FBI Probes Ultrafast Trading

HFT has come under powerful scrutiny in recent months, with Lewis's book being the latest high-profile investigation.

The Federal Bureau of Investigation (FBI) is investigating high-speed buying and selling of securities on US markets, in an attempt to determine whether firms engaged in this practice are contravening rules on insider trading.

Specifically, the FBI is investigating whether traders are acting on non-public information to transact ahead of the market. The news that the FBI, which has jurisdiction to investigate the matter under its white-collar crime remit, is now looking into the area comes weeks after the New York Attorney General, Eric Schneiderman, announced that he would be scrutinizing practices such as co-location.

Dr Roman Kozhan, associate professor of finance at Warwick Business School, says that the FBI investigation has two aspects. The first is whether HFT or high-speed firms manipulate the market through sending false orders, which can be done through flash orders. The second, more serious charge of insider trading is harder to make stick and not necessarily related directly to HFT.

"If a particular trader is getting some material and non-public information before the general public, there may be some legal implications," he says. "However, this is an old issue which existed long before the introduction of HFT and algorithmic trading. Regardless of whether the trader manually entering orders based on illegal information or using a sophisticated computer-based algorithm, the implications are the same; in both cases the traders will be subject to insider trading regulations. So I do not think this is anything much to do with HFT per se."

Flash Boys
In addition, the release of a book by journalist Michael Lewis on Monday has provoked consternation and debate on Wall Street. "Flash Boys", as the book is titled, accuses banks, market-making firms and exchanges of rigging the stock market through the use of high-frequency trading (HFT), which the author claims disadvantages regular investors. A highly publicized interview on the US television show "60 minutes", broadcast on Sunday, repeated the claims.

While many have praised Lewis for his book, some quarters have reacted angrily. Mike Conaway (Rep.), US Representative for the 11th Congressional District of Texas, released a brief statement on HFT that defended the role of market participants in deciding competent policy.

Market participants are best equipped to determine what role HFT should continue to play. Americans should be wary of an overreaction by Congress or regulators, who may choose to act because of headlines, rather than an understanding of the issues. - Rep. Mike Conaway, 11th Congressional District of Texas.

"Market participants are best equipped to determine what role HFT should continue to play," he says. "Americans should be wary of an overreaction by Congress or regulators, who may choose to act because of headlines, rather than an understanding of the issues."

Meanwhile, an internal memo from a BNP Paribas analyst, John Nunziata, was circulated throughout Wall Street yesterday, claiming that Lewis held a stake in trading platform IEX, which features heavily in "Flash Boys". The memo's information was later proven to be false, and was categorically denied by both Lewis and IEX.

While the FBI's investigation is not linked to the release of Lewis's book, having begun a year ago according to the Wall Street Journal, the HFT landscape has already undergone significant changes over the past few months. Certain data providers said that they would no longer run a specialized information delivery service designed for HFT clients, while high-speed powerhouse Virtu financial announced that it would file for an initial public offering (IPO), the first HFT shop to do so and bare its books to public scrutiny. Recently, Goldman Sachs announced that it would be embracing ways to make trading fairer in the high-speed realm, a remarkable turnaround for a bank that has, traditionally, been content to stay out of the public HFT debate.

Outside of futures and equities, the foreign exchange (FX) market has been undergoing a series of experiments with randomized pauses in the order process, designed not to eliminate HFT, but to mitigate the effects of what they uniformly describe as "predatory" tactics.

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