U.S. exchange flags internal trading discrepancy

The discrepancy that Direct Edge found in its mid-point-match (MPM) order types has existed since trading platform EDGX officially launched as a national securities exchange in July 2010, the company said in a notice to traders.

An order type is the set of instructions that govern the price and other variables in stock transactions. Critics have charged that their complexity has led to trading abuses. Some have called for a ban on new order types because exchanges have been rolling them out faster than industry experts can fully understand them.

The discrepancy Direct Edge found involves the exchange's Rule 11.8(a)(2), which is supposed to assign priority to MPM orders over, among others, non-displayed limit orders.

Direct Edge said EDGX usually assigns priority for MPM orders but it had identified a circumstance in which the trading platform did not.

The MPM order is designed to provide at least a half-cent price improvement on every execution for stocks priced above $1, according to Direct Edge. In addition, the likelihood that MPM orders are executed and result in price improvement is higher because they automatically interact with displayed order flow.

"It's marketed to all type of players in the industry, 'Use this. You'll get price improvement, it's worth paying up for,'" said Sal Arnuk, a co-founder of brokerage Themis Trading LLC in Chatham, New Jersey. "It's in direct contradiction to its own rule book."

How often the trading priority that MPM was supposed to deliver but didn't was not indicated in the trading notice. Direct Edge spokesman Jim Gorman declined to comment.

The Securities and Exchange Commission has insisted that exchanges publish rules that are coherent and clear, and that they abide by them. The SEC declined to comment on Direct Edge's trading notice.

(Reporting by Herbert Lash)