In general, if a quotation is considered protected, other trading centers must honor that quotation by not executing trades at inferior prices, also known as "trading through," the protected quotation pursuant to the SEC Rule 611 (the Order Protection Rule).6
Specifically, the SEC will assess whether an intentional delay is "so short as to not frustrate the purposes of the Order Protection Rule by impairing fair and efficient access to an exchange's quotations." Thus, if an intentional delay meets this standard, the intentional delay will be considered de minimis and therefore "immediate" for the purposes of SEC Rule 600(b)(3) (defining "automated quotation") and the Order Protection Rule.
A key differentiator between the newly approved IEX and other national securities exchanges such as the New York Stock Exchange, Nasdaq Stock Market and Bats BZX Exchange was blessed by the SEC in its revised interpretation of the order protection rule
. The commission said it would "require trading centers to honor automated securities prices that are subject to a small delay or speed bump when being accessed." IEX's so-called speed bump of 350 microseconds is within the 1 millisecond now allowed by the SEC.
The Order Protection Rule
generally requires that trading centers trade at the best-quoted prices or route orders to the trading centers quoting the best prices.
Specifically, we use data from US equity markets in 2008 to investigate the US Securities and Exchange Commission's (SEC) "Flickering Quote Exception" to the Regulation National Market System (Reg NMS) Order Protection Rule that defines the benchmark price for evaluation of trade throughs and provides a one second look back exception.
Section I provides an overview of the SEC Reg NMS Order Protection Rule and the Benchmark Quote Exception and describes the quote-arbitrage trading strategy.
Reg NMS Order Protection Rule and Flickering Quote Exception
To better integrate the various exchanges trading equities and to encourage the display of liquidity, the SEC adopted the Order Protection Rule, Rule 611, in 2005.
The Order Protection Rule and the Benchmark Quote Exception establish the regulatory environment that forms the basis of our analysis.
One potential cause of our current and proceeding results is that the Order Protection Rule is simply ignored by the exchanges.
The SEC's Benchmark Quote Exception to the Order Protection Rule allows trades on an exchange to occur at prices inferior to the best contemporaneous prices on other exchanges as long as the trade occurs at a price equal to or better than the Benchmark Quote.
The Commissions interpretation applies to the Order Protection Rule
under Regulation NMS, which protects the best priced automated quotations of certain trading centers by generally obligating other trading centers to honor those protected quotations and not execute trades at inferior prices.