A senior Democratic senator has warned the Securities and Exchange Commission that if it does not curb the practice of flash orders, which give traders at large financial firms with high-speed computers a brief advantage over other market participants, he will move to sponsor legislation to limit their use. In a letter Friday to SEC Chairman Mary Schapiro, Sen.Charles Schumer, a member of the Senate's banking committee, said he is concerned that ”the integrity of our capital markets is being compromised by the ability of some insiders to view order information before it is available to the entire market, and use electronic trading strategies to profit from that information at the expense of other investors.” Flash orders allow certain members of Direct Edge, Nasdaq and BATS exchanges access (for a fee) to buy and sell order information for milliseconds prior to that information being made available to the public. High-speed computer software can take advantage of that brief period to allow those members to trade ahead of those orders - at better prices - and therefore profit from advanced knowledge of buying and selling activity. “If the SEC fails to curb this practice, I plan to introduce legislation in the US Senate to prohibit the use of flash orders in connection with optional pre-routing programs in order to ensure that trading in US public capital markets is fair and transparent for all market participants,” Schumer added. Schapiro said last month that the SEC was working to identify emerging risks to investors, including so-called “dark pools,” or automated trading systems that don't publicly provide price quotes. Large institutional investors like banks, pension funds and mutual funds use such systems when they buy and sell large blocks of shares. While the pools - where some flash orders are sent first - are said to generate additional liquidity in the market, Schapiro has noted that they create a lack of transparency that could cause suspicion and speculation, and cut the public out of the mix. Given the risk, Schapiro has maintained that dark liquidity may face increased regulatory action and scrutiny in the future. Even BATS Exchange Inc. CEO Joe Ratterman called for an industry review of the practice earlier this month. In a July 7 e-mail to BATS members and others in the industry, Ratterman noted that the SEC currently deems flash order functionality legal and compliant with regulations, but said BATS is ready to participate in an industry review of potential issues.
