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.