Exchange to crack down on manipulators

A major stock exchange Thursday unveiled a new rule that could allow it to more swiftly stop "spoofing" and other manipulative practices that may have helped cause the 2010 stock market dislocation known as the Flash Crash.

The rule must still be approved by the Securities and Exchange Commission (SEC). But if approved, BATS Global Markets (BATS)  — the nation's second largest stock exchange operator — will be able to stop manipulative conduct in a matter of weeks rather than years, the company said.

Spoofing is when traders place bogus orders and cancel them before they're completed in order to create the false appearance of a bigger market. "Layering" is when spoofing is done in cycles throughout the day.

The practice artificially lifts prices, especially in small- and mid-cap stocks. It has also been linked to the Flash Crash, which saw hundreds of billions of dollars in market value erased inexplicably before recovering minutes later.

The severity of potential losses due to the Flash Crash spooked investors and sent regulators scrambling to explain the event and come up with policies to prevent it from happening again.

Under the current process, BATS will often ask broker-dealer members that are executing fake trades to find the spoofer and put a stop to it. But BATS currently has no way of forcing brokerage firms to take swift action, especially when the perpetrator is outside the U.S., said Chris Concannon, president and chief executive officer of BATS.

Under the new rule, BATS could demand firms dealing with spoofers stop the practice or risk losing their trading privileges, Concannon said. "If they don't (act), their entire access to the US markets will be shut down," Concannon said.

BATS said the rule mainly targets overseas perpetrators, who are harder to stop because they are out of reach of the SEC and Department of Justice (DOJ), said Concannon.

Neither the New York Stock Exchange nor Nasdaq OXM Group responded to comment on whether they might seek a similar rule request. BATS is the second largest exchange by aggregate volume, behind NYSE, according to Tabb Group, which tracks the exchanges.

The Financial Industry Regulatory Authority (FINRA), which helps oversee the brokerage industry, said it is "actively considering a similar measure" for broker-dealer members.

"FINRA believes that BATS’s proposal has the potential to significantly alter behavior in the marketplace, and FINRA staff is actively considering a similar measure," said George Smaragdis, director of media relations at FINRA.

In April, the DOJ and the Commodity Futures Trading Commission (CFTC) announced the arrest of a small-time London trader who they said contributed to the 2010 Flash Crash, which saw the Dow Jones industrial Average plunge nearly 600 points in five minutes.

Navinder Singh Sarao, 37, and his company, Nav Sarao Futures Limited PLC, used computer software to manipulate Standard & Poor's futures contracts, the CFTC and DOJ said. Sarao's alleged scheme operated from as early as 2009 through this year. His activities were only detected after an unnamed whistleblower went to the CFTC.

In addition to the spoofing and layering, the FBI also found evidence of a third technique wherein Sarao "flashed" a large 2,000-lot order on one side of the market, executed an order on the other side of the market, and then canceled the 2,000-lot order before it was executed, the DOJ said.