers, and traders freely flowing data back and forth during the non-market hours, attention to regulation, and maximum transparency of how initial prices are set by exchanges should be a priority for the Commission to avoid events like the Aug 24 flash crash and the ability to profit from such drastic price moves which was available to some market participants. for however brief a period. According the the staff report, the SPY index had a market cap of $160 billion and a brief 5% swing. That amounts to a transfer from some market participants to another of probably $8 billion.