Bats agrees to merge with Direct Edge as exchange volume shrinks

‘Dominant Stranglehold’

“When Cummings set up Bats, it was really in response to the New York and Nasdaq having a dominant stranglehold on the equity trading market,” Larry Tabb, chief executive officer of the Tabb Group in New York, said in a phone interview on Aug. 23. “But time moves on, order flows declined, it’s gotten much more competitive.”

This year’s acquisition of market-making firm Knight Capital Group Inc. by Getco LLC, the Chicago-based high- frequency trader, may have made today’s merger more likely, Tabb said. Both are shareholders in Bats. Knight, now KCG Holdings Inc., also owns a stake in Direct Edge.

Electronic platforms have seen their reputations dim over the last week after a connectivity issue caused Nasdaq to halt trading in all its listed shares for three hours yesterday and Goldman Sachs Group Inc. bombarded markets with mistaken options orders. Bats shut its main market for almost an hour on Aug. 6 when a computer system malfunctioned.

Multiple Platforms

Bats, run with about 160 employees from a two-story office complex, operates two stock exchanges and an options market in the U.S. as well as Bats Chi-X Europe, the largest pan-European stock exchange.

O’Brien said in September 2012 that he was focused on expanding as an independent company following a report in the Wall Street Journal his firm was in merger discussions with the owner of the Toronto exchange.

Speculation over a Direct Edge sale dates to December 2011, when the U.S. Justice Department made the divestiture of Deutsche Boerse AG’s 31.5% stake in the company, held through its International Securities Exchange unit, a condition of its proposed merger with NYSE Euronext. European regulators blocked the trans-Atlantic union two months later and the Frankfurt-based exchange never made a deal.

Both companies count trading firms and banks among their owners, and Bats gained two new shareholders this month. Private-equity firms Spectrum Equity Investors LP and TA Associates Management LP bought all of Lehman Brothers Holdings Inc.’s estate when it exited its investment, according to a statement from Bats and the investors.

Largest Owners

Bats lists Getco as its largest owner with a 15.4% voting interest. Other owners include Morgan Stanley, Credit Suisse Group AG, Nomura Holdings Inc. and Citigroup Inc. KCG, Goldman Sachs Group Inc. and Citadel all have a 19.9% stake in Direct Edge. An additional 8.8% belongs to a group of five brokers, including New York-based JPMorgan Chase & Co.

“It makes sense,” Paul Gulberg, an analyst at Portales Partners LLC, said in a phone interview Aug. 23. “A combined company is probably more efficient to run.”

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