/>iOn Tuesday, Aug. 16, 2022, the U.S. Securities and Exchange Commission (“SEC”) instituted Administrative and Cease-and-Desist Proceedings (the “Proceedings”) against Conrad Neil Normann (“Normann”), 57, of Scottsville, New York. Normann was associated as a day trader with a proprietary trading firm registered with the SEC as a Broker/Dealer. According to the SEC’s Aug. 16, 2022, Order (the “Order”) issued in response to the Proceedings, Normann, from September 2017 through May 2018 (the “relevant period”), “carried out a manipulative securities trading scheme.” The scheme “involved placing and then, seconds before market close, cancelling Closing D Orders… thus fraudulently altering … [the New York Stock Exchange {“NYSE”}]’s closing auction order imbalance messages.” Those imbalance messages are “electronic messages published by the NYSE to market participants during the last ten minutes of trading and reflecting…the balance of selling and buying interest for the NYSE’s closing auction in a particular security.”
The Order recites that during the relevant period, Normann placed over 700 fraudulent Closing D Orders that he had no intention of completing. By so doing, he created “a false appearance of increased supply or demand for a particular security during the five-minute window when NYSE included Closing D Orders in its closing auction order imbalance messages.” This distorted the information provided to market participants and allowed Normann to establish positions on the opposite side of the market from his fraudulent Closing D Orders. As the Order states, “[t]hen, seconds before market close, Normann would cancel” his fraudulent D Orders, and realize a profit “from his manipulative conduct.” Normann made over $94,000 in “ill-gotten gains” from these actions. The scheme worked because Closing D Orders (where the “D” stands for “Discretionary”) permit the person placing the D Orders to cancel them up to ten seconds before the close of trading.
The NYSE allows three types of closing orders: i) Market-On-Close orders, which can be placed up until 10 minutes before the close, and are orders to buy or sell a security at the closing price; ii) Limit-on-Close orders, which also can be placed up until 10 minutes before the close and set the maximum purchase price or minimum selling price of a security at the close; and iii) Closing D Orders, which cannot be placed until five minutes before the close, but (as already noted) can be cancelled up to ten seconds before the close. Beginning at 10 minutes before the close, the NYSE continuously disseminates to market participants “closing auction order imbalance information,” which indicates probable closing prices. Someone like Normann can, accordingly, try to make an illegal profit by using the flexibility offered by Closing D Orders to reap the consequences of canceling fraudulent orders that have been used to mislead other participants about the probable closing price.
The SEC charges Normann with violating: i) Sections 17(a)(1) and (a)(3) of the Securities Act of 1933, as amended; and ii) Sections 9(a)(2) and 10(b) of the Securities Exchange Act of 1934, as amended, as well as Rules 10b-5(a) and (c) thereunder. The Commission imposed the following sanctions in the Order, to which Norman consented: he must cease and desist from future violations of the cited securities laws; he must disgorge $94,891 together with prejudgment interest of $15,447.37; and he must pay a civil money penalty of $50,000. In addition, he is barred from involvement with the securities industry in any capacity, and from participation in any penny stock offering or related activity.
One might ask, given the potential for market manipulation posed by Closing D Orders (which Normann exploited), why does the NYSE permit such a procedure? The probable answer involves two factors: the nature of the processes of the NYSE; and the developments in the marketplace driving the importance of the closing price for market participants. The official founding of the NYSE occurred with the signing of the famed Buttonwood Agreement by 24 stockbrokers on May 17, 1792, in response to America’s first financial panic. The Agreement was signed under the shade of a Buttonwood tree on lower Broadway, near the location of the City’s protective wall on its northern boundary (which is where the name Wall Street comes from). The NYSE has earlier roots though, going back to the purchase of New Amsterdam from the Dutch in 1624 and the development of informal places (typically taverns) to buy and sell securities. After the Revolutionary War, the Compromise of 1790 made Wall Street the new nation’s financial capital and provided the platform from which Alexander Hamilton, as President Washington’s Secretary of the Treasury, organized the assumption of the war debt, using federally issued bonds, and persuaded the federal government to create a central bank.
After the Civil War, the NYSE introduced the use of specified posts for each security to be traded, with the trading in those shares conducted on a continuing basis throughout the day. This greatly improved the efficiency of trading, which had been done since the outset on an auction basis, with buyers and sellers lining up and calling out (the open outcry system) offers to buy and to sell. The use of specified posts helped organize “the crowd” into persons focused on a particular security at a given post. The introductions of the stock ticker in 1867 and telephone in 1878 aided the great expansion of securities trading in the post-Civil War economic boom. The NYSE moved into its current building, 11 Wall Street, in 1903.
