U.S.

Research
July 27, 2009
Financial Services
Industry Brief
Patrick O'Shaughnessy, CFA, (312) 612-7687, Patrick.OShaughnessy@RaymondJames.com
Megan E. Repine, Res. Assoc., (312) 612-7820, Megan.Repine@RaymondJames.com

Brokerages and Exchanges: Gov. Relations/Regulations _____________________________________________________________

Assessing the Impact: Proposal to Eliminate Flash Orders in Equity Trading

♦ Senator Schumer proposes to prohibit flash orders. In a letter to the SEC on Friday, New York Senator Chuck Schumer wrote
“Specifically, I request that the Securities and Exchange Commission (“SEC”) act to prohibit the use of so-called “flash orders” in
connection with optional display periods currently permitted by DirectEdge’s Expedited Liquidity Program, NASDAQ’s Flash order
program and BATS’s Bolt Optional Liquidity Program…If the SEC fails to curb this practice [flash orders], I plan to introduce
legislation in the U.S. Senate to prohibit the use of flash orders in connection with optional pre-routing programs in order to
ensure that trading in U.S. public capital markets is fair and transparent for all market participants”. We believe Senator
Schumer’s action is the result of recent complaints by NYSE Euronext, the Securities Industry and Financial Markets Association
(SIFMA), and other market participants regarding the fairness of these orders.

♦ Elimination of flash order type would likely be positive for NASDAQ OMX, BATS, and especially NYSE Euronext. The
elimination of flash orders would be to the significant detriment of Direct Edge, the ECN that pioneered the order type through
its Enhanced Liquidity Provision (ELP) innovation. We believe that ELP trades represent between 10% and 20% of Direct Edge’s
matched trade volume, but as the firm receives an above-average fee per trade from the trading firms that interact with this
order flow, it likely represents a much greater percentage of the firm’s overall revenue. The innovation of ELP is also Direct
Edge’s competitive advantage, and we believe the elimination of the order type would substantially hurt the firm’s competitive
position. A loss for Direct Edge would likely be a gain for the three other major U.S. stock exchanges: BATS, NASDAQ OMX, and
NYSE Euronext. As NYSE Euronext is the only one of the three to not have launched its own copycat flash order type, we expect
it would see the largest market share boost should the order type be eliminated.

♦ Dark pools, high frequency trading could be the next issues in the legislator/regulator crosshairs. The SEC has already
announced that it is looking into the market impact of ever-proliferating dark pools, while recent stories in the media
surrounding the increasing dominance and profitability of high frequency trading (HFT) could lead to yet another SEC area of
inquiry. Ultimately, these topics address the same core issues around equal access and market transparency that flash orders
encounter, but could have much more serious market implications.
In our opinion, any move to reduce the trading allowed on dark pools would be to the benefit of publicly-displayed exchanges,
but, conversely, limitations on HFT could have a profoundly negative impact on exchanges. While dark pools represent ~10% of
all trading volume currently, HFT volume is estimated to represent ~70% of market trading volumes. Any move to restrict high
frequency trading could have a significant impact on exchanges’ transaction fees as well as revenue earned from co-location;
there is also the chance that efforts to restrict HFT in the equities world could bleed over into other asset classes as well,
including futures. We view potential regulatory changes as a net negative for exchanges, but it is far too early to assess the
impact of potential regulation on these two issues.

♦ Flash Orders 101. A flash order is an order that executes at an exchange or ECN if marketable, but if not, is “flashed” to the
exchange/ECN’s members for a brief period (generally around 30 milliseconds) before being routed to another market center.
During the flash period, the exchange or ECN members are given a brief look at the order and allowed to execute against it at
the current NBBO.
The primary argument against the flash order type is that it preferences some market participants ahead of others. A
marketable order at a competing exchange may not be filled because the order was first forwarded to a select group of trading
firms. Although virtually any trading firm has the ability to subscribe to become a member in such a program, the question is
whether that ability is the equivalent of having a fair and open marketplace. There is also the concern that participants in these
Please read domestic and foreign disclosure/risk information beginning on page 3 and Analyst Certification on page 5.

© 2009 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.
International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
Raymond James U.S. Research
flash order programs use the information they learn during the flash period to trade ahead of these orders and profit from their
advanced knowledge.
Additional points:

♦ Direct Edge’s version is called the Enhanced Liquidity Provider (ELP) program while BATS’ is called BATS Optional Liquidity
Technology (BOLT). NASDAQ OMX also has a flash order type (but no fancy acronym) while NYSE Euronext does not have
one.

♦ Both Direct Edge and BATS estimate that flash orders represent less than 4% of U.S. stock trading.
♦ An example of a trade using BATS’ order type is as follows:
Sequence Description NBBO Results

1 BOLT Routing order arrives to Buy 6000 @$10.02. 10.01x10.02 BATS book is accessed first.
Order executes against 1000 shares on the BATS
book @ $10.02 and is assessed the standard
2 1000 shares filled at BATS @ $10.02 10.01x10.02 $.0025 remove fee.
BATS will expose the Buy of 5000 @$10.02 for up
to 25 milliseconds on the BATS proprietary market
3 BOLT order is exposed. 10.01x10.02 data feeds.

4 1000 shares filled at BATS during exposure period. 10.01x10.02 $.0015 rebate received for fills at BATS at $10.02.
Order routes out via CYCLE strategy and 2500 BATS will route at $10.02. The low routing fee of
5 shares are filled at away markets. 10.01x10.02 $.0025 is applied to any routed fills.
BATS 10.02 bid displayed to SIP and BATS
6 Order books at BATS. 10.01x10.03 proprietary feeds
Order receives fill for 1500 shares at $10.02 and
7 Remaining 1500 shares filled on BATS book. 10.02x10.03 standard $.0024 rebate per share.
Source: BATS Trading

Public companies mentioned in this report.

Priced as of RJ&A Rating
Company Name Ticker 07/24/09 (if Applicable)
NYSE Euronext NYX $26.92 Market Perform
The NASDAQ OMX Group, Inc. NDAQ $20.34 Market Perform

© 2009 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. 2
International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863