(Bloomberg) -- A federal judge challenged a lawyer for Citadel Securities LLC about its motives in trying to thwart a new type of market order from IEX Group Inc., the stock exchange operator made famous by “Flash Boys.”
“It’s you who’s going to a federal agency and saying stop a private entity from doing what they want to do,” U.S. Circuit Judge Justin Walker said at a hearing in Washington on Monday, after attorney Jeffrey Wall argued that the order type interferes with the natural course of the market.
The electronic trading firm founded by billionaire Ken Griffin has asked the court to send the order type -- which imposes a roughly 350-microsecond delay to blunt the advantage of high-frequency traders -- back to the Securities and Exchange Commission for reconsideration and reversal.
“You’re the one who’s trying to regulate your way into a market victory,” Walker said, amid sharp questioning of both sides by a three-judge panel.
The hearing came as the SEC under Gary Gensler weighs changes to stock market rules that could directly affect Citadel Securities’ business. For example, Gensler has said the agency may ban the widespread practice of payment for order flow, in which trading firms pay retail brokerages to execute their trades. The agency hasn’t released a concrete proposal for such a change.
IEX calls the new order type a discretionary limit, or D-Limit. It says D-Limit can work against high-frequency traders’ use of amped-up computing power and fast data connections and help level the playing field for others. IEX began offering the order type last October after the SEC approved it that August. IEX itself was launched in 2016 and marketed as a champion of fairness in pricing.
Citadel Securities argues that D-Limit hurts investors and that the agency “abdicated its statutory responsibility” to carefully scrutinize the proposal. It said in a statement last week that the order type “will ultimately detract from the integrity of our markets and undermine the ability of investors to trade at the prices they see on the screen.”
Read More: Citadel Securities Sues SEC, Escalating Fight Over IEX Order
IEX says the firm, one of the top market makers on the exchange, is no friend of the individual investor. It says Citadel, “despite claiming to represent the interests of retail investors,” is fighting “against the SEC’s well-reasoned approval of an IEX innovation that is designed to safeguard all investors from predatory trading strategies, increase displayed trading, and improve price discovery on public exchanges.”
The SEC declined to comment.
‘Quibbling’ Over Microseconds
Citadel Securities has a tough fight on its hands, Larry Tabb, head of market structure research for Bloomberg Intelligence, said in an interview. The SEC has called D-Limit a “speed-bump” that shouldn’t harm market participants, he said.
“You’re quibbling over 350 microseconds, which is a hard argument to make,” Tabb said.
Firms that have voiced their support of D-Limit orders include Goldman Sachs Group Inc., Jefferies LLC, California Public Employees’ Retirement System, Virtu Financial and Vanguard Group Inc.
Citadel Securities says D-Limit creates unfair advantages for both IEX and the trading firms that use it. Other opponents of the new order type include Nasdaq Inc., Hudson River Trading LLC and FIA Principal Traders Group.
“Exchanges are meant to be platforms -- they’re meant to facilitate trading,” Wall told the judges at Monday’s hearing. “This is an exchange -- the only one -- that’s reaching in and repricing the quotes themselves. That’s sort of a novel thing.”
By introducing a feature that slows down a trade, IEX isn’t necessarily getting the best price for the customer, Wall argued.
“Once an order hits the exchange,” you “can’t tinker with it,” Wall said. IEX is putting the market participant at a disadvantage by not completing the order immediately, he said. D-Limit is about IEX moving orders off of other exchanges and onto its own to increase liquidity and its overall profits, he said.
Better Markets, a nonprofit group that advocates for individual investors and filed a brief in support of the SEC, said Citadel Securities is taking advantage of the system.
“Citadel is fighting desperately in court to protect its ability to generate near-certain profits -- to print money in effect -- through their privileged data access and sophisticated trading technology,” Legal Director Stephen Hall said in a statement Monday. He said the SEC “acted in accordance with the law and its core mission as it put investor protection and market integrity” first.
The case is largely about the regulatory process. Citadel Securities argued in a filing that the SEC violated the Administrative Procedure Act, which sets requirements for making changes to agency regulations. The firm said the SEC disregarded important data showing that the rule would hurt retail investors.
“The commission failed to conduct anything remotely resembling the reasoned decisionmaking required,” it said.
The SEC said in a filing that it “considered the extensive data in the record and comments from numerous interested parties.” It defended IEX, arguing that Citadel Securities had offered no reason to disregard the government’s conclusions.
“They seek to substitute their judgment of IEX’s legitimate policy and business choices to eliminate a trading imbalance that high-frequency traders were exploiting on its market,” the agency said.
The case is Citadel Securities LLC v. SEC, 20-1424, U.S. Court of Appeals for the District of Columbia Circuit.
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