Shorts get shortchanged
BATS Global Market, the third-largest U.S. equity exchange by volume behind Nasdaq OMX (NDAQ -0.02%) and NYSE Euronext (NYX.DL), revealed yesterday that it may have violated securities laws by failing to provide investors with the best price on more than 400,000 short-sale transactions since October 2008.
The admission is another black eye for a company that leveraged its technology to wrestle volume away from its more established competitors. Last year, BATS was forced to pull its own initial public offering after a technical fault on its own platform had the price of its shares plummeting as they were launched.
The financial impact of the latest incident is relatively inconsequential: The company estimates that BATS customers lost less than half a million dollars over the course of four years -- roughly a dollar per trade. However, it raises some thorny questions regarding the ability to police securities regulations in fragmented equity markets that have become staggeringly complex. BATS' violation relates to matching the trade itself, rather than providing the "national best bid or offer," or NBBO -- the best price available across the disparate platforms that constitute the entire marketplace. Providing the NBBO was mandated by a sweeping piece of legislation: Regulation NMS (for "National Market System"), which was passed in the latter half of the 2000s.
At a higher level, one may also question whether the incessant drive to push trading costs down has reached its natural limits or may even have produced counterproductive consequences for long-term, fundamentally oriented investors. This latter class -- which represents a small fraction of exchange activity -- need not be concerned with improving their executions by fractions of pennies or seconds.