The BATS IPO was an ironic disaster. BATS, a stock exchange that billed itself as the future of stock trading, botched the IPO of its own stock, which was supposed to be listed on the BATS exchange beginning March 23rd. According to the company, the failure was caused by a software bug, and not by high-frequency trading algorithms, as some have speculated. Not only did the failure cause BATS to abandon its own IPO, it also rattled shares of Apple, mirroring the events of the 2010 Flash Crash.
While the IPO was an embarrassment for BATS, it put the SEC’s regulatory response to the Flash Crash on display. The 2010 Flash Crash was a series of events that caused the Dow Jones Industrial Average to plummet more than 700 points in a matter of minutes, only to recover within a half hour. In response to the Flash Crash, single stock circuit breakers were established to curb the effects of extreme market volatility. By most accounts, single stock circuit breakers have been effective in restoring order to markets after numerous test runs during other “mini flash crashes,” hitting a high of 51 in December of 2011.
Despite the successes of single stock circuit breakers, market participants are urging the SEC to approve the “Limit up – Limit down” (LULD) rule to replace circuit breakers. LULD is considered an improvement upon the current circuit breaker rules for various reasons, according to Steve Nelson, founder of the Nelson Law Firm and an attorney for the New York chapter of the Security Traders Association. With respect to the BATS IPO, the refined LULD rules would have prevented disruption in trading of Apple stock. Under LULD, a trade beyond a certain percentage price range, or “limit band,” does not immediately halt trading. Unlike circuit breakers, LULD waits several seconds to see if trading resumes in the allowed price range; if trading remains outside this range, only then is trading halted. Observers note that because of the availability of liquidity in Apple stock during the BATS IPO, markets could have naturally corrected the stock’s price without the shock of a market halt. The SEC is currently considering implementing the LULD rule and has extended the comment period to May 31.
Although high-frequency traders were not implicated in the cause of BATS’s failed IPO, LULD is one of the few tools that the SEC has proposed in its struggle to control the effects of high-frequency trading strategies, which played a role in 2010’s Flash Crash. Though LULD may do a good job in helping the SEC fulfill its mission to facilitate “orderly markets,” academic studies show that LULD may fall short in allowing the SEC to establish “fair and efficient markets” because the plan does not address the information asymmetry and adverse selection issues perpetuated by high-frequency trading strategies. Further rule refinements must be made to reconcile the SEC’s mission with the prevalence of high-frequency trading.