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From Securities Regulation Daily, January 12, 2015

Record-breaking $14M penalty concludes first SEC case on exchange order types

By Jacquelyn Lumb and Anne Sherry, J.D.

The SEC today announced that two exchanges formerly owned by Direct Edge Holdings and since acquired by BATS Global Markets have agreed to pay $14 million to settle charges that their rules failed to accurately describe order types. The case is the SEC’s first to focus primarily on order types, and the penalty is the SEC’s largest against a national securities exchange (In the Matter of EDGA Exchange, Inc., Release No. 34-74032, January 12, 2015).

At a press conference following the announcement, SEC Enforcement Director Andrew Ceresney confirmed that the case revolved around disclosure and not the order types themselves. The exchanges used the order types for over four years before finally updating their rules and submitting them for SEC approval in 2014. The case involved serious violations with serious implications, according to Ceresney. The SEC and market participants must be fully aware of what is happening with all order types if the markets are to operate fairly, he advised.

Background. The order instituting proceedings stresses the role of order types as the main way for market participants to communicate their instructions for handling their orders to an exchange. The respondent exchanges, EDGA and EDGX, are alleged to have failed to submit and obtain SEC approval of proposed rules accurately reflecting the operation of “price sliding” on the exchanges. Instead of keeping to a single price-sliding process as described in their rules, the exchanges actually accepted three different price-sliding order types, including a type called “hide not slide” (HNS), which was not named or clearly described in the rules. Some members were provided complete and accurate information about HNS, but not all, creating a risk that the manner in which HNS operated would not be understood by all members. Furthermore, the “price adjust” order type was not accurately described in the rules even though it was sometimes the default functionality on the exchanges.

SEC investigation. When asked at today’s news conference why the SEC took so long to bring the case, given that the exchanges operated without disclosing the order type information from July 2010 to late 2014, Ceresney said it was a complicated investigation that led in different directions. The SEC moves as quickly as it can, he said. Ceresney would not comment on a number of areas, including whether the SEC would have brought the case were it not for receiving information from a whistleblower. He also declined to answer how the commissioners voted on the matter.

Harm to market. When asked whether the lack of disclosure harmed retail investors, Ceresney said it harmed all market participants. While there was no disgorgement piece to the remedies in this case, Ceresney noted that the $14 million penalty was the highest ever against an exchange. The previous high was a $10 million penalty against Nasdaq. The penalty reflects the egregiousness of the conduct, he said.

The press release announcing the settlement notes that EDGA and EDGX neither admitted nor denied the SEC’s charges and that the exchanges were found to have violated Exchange Act Sections 19(b) and 19(g) in 2011.

The Release is No. 34-74032.

Companies: EDGA Exchange, Inc.; EDGX Exchange, Inc.; DirectEdge Holdings LLC; BATS Global Markets, Inc.

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