One significant feature of the NYSE’s continuous auction system is the use of market makers known as Specialists. To prevent the auction process from seizing up when there is an imbalance of buy and sell orders, Specialists maintain liquidity in the market by buying and selling for their own accounts (using their own capital), and then reselling or rebuying to even out the imbalances, making a small profit (known as the spread) on each transaction. Your author once represented a newly formed Specialist company in the 1980’s and became somewhat knowledgeable of their operation. The senior executive of that firm eventually became the President of the NYSE.
Over time, the introduction of computers and related technological advances led many market participants to question the inefficiencies and financial risks inherent in the open outcry continuous auction system, especially in times of market stress. Thus, efforts are regularly made to enhance the efficiency and lower the risks by tinkering with the NYSE trading system. Some innovations were the result of competition from NASDAQ, organized Feb. 8, 1971, by the National Association of Securities Dealers (now called the Financial Industry Regulatory Authority) as the National Association of Securities Dealers Automated Quotation system. As its name suggests, NASDAQ is not a continuous auction exchange; rather, it is an electronic exchange (as described in “The Birth of Stock Exchanges,” Investopedia, March 22, 2022) which, it is claimed, “made trades more efficient and reduced the bid-ask spread.” That Investopedia article goes on to say, “the competition from NASDAQ has forced the NYSE to evolve;” noting that “NASDAQ is catching up to the NYSE in terms of market capitalization.” In a related Investopedia article “NASDAQ Market Maker vs. NYSE Specialist: What’s the Difference?” from Oct. 26, 2021, the authors write “NASDAQ is an electronic market (basically a computer network) that does not have a trading floor.” NASDAQ relies on broker/dealers who are members of it and who serve as market makers, typically 14 for each security, to provide liquidity and efficient trading. In response the NYSE has greatly increased reliance on technology at the trading posts and in operating systems, with concomitant reduction in the role of Specialists. The NYSE and its supporters continue to insist that” [u]nlike the other, purely electronic exchanges, NYSE empowers human floor brokers with capabilities customers can’t find elsewhere,” Rosenblatt Securities, 2022. The notion is that in the face of major market turmoil (such as the crash on Oct. 19, 1987, related to Long Term Capital and its holding in Russian securities; the so-called “flash crash” of May 6, 2010; and the high frequency trading disruption of Aug. 24, 2015) human intervention not necessarily tied to a preprogram offers a better potential to respond to the crisis effectively.
The other factor explaining the availability of Closing D Orders on the NYSE is “[t]he increasing popularity of passive and indexed investments,” which according to Traders Magazine in a May 23, 2017, article, “ITG Discusses Trading the Close and The NYSEs D-Quote,” “has effected change in volume profiles for the U.S. equity market. As more money flows into ETFs and index funds, a growing percentage of volume is moving to the end of the trading day, specifically to the closing auction itself.” That same article notes that Closing D Orders were introduced in 2007 “as a tool to help floor traders better manage closing imbalances.” Or as Rosenblatt Securities wrote in a 2022 article, Closing D Orders provide “flexibility when trading around the closing auction. The close is by far the biggest liquidity opportunity of the day.” And again, “D Orders give investors maximum flexibility to play in the closing auction without forgoing continuous market liquidity.” So the Closing D Order was created and authorized to give the NYSE a “leg-up” in competing with NASDAQ and other electronic exchanges.
Jeff Bacidore, the founder and president of The Bacidore Group, LLC., wrote in a July 22, 2019, article, “The NYSE D-Quote: The Disney Fastpass of Trading,” that the Closing D Order “can be useful to buyside traders” by allowing traders “to work their order into the market for a longer period of time before their on-close interest is revealed to the market.” That Bacidore article details several risks (beyond the potential for fraud) presented by Closing D Orders, which may impose a “cost” for the flexibility offered by their use. As the Bacidore article notes, a Closing D Order “is by no means a silver bullet.”
So, at the end of the day (quite literally), the NYSE created an opportunity for market abuse in the interest of giving NYSE traders an “extra shot” of profiting at the close. Without judging either the NYSE or Normann, it suggests that the effort to enhance the attractiveness of trading on the NYSE must nonetheless be weighed against the temptations and trespasses offered by Closing D Orders.
