High Frequency Trading: a brazen abuse of long standing security laws

Attorney General Eric Schneiderman has launched an investigation into whether U.S. stock exchanges and alternative venues provide high-frequency traders with improper advantages. [Answer: YES]. See: High-Speed Trading to face NY Probe into fairness.

Investment banks and rapid-fire trading firms pay thousands of dollars a month for services that give them locational advantage and information ahead of other market participants. Stock exchanges that are supposed to be charged with maintaining the integrity and stability of their platforms, have migrated to being bought toll takers on a corrupt information highway. Nasdaq OMX Group said in an investor presentation last week that it reaped close to $40 million in revenue from the U.S. proprietary market data in just the fourth quarter of 2013 alone. The company did not reveal how much it receives from co-location of servers–where they sell some traders enhanced access to tie directly into exchange servers in order to receive split-second advantage over others using public markets.

Computer or “algo” driven trades can be executed in 300 microseconds. So 1,000 trades can be made in less than the 400 milliseconds it takes to blink the human eye. At their peak, algorithms shot some 323,000 stock-trading messages each second in the U.S. last year. This compares with less than 50,000 such trades for the busiest period in 2007, according to data compiled by the Financial Information Forum.

If you think this sounds like healthy market liquidity, think again. All this noise comes from the High Frequency guys trying to game each other or fool traders–a form of high-stakes chicken that also serves to suck in and then evaporate the savings of an unsuspecting public who tends to think that transaction volume and bids are evidence of legitimate investor interest. In reality more than 80% of HFT trades are cancelled before they can be executed; providing nothing more than a mirage of liquidity which instantly vanishes in moments of market distress: “Today, 90 to 95 percent of all quotes emanate from High Frequency machines…… This doesn’t imply share volumes just quotes traveling on the tape.” See: High Frequency Trading: Is it a dark force against ordinary human traders and investors? These practices are entirely indefensible in any broad rational or ethical assessment.

They are also clearly in contravention of duties prescribed under section 11 of The Securities Exchange Act of 1934–still in force, see the full text here–which specifies that exchanges are to enact rules to maintain orderly markets in an ethical manner in order to protect investors and the public’s interest, to promote equitable practices and to prevent fraud and manipulation. In addition, the New York Attorney General also has broad powers under the still valid 1921 Martin Act which prohibits “[a]ny fraud, deception, concealment, suppression, false pretense or fictitious or pretended purchase or sale” in “the issuance, distribution, exchange, sale, negotiation or purchase … of any securities or commodities.”

Last month in the first meaningful step toward more ethical practices, Business Wire, the distributor of press releases owned by Warren Buffett’s Berkshire Hathaway Inc., said it would stop sending the statements directly to high-frequency firms ahead of everyone else. The AG’s office has called this an important break through in the road back to restoring some fairness and ethics to trading in public securities markets.

In this case we do not need more regulation or new laws, we just need the public to demand that current laws be enforced on our stock exchanges that have become entirely short-term-profit focused at the expense of their social utility and mandate to serve free market principles.

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