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Wall Street Journal: Wall Street Fears Nasdaq Proposal Would Expose Trading Secrets

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Mark Dowd

Mark Dowd

Some Wall Street heavyweights are crying foul over a proposal by Nasdaq Inc. that they say will expose hidden trading strategies—the latest clash between traders and exchanges over Big Data.

A dispute has erupted over Nasdaq’s plan to launch an options-data service called the “Intellicator Analytic Tool.” Critics say that if approved by the Securities and Exchange Commission, the service could enable sophisticated algorithmic traders to exploit investors.

“In the interest of fairness and the investing public, this initiative should be denied by the regulator,” Thomas Peterffy, the billionaire chairman and chief executive of Interactive Brokers Group Inc. and one of the pioneers of automated options trading, said in an email.

Exchanges in recent years have sought to boost profits by selling data, often reaching into the torrent of electronic trading activity that rushes through their markets for data to package and sell.

Nasdaq PHLX is the second-biggest U.S. options exchange. Some 12 to 14 billion digital messages a day zip through its systems, representing trades and other information, according to Nasdaq.

The Intellicator—a combination of the words “intelligent indicator”–would use that activity to gauge market sentiment. Every minute, it would spit out numbers corresponding to a part of the options market and show whether investors in that market segment were bullish or bearish.

While it wouldn’t reveal the identities of investors, the Intellicator could reveal the “customer type” of buyers or sellers in thinly traded markets. For instance, it could show whether a trade was initiated by a small investor or big money manager, by identifying certain traders as “professional customers” who place larger volumes of orders each day.

Nasdaq said in a September SEC filing that, in some cases, the Intellicator could be used to “reverse-engineer” the strategies of certain kinds of firms, yielding information “not otherwise available on the Exchange’s data feeds.”

That could harm pension funds and other institutional investors, for whom it is critical to get big trades done quietly, said Peter Maragos, chief executive of Dash Financial Technologies, an equities and options brokerage.

When such big investors want to buy or sell large quantities of options, their brokers will often break the order into chunks and execute them throughout the day. The idea is to avoid tipping off the market about the large investor’s intentions.

But if the Intellicator reveals a small order was initiated by a big investor, others could infer that the investor is about to buy or sell many options, potentially affecting the price of the underlying stock. An algo trader could quickly buy or sell that stock, resulting in a worse price for the investor on the options, Mr. Maragos said.

“We don’t see how this benefits investors in any way,” he said.

A major Wall Street lobby group urged the SEC to block the Intellicator proposal in a letter released Thursday. “If this data is made publicly available, customer trades could be adversely impacted if bad actors attempt to utilize this data to manipulate the market,” the group, Sifma, said in the letter, which was dated Wednesday.

Jeff Kimsey, Nasdaq’s head of global data products, said in an emailed response: “We have developed these products with great care and consideration to ensure that they cannot be used in a manner that is detrimental to the market.”

Nasdaq says it is actually trying to “democratize” options data, or level the playing field between high-tech traders and ordinary investors. The New York exchange operator consulted with dozens of its customers before unveiling the Intellicator and sought to minimize the risk of exposing anyone’s secrets, Mr. Kimsey said in an interview.

Customer-type data is available elsewhere, and savvy traders already use it, he said, though he added that no other source releases such data as frequently as every 60 seconds, as the Intellicator would.

Some market veterans say the Intellicator proposal won’t have as much impact as critics fear. “What Nasdaq is trying to do is add a little more transparency,” said Henry Schwartz, president of options data firm Trade Alert LLC. “But I don’t think they’re overdoing it.”

The SEC has until Nov. 18 to respond to Nasdaq’s plan, though it could just decide to delay a decision for months.

Nasdaq unveiled the Intellicator in an August SEC filing, but withdrew that filing less than two weeks later. When it filed an expanded version in September, it included the material about how the Intellicator could help reverse-engineer hidden trading strategies. Mr. Kimsey said Nasdaq added those sections after talking to the SEC. An SEC spokeswoman declined to comment.

The clash comes as the arcane business of exchange data feeds has come under growing scrutiny, even drawing attention from the administration of President Donald Trump.

Banks and trading firms complain Nasdaq and the New York Stock Exchange unfairly use their access to raw market data to sell ever-costlier “data products.” Nasdaq and the NYSE counter that their pricing is fair and that they are only responding to growing demand for data in today’s electronic markets.

But on Oct. 6, the Treasury Department sided with the exchanges’ critics, stating in a report that “limited constraints on exchange pricing power [have] allowed exchanges to regularly raise prices.” Shares of Nasdaq dropped 4.8% that day, while shares of NYSE owner Intercontinental Exchange Inc. fell 2.7%.

Nasdaq has also faced allegations that it gives some traders an unfair edge by selling data feeds that shed light on other firms’ trading activities.

Last week, it stopped offering a package of data feeds called Nasdaq Market Analytics after customers complained that it revealed “too much information about the trading strategies of participants on the Exchange,” Nasdaq said in an Oct. 30 filing. Nasdaq said it didn’t think the complaints were justified, but terminated the package anyway, calling it “potentially controversial.”

The stakes are higher than one new data feed, observers say. If the SEC backs the Intellicator, Nasdaq’s rivals will likely launch copycats, said Jim Toes, head of the Security Traders Association, a financial-services trade group.

Data has grown increasingly important to exchanges, he added. “The exchanges are getting more creative in their business models,” Mr. Toes said. “It’s a new world.”

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