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An ongoing debate over the future of so-called flash orders is pitting two of the most powerful U.S. financial firms on opposite sides, with Citadel LLC and Getco LLC continuing a rich history of clashes among Chicago's trading elite.
The dispute revolves around regulators' proposed ban on flash trades in U.S. stock and options markets. The practice gives some market participants the chance to act on unfilled orders for stocks or options before they are routed on to another exchange to be filled.
While stock-trading venues have largely abandoned the process, the issue remains divisive among options exchanges and major traders in that marketplace.
Getco, one of the world's largest electronic market makers, has urged regulators to eliminate flash orders in options as well as stock markets.
Citadel, best known for its hedge fund business but with a large securities arm, has in turn charged that Getco supplied "misleading and incomplete" data on the matter in a letter to the Securities and Exchange Commission.
John McCarthy, Getco's general counsel, said Wednesday that for the past year and a half his company and exchanges like NYSE Euronext (NYX), Nasdaq OMX Group Inc. (NDAQ) and BATS Global Markets have argued that the flash practice gives information advantages to some investors over others, "with little to no regulatory oversight."
"Despite the rhetorical arguments put forth by supporters of flash orders we have seen no evidence to refute this contention or demonstrate how flashing an investor's order to a subgroup of participants does not undermine the overall integrity of our capital markets," he said.
Citadel has argued that banning flash orders in options will push options exchanges to raise fees for retail investors and brokerages, while overall liquidity could become less dependable.
Both firms maintain a sizable presence in U.S. options trade. Citadel accounts for about one-third of daily U.S. options trading activity, through a combination of in-house business and the routing of orders from retail investment firms. Getco ranks as a major market maker on U.S. options exchanges and is an investor in BATS, which introduced its own options platform in February.
The SEC proposed a ban on flash order types in September 2009, after controversy flared over stock exchanges' use of the technology. Debate soon shifted to the options market, where top executives of the Chicago Board Options Exchange and the International Securities Exchange argued that the flash function can shield customers from trading fees incurred when their orders are sent on to other exchanges to be filled.
The proposed ban is still pending, according to a spokesman for the SEC.
Getco wants the practice barred in all markets, arguing that giving traders on traditional options exchanges, like the CBOE and ISE, a second crack at unfilled orders means less competitive prices for investors who trade on those venues.
In a late-September letter to the SEC, Getco's McCarthy reported that NYSE Euronext's Arca exchange and Nasdaq OMX Group Inc.'s PHLX exchange were most often home to the best prices available for options contracts in June 2010.
Both of those exchanges incorporate maker-taker pricing, in which market makers like Getco compete to take the other side of customer trades, and collect rebates for doing so. Traditional-model exchanges, including the CBOE, charge market makers to do business and pay brokers to route orders to their platforms.
John Nagel, Citadel's general counsel, responded in a letter to the SEC late last month that doing away with the flash function would essentially force all options exchanges to embrace the maker-taker model, diminishing investor choice, and that Getco's data overstated those exchanges' benefits.
"If anything, the data shows that the market is well served by a combination of the maker/taker model and the traditional exchange model," Nagel said.
Just because maker-taker options exchanges display competitive prices doesn't mean that those prices would not have been posted elsewhere, said Nagel, and those quotes may well have been directed to maker-taker venues in order to earn the rebate paid to market-makers.
In Getco's letter, McCarthy wrote that because rebates offered by maker-taker exchanges are smaller than the minimum increments for price quotes, capturing rebates "cannot be the only reason" that firms are willing to offer more competitive prices on maker-taker platforms.
-By Jacob Bunge, Dow Jones Newswires; 312-750-4117; email@example.com