The Flash-Trading Thorn in NYSE's Side - WSJ.com

AUGUST 31, 2009 The Flash-Trading Thorn in NYSE's Side

By RANDALL SMITH William O'Brien's father was a seat holder and trader on the New York Stock Exchange in the 1970s. Now, the younger Mr. O'Brien has become one of the Big Board's top rivals.

The 39-year-old Mr. O'Brien is chief executive of Direct Edge, a trading system that has commandeered 12% of U.S.-listed stock trading, a six-fold increase in just two years. The Big Board is leading an attack against Direct Edge, and has found a sympathetic ear in Congress and the Securities and Exchange Commission.

Direct Edge, of Jersey City, N.J., is at the heart of the world of high-frequency trading, in which computerized models dash in and out of stocks by the millisecond, hoping to capture fleeting distortions between the prices of securities.

What has gotten the NYSE so upset is Direct Edge's advocacy of "flash trading" -- a View Full Image particular variety of high-frequency trading Reuters that briefly previews some orders to a few Flash trading has helped CEO William O'Brien's Direct Edge grab 12% of U.S.-listed stock trading. dozen market participants and trading platforms in hopes of finding a match.

New York Sen. Charles Schumer last month said use of such orders "creates a two-tiered system where a privileged group of insiders receives preferential treatment," and he urged the SEC to ban them. In response, SEC Chairman Mary Schapiro has vowed to curb any "inequity" in such orders as part of a review of high-speed trading practices and "dark pools" operated by Wall Street firms and other traders.

While some competitors say they won't do flash trades, Mr. O'Brien takes an unrepentant approach. To him, the orders allow his customers to access additional orders to buy and sell stocks, providing a "bridge" to off-exchange trading pools, including dark pools, that may give them better prices. Customers' use of such orders is voluntary, he adds.

Flash orders account for about 25% of Direct Edge's profit, even though they account for only 5% of its trading volume, according to trading executives. "It's a much higher percentage of their profitability than of their trading volume," says Patrick O'Shaughnessy, who follows exchanges at Raymond James Financial Inc.

Direct Edge, valued at about $450 million at the end of the 2008, is owned 31.5% by the German-Swiss owned International Securities Exchange, with another three partners at 19.9% each -- Knight Capital Group Inc., Citadel Investment Group, and Goldman Sachs Group Inc.

In the past two years Direct Edge and another trading system, BATS Exchange Inc., have gained a combined 16 percentage points of market share, much of that at the expense of the NYSE, owned by NYSE Euronext, and the Nasdaq OMX Group Inc.'s Nasdaq Stock Market, according to Direct Edge data. They have risen from a combined 6.3% of matched trading in stocks listed on U.S. exchanges in July 2007 to 22.6% in July 2009, Direct Edge says. In the same period, the combined share for the NYSE and Nasdaq has fallen from 71.3% to 50%.

http://online.wsj.com/article/SB125167381855770865.html[8/31/2009 8:53:15 AM] The Flash-Trading Thorn in NYSE's Side - WSJ.com

In a comment letter to the SEC, Morgan Stanley said the use by exchanges of such orders "directly undermines" the regulatory principle of fair and non-discriminatory access to the markets displaying the best prices. In a presentation to clients, trading executives at Morgan Stanley have warned that that the orders "leak information" about their trading plans.

But Mr. O'Brien says banning such orders From the Archives "would simply deny brokers and investors Senator Seeks Broad SEC Market Study access to liquidity they previously enjoyed." 8/24/09 Customers whose orders are matched in this SEC Falls Behind in Tech Race 8/20/09 process can save money, Direct Edge says. High-Frequency Trading Goes Well Beyond Stocks Indeed, one of his biggest customers, TD 8/19/09 Ameritrade Holding Corp. the largest online Will DirectEdge Lose Its Edge? broker, says rebates for such orders help TD 8/10/09 Ameritrade cut its costs, with discount Trading Tactic Is the Rage: What's trading commissions of just $9.99. "Despite Behind High-Frequency Trading? the controversy, we have no evidence that 8/1/09 any of our clients are being harmed," says NYSE's Fast Trade Hub Rises Up in New Jersey Chris Nagy, head of order routing strategies 7/30/09 at TD Ameritrade.

Opinion After graduating from Notre Dame and In Defense of Flash Trading University of Pennsylvania law school, Mr. 8/27/09 O'Brien worked at law firm Orrick, Herrington & Sutcliff LLP, specializing in market regulation, from 1995 to 1998. "It never surprised me he went into the business, he was always so intrigued with market dynamics," said Orrick senior counsel Sam Scott Miller.

After a two-year lawyering stint at Goldman Sachs Group Inc., Mr. O'Brien joined a trading system known as Brut in 2000. There he rose to chief operating officer before Brut became part of Nasdaq in an acquisition in 2004.

At Nasdaq, Mr. O'Brien ran market-data distribution and then U.S. new listings before joining Direct Edge in July 2007.

On Nasdaq sales trips, one former colleague recalls, he enjoyed visits to local casinos, playing blackjack and then craps, a dice game. Mr. O'Brien says he likes craps because it offers "the lowest house edge."

Write to Randall Smith at [email protected]

Printed in The Wall Street Journal, page C1

http://online.wsj.com/article/SB125167381855770865.html[8/31/2009 8:53:15 AM]