(BN) Bats Says System Errors Caused Pricing Problems Over 4 Years

(Bloomberg) Bats Global Markets Inc., the third- largest U.S. stock exchange operator, said it discovered a programming issue with the computers underpinning its markets that allowed trades that violated U.S. guidelines intended to ensure all investors get the best possible price.

The computers that match trades for two Bats equity exchanges and an options venue allowed some trades to occur at prices inferior to the best available bid or offer and enabled others to violate rules for short sales, or bearish bets, the exchange said in a notice published on its website yesterday.

The issue reported in a notice to users of the Lenexa, Kansas-based company may have allowed technical infringement of rules in the U.S., where trading is fragmented across 13 exchanges and dozens of other venues, aimed at preserving fairness. That may not have been the case in thousands of instances when shares changed hands under rules governing short sales, Bats said.

"Once again, we see there's a problem with electronic systems, this time an exchange system," Larry Harris, a finance and business economics professor at the University of Southern California in Los Angeles and former chief economist at the U.S. Securities and Exchange Commission, said in a phone interview. "Bats will get a lot of scrutiny from the SEC at a time when nobody wants that kind of attention. That said, it's important to recognize that Bats itself identified the problem and brought it to public attention and to the attention of regulators."

Inferior Prices

The trades at inferior prices, called trade-throughs because they trade through or ignore the best available bid or offer, may have happened 433,000 times, an average of 410 a day from October 2008 to January 2013 on the main Bats stock exchange, the company said. Almost 8,000 similar incidents occurred on the second Bats stock exchange and 617 on its options market, the firm said. Short-selling violations involved more than 3,600 incidents across its equity venues, Bats said.

The pricing issues at Bats follow the company's withdrawal of its own IPO after a technology glitch in March and the Nasdaq Stock Market's botched initial public offering of Facebook Inc. in May, events that undercut investor confidence that exchanges are in command of their technology systems.

Bats IPO

Bats, whose name stands for Better Alternative Trading System, rose to prominence in tandem with the proliferation of electronic firms that now dominate the buying and selling of equities in the U.S. The six-year-old equity exchange canceled its initial public offering on March 23 after errors on its own computer systems kept its stock from trading and forced a halt in Apple Inc. shares.

Nasdaq mishandled Facebook's IPO on May 18 when an auction to set the first traded price for the shares failed. The exchange's systems were overwhelmed by order updates and cancellations before the stock began trading, causing the market operator to make technology changes that prevented confirmations of orders and trades from being disseminated for hours, and leading to confusion among investors, brokers and market makers.