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SEC Sanctions Two Exchanges for Failing to Accurately Describe Order Types and Making Preferential Disclosure to High Frequency Traders

On January 12, 2015, the Securities and Exchange Commission announced that it had obtained a $14 million settlement against two exchanges formerly owned by Direct Edge Holdings, EDGA and EDGX (the “Respondent Exchanges”) for their failure to file Exchange Rules that accurately described the order types they offered, and for providing preferential disclosure to certain high frequency traders.  This recovery constitutes the largest penalty ever levied by the SEC against a national securities exchange and appears to be the first action focusing primarily on exchange order type issues.

According to the SEC’s Order, the official Rules filed by both Exchanges only described a single price sliding order type, while each Exchange actually offered three variations to their members: Hide Not Slide, Price Adjust, and Single Re-Price.  The SEC claims that the Rules failed to describe each order’s functionality and their priorities relative to each other and other order types.  Moreover, although this information was not available to all members, the Exchanges provided it to a select few customers, including several high frequency trading firms.  The SEC also claims that that two of these order types were developed in response to requests from high frequency trading customers and that both Exchanges would rotate which order type was used by default without filing the necessary Rule Amendment or providing notice to anyone except these “preferred” members.

The SEC’s Order found that the Respondent Exchanges had violated Section 19(b)(1) of the Exchange Act (for failing to file Proposed Rules and Rule changes that accurately and completely described available order types and how they operated) and Section 19(g)(1) of the Exchange Act (for failure to comply with the Exchange Act and their own Exchange Rules).  As part of the Settlement, the Respondent Exchanges agreed to cease and desist from such violations and to undertake (1) to ensure that their regulatory functions were independent from their commercial interests; (2) to create and implement written policies and procedures relating to the development of order types, the rule filing process for such, and the communication of information regarding order types to members; and (3) for the next three years, to have their principal executive officers certify in writing to the Division of Enforcement, that the Exchanges’ rules accurately and completely describe all order types, procedures, and modifiers available.

As previously reported on this blog herehere and here, high frequency trading has been the subject of considerable recent regulatory interest.

© 2019 Proskauer Rose LLP.

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About this Author

Harry Frischer, Litigation Attorney, Proskauer Law Firm
Partner

Harry Frischer has experience in a wide variety of complex commercial litigations and arbitrations involving securities, accounting and finance, corporate control, intellectual property, contracts and partnerships. A substantial portion of Harry’s practice involves the representation of financial institutions in connection with litigation, regulatory investigations and enforcement proceedings and arbitrations. He has tried cases in the federal and state courts, and has conducted arbitrations before the Financial Industry Regulatory Authority, the New York Stock Exchange...

212-969-3680
Stephen L. Ratner, Financial Services Attorney, Proskauer Law Firm
Partner

Stephen L. Ratner is a Partner in the Litigation Department and co-head of our Financial Services Practice Group. His practice focuses on the representation of banks and other financial services institutions in complex litigations, investigations and enforcement proceedings, arbitrations and mediations, compliance issues, and regulatory controversies involving securities, commodities, and derivative products.

Matters Steve handles include the defense of class actions and other actions involving, for example, high frequency and algorithmic trading, short selling practices, IPO allocations, and data security and privacy issues. He also handles internal investigations and investigations and enforcement proceedings by the SEC, CFTC, Department of Justice, FINRA and other regulators regarding issues such as high frequency and algorithmic trading, market access, securities lending, trade reporting, short selling, electronic communications, and supervision. Steve also represents banks and other financial institutions in fraudulent transfer litigation and other litigation based upon failed LBOs and alleged Ponzi schemes.

212-969-3290
Brian L. Friedman, Litigation Attorney, Proskauer Law Firm
Senior Counsel

Brian L. Friedman is a Senior Counsel in the Litigation Department and a member of the Financial Services Group and Securities Litigation Group, resident in the New York office.

Brian regularly represents clients in a variety of complex matters, including litigations, investigations and enforcement proceedings in the financial services area, contract disputes, business torts, and construction matters. His practice includes matters in state and federal courts, and in domestic and international arbitrations.

212-969-3256
Boris Zeldin, Litigation Attorney, Proskauer Law Firm
Associate

Boris Zeldin is an Associate in the Litigation Department, resident in the New York office.

Boris previously worked in the Special Federal Litigation Division of the New York City Law Department. While in law school, he interned for the Office of Staff Counsel of the U.S. Court of Appeals for the Second Circuit and the Commodity and Futures Trading Commission. He also also worked with, and later became President of the Brooklyn Law School chapter of the Unemployment Action Center.

212-969-3380