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How One Whistleblower Turned the Tables on High-Frequency Traders
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How One Whistleblower Turned the Tables on High-Frequency Traders

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How One Whistleblower Turned the Tables on High-Frequency Traders

A once esoteric corner of the stock market —- “order types” —- has taken center stage the past few years in the debate about the health of the market, the role of high-speed traders in it and how stock exchanges interact with clients.

A big reason for the scrutiny: Order types in many ways stand at the boundary between exchanges and their trading clients. As such, they play a crucial role in how buy and sell orders are handled and can determine whether an order is successful or not.

But few realized how complicated, and how problematic, they had become until a former high-speed trader, Haim Bodek, decided to blow the whistle to regulators in 2011.

First, a quick primer. Order types are instructions traders use to tell an exchange how a buy or sell order should be handled by the exchange, such as whether the order should be executed immediately or wait until a stock reaches a certain price level. There are hundreds of variations of order types, and many have proliferated in recent years, adding to the market’s complexity.

Most investors, including many sophisticated traders, once believed that order types were relatively simple, giving them the ability to tell an exchange whether to execute an order immediately (a “market order) or to wait until a stock price hit a certain price limit (a “limit order”).

Then along came “Hide Not Slide.”

Hide Not Slide is an order type provided by Direct Edge, a computer-driven stock exchange now owned by BATS Global Investors. The Wall Street Journal reported late Tuesday that the Securities and Exchange Commission is in settlement talks with BATS, which merged with Direct Edge earlier this year, regarding Direct Edge order types, including Hide Not Slide.

Other exchanges provide similar order types (here’s how they work), and the SEC is also looking into them.

Mr. Bodek first encountered Hide Not Slide when he was running a high-speed trading outfit in Stamford, Conn., called Trading Machines, in the spring of 2009 — about the same time that Direct Edge first rolled out Hide Not Slide. Suddenly, his firm started taking big hits on its stock trades (Trading Machines largely specialized in options but also traded stocks). He didn’t know why, and neither did his traders. Later that year, Mr. Bodek says, a Direct Edge employee told him that his firm should stop using plain vanilla limit order and start using Hide Not Slide.

The conversation was a revelation. He realized that his firm had been losing out because it hadn’t been using an esoteric order type he’d heard little about. It made him wonder who else knew about it, and why. Were some firms getting special treatment from exchanges, while others were being victimized?

Mr. Bodek “became convinced exchanges were providing such an edge after he says he was offered one himself when he ran a high-speed trading firm—a way to place orders that can be filled ahead of others placed earlier,” a page-one Wall Street Journal story in September 2012 recounted.

Mr. Bodek eventually shut down Trading Machines. Then, in the summer of 2011, he approached the SEC and revealed his concerns about what he called “toxic” order types, such as Hide Not Slide, in a Dodd-Frank whistleblower complaint.

In the following years, as news emerged about Mr. Bodek’s concerns and a mounting SEC investigation, the industry’s awareness of order types exploded. And regulators are cracking down. SEC Chairman Mary Jo White said in a recent speech in New York that a source of concern for the agency is the “large number of order types offered by the exchanges, which have been a recent focus of the SEC examination program.” Ms. White said she has asked exchanges to conduct a comprehensive review of order types and “how they operate in practice.”

Such intense scrutiny might not have occurred if Mr. Bodek hadn’t drawn attention to the issue, experts say.

“None of this would have happened without him,” said Dave Lauer, a former high-speed trader and President of KOR Group LLC, which conducts market research. “Haim took a huge risk personally and professionally in exposing these issues and spent years pushing for action and devoting himself to it.”

How One Whistleblower Turned the Tables on High-Frequency Traders - MoneyBeat - WSJ

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