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SEC Sanctions Direct Edge Electronic Exchanges

Tuesday, October 18, 2011

Yoomi Lee | Bloomberg LawSEC Press Release No. PR-2011-208 (Oct. 13, 2011); SEC Release No. 34-65556 (Oct. 13, 2011); Administrative Proceeding File No. 3-14586 (Oct. 13, 2011) The Securities and Exchange Commission (SEC) entered into a settlement agreement with EDGA Exchange, Inc. (EDGA), EDGX Exchange, Inc. (EDGX, and together, Exchanges), and their affiliated routing broker-dealer Direct Edge ECN LLC doing business as DE Route (collectively, with Exchanges, Respondents). The SEC charged Respondents with violations of the federal securities laws as a result of their weak systems, processes, and controls on two separate occasions. Without admitting or denying the allegations, Respondents agreed to be censured and to cease and desist from committing or causing further violations. Moreover, Respondents agreed to implement remedial measures, including (1) enhancing their system development and maintenance policies and procedures, (2) employing an enterprise risk management framework and information security program, and (3) hiring a corporate training director to train employees regarding the Exchanges' policies and procedures.

November 8, 2010 Systems Incident

According to the SEC, the Exchanges allegedly implemented certain code changes relating to the processing of customer orders without first testing them. The code changes caused an operational error whereby the Exchanges' systems overfilled the orders submitted by three members. At the Exchanges' instruction, one member traded out of the overfilled shares and submitted a claim for $105,000 in losses. The other two members, however, refused to follow suit, and the Exchanges decided that DE Route would assume and liquidate the overfilled positions through its error account. The SEC claims that DE Route's activities exceeded the Exchanges' rules, and therefore, required SEC approval. Moreover, DE Route allegedly engaged in short selling activity and violated Regulation SHO in an attempt to liquidate the overfilled positions as quickly as possible. Specifically, DE Route failed to mark its short orders or marked them as long, and did not locate or document the availability of securities to borrow prior to effecting these short sales. The November 8, 2010 operational error allegedly caused an estimated 27 million shares of excess trading for the three members with a value of approximately $773 million across 1000 symbols. This error cost the Exchanges approximately $2.1 million in losses.

April 13, 2011 Systems Incident

The SEC also alleged that on April 13, 2011, an EDGX database administrator inadvertently entered a command that disabled database connections, disrupting the exchange's ability to process incoming orders, modifications, and cancellations. EDGX immediately began receiving internal system alerts and external notifications from members seeking to cancel unfilled trades and from trading centers that were bypassing EDGX because it was not responding to incoming orders. EDGX, however, allegedly waited approximately 24 minutes after the outage to remove its quotations from public market data and failed to indentify its quotations as manual quotations in violation of Regulation NMS. As a result, EDGX members submitted claims for more than $668,000 in losses.

Federal Securities Law Violations

The SEC charged the Exchanges with violating Sections 19(b) and 19(g) of the Securities Exchange Act of 1934 (Exchange Act). The SEC further charged EDGX with violating Rule 602(a)(3) of Regulation NMS. Finally, DE Route was charged with violating Exchange Act Section 19(g) and Rules 200(g) and 203(b)of Regulation SHO.     DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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