June 22, 2016
NASDAQ has proposed a rule 9400 to permit expedited suspension or exclusion of an entity or entities who engaged in disruptive behavior consisting of quoting or trading. This rule should be adopted, and is supported as beneficial to public confidence in markets and prevention of harm to the public and market participants.
THE SEC SHOULD CONSIDER SIMILAR RULES FOR ALL EXCHANGES
The rule is so beneficial that it should
be presented to and considered by the Securities and Exchange Commission (SEC) Equity Market Structure Advisory Committee to consider whether an identical or highly similar rule should be adopted by all exchanges under the jurisdiction of the SEC.
THERE ARE SUBSTANTIAL REASONS FOR ADOPTING THE PROPOSED RULE
Reasons for adoption of the rule have been set forth and are compelling. Some parties may object to the rule's provisions which allow suspension of suspected harmful or manipulative activity prior to full due process, but this objection fails in comparison to the potential harm of permitting manipulative bidding and offering or trading behavior to continue subject to retrospective review. It has already been reported that such disruptive quoting, in the form of spoofing bids and offers, and trading may have contributed to the flash crash and unstable market swings of August 24. The fact that Rule 9400 and its associated manipulation definitional rules can reduce the likelihood of flash crashes or market open or close failures should be enough to support adoption of these rules.
In addition, the propose rules against disruptive quoting and trading are consistent with and permissible under the spirit, intention, and approach of the Dodd Frank legislation designed to reduce market manipulation risks and behaviors. See the attachments describing the CFTC and letters of support to the CFTC in connection with increased regulations against market manipulation of this sort including spoofing and false bid layers.
The expedited suspension or exlusion of such manipulative quoting, ie bidding and offering, or trading activity, is justified by an analogy to computer systems. When a virus intended to disrupt computer programs and systems is detected, expedited
anti-virus protocols must be employed before the entire program or network is disrupted. Similarly, when disruptive spoofing or trading is detected, the exchange must be able to protect its systems, prices, and participants from such activity before either individual market participants or the market as a whole is significantly damaged. This can occur within a matter of minutes or hours as the events of Aug 24 indicated.
MODEST CHANGES SHOULD BE MADE INCLUDING SEC NOTIFICATION
Four changes should be considered in the rules: First, the SEC should be notified on the occurrence of two events, 1) The detection of behaviors which could trigger suspension or prohibition of market participants under Rule 9400. This would permit Commission oversight of the application of the Rule, as well as notifying the Commission of events which might reqquire further Commission action to protect markets or enforce rules and laws against manipulative participants; 2) The results of any further rule under Rule 9400 such as the result of a hearing or determination of other prohibitions or exclusions after due process. This will afford the market participants, the Exchange, and the Commission transparency in the deliberative process to review reasoned investigation of the suspected behavior.
Second, the definition of disruptive quoting and trading should be clarified. Disruptive quoting should be defined to include providing either bids or offers with a purpose to manipulate prices, which can be determined by the patterns of such bids and/or offers, without any requirement for evidence of scienter. That is, the pattern of disruptive activity can be enough without a requiring of an explicit admission that the behavior is intended to be manipulative. No one is going to said I was speeding because I was drag racing. A pattern of two cars hurtling at high speed down a street is enough.
Third, the rules for applying the Rule 9400 and associated rules to individual or multiple coordinating parties should be clarified to indicate that coordinated actions by multiple parties to participate in a scheme or conspiracy to engage in disruptive quoting or trading will permit enforcement and exclusion activities against all participants in the scheme or conspiracy.
Fourth, the Exchange should notify FINRA and other exchanges of any occurrence of behaviors identified under the rule which resulted in exclusion, so that other exchanges may be able to detect and avoid transfer of such behaviors to alternative markets.
As indicated, attached are various files suggesting the need for, and appropriateness of enhanced enforcement of rules, including these proposed rules, against distru