NYSE fined after some clients got early look at data

WASHINGTON Fri Sep 14, 2012 4:09pm EDT

A flag flies at the exterior of New York Stock Exchange June 15, 2012. REUTERS/Eric Thayer

A flag flies at the exterior of New York Stock Exchange June 15, 2012.

Credit: Reuters/Eric Thayer

WASHINGTON (Reuters) - The New York Stock Exchange will pay $5 million to settle U.S. civil charges that it gave certain customers "an improper head start" on trading information due to software issues and compliance failures.

The Securities and Exchange Commission's case marks the agency's first financial penalty against a U.S. exchange and is part of its wider crackdown on exchanges to make sure that retail investors aren't harmed as high-speed trading increasingly dominates markets.

The SEC alleges that beginning in 2008, some NYSE customers got an early look at trade order information that ranged from single-digit milliseconds to multiple seconds.

"Improper early access to market data, even measured in milliseconds, can in today's markets be a real and substantial advantage that disproportionately disadvantages retail and long-term investors," said SEC enforcement director Robert Khuzami.

NYSE settled the case without admitting or denying the charges.

In a statement, NYSE, which is operated by NYSE Euronext, said the SEC was not alleging "any intentional misconduct or that the NYSE data delays caused any investor harm."

"NYSE is pleased to have this matter resolved, and believes that the settlement is in the best interest of its shareholders, clients and employees," said NYSE Euronext Chief Executive Duncan Niederauer.

The SEC's case hinges on alleged violations of a rule known as Regulation National Market System, or REG NMS, which was adopted in 2005 to ensure customers get the best price and to promote fair access to market data.

The rule prohibits exchanges from improperly sending market data to proprietary customers before sending the information to the consolidated tape for broader use.

The SEC said that NYSE violated the NMS rule beginning in 2008 by sending data through two of its proprietary feeds before sending it to the consolidated feeds.

"The violations at NYSE may have been technological, but they were not technical," said Daniel Hawke, chief of the SEC enforcement division's market abuse unit. "Robust technology governance is just as important to preventing investor harm as any other compliance or supervisory function."

The SEC does not allege that any investors used the information to gain an unfair edge.

Access to proprietary feeds can be purchased by any major player in the market, from hedge funds and banks to high-frequency traders.

Many professional traders and highly active investors subscribe to such feeds in order to get more detailed access to an exchange's data on trade orders, according to a person familiar with the exchange's operations.

The NYSE makes a profit off the proprietary feeds as well as the consolidated tape, though the company's financial disclosures do not break down how much money it specifically makes from proprietary feed subscriptions.

"Today's action by the SEC affirms what many have believed for years, that our U.S. capital markets are threatened by those with the resources and access to get split second advantages over the rest of us," said Democratic Senator Carl Levin.

NYSE agreed to retain an independent consultant to review its systems. The exchange operator said that technology upgrades in 2010 and 2011 corrected the problems at the center of the SEC's investigation.

The SEC's specialized market abuse unit has become more active since the May 6, 2010, "flash crash" in which the Dow Jones Industrial Average plunged 700 points before rebounding.

Earlier this year, the SEC disclosed it is conducting roughly 20 different inquiries, ranging from order types to how exchanges police their markets.

Last year, the SEC sanctioned exchange operator Direct Edge, saying the fourth-largest exchange had weak internal controls that led to millions of dollars in trading losses and a systems outage.

The SEC also has active investigations pending against Chicago Board Options Exchange, BATS Global Markets, and more recently, NASDAQ OMX, which is being investigated for its handling of the Facebook IPO.

Even though the amount of the fine is too small to have any material impact on the exchange, the SEC's case against NYSE was a "big development," said James Cox, a professor at Duke University School of Law.

"NYSE is right up there with Coca-Cola in terms of an international brand name," said Cox, who has in the past been a vocal critic of the SEC. "I think it is not the magnitude of the fine, I think it is the existence of the fine that is more important."

(Reporting By Sarah N. Lynch and Aruna Viswanatha; Additional reporting by John McCrank in New York and Alexandra Alper in Washington.; Editing by Jeffrey Benkoe, Steve Orlofsky, Gary Hill)