December 3, 2020

High-Frequency Stock Trading Catches Regulators’ Eyes

Regulators in the United States and overseas are cracking down on computerized high-speed trading that crowds today’s stock exchanges, worried that as it spreads around the globe it is making market swings worse.

The cost of these high-frequency traders, critics say, is the confidence of ordinary investors in the markets, and ultimately their belief in the fairness of the financial system.

“There is something unholy about them,” said Guy P. Wyser-Pratte, a prominent longtime Wall Street trader and investor. “That is what caused this tremendous volatility. They make a fortune whereas the public gets so whipsawed by this trading.”

Regulators are playing catch-up. In the United States and Europe, they have recently fined traders for using computers to gain advantage over slower investors by illegally manipulating prices, and they suspect other market abuse could be going on. Regulators are also weighing new rules for high-speed trading, with an international regulatory body to make recommendations in coming weeks.

In addition, officials in Europe, Canada and the United States are considering imposing fees aimed at limiting trading volume or paying for the cost of greater oversight.

Perhaps regulators’ biggest worry is over the unknown dynamics of the computerized stock market world that the firms are part of — and the risk that at any moment it could spin out of control. Some regulators fear that the sudden market dive on May 6, 2010, when prices dropped by 700 points in minutes and recovered just as abruptly, was a warning of the potential problems to come. Just last week, the broader market fell throughout Tuesday’s session before shooting up 4 percent in the last hour, raising questions on what was really behind it.

“The flash crash was a wake-up call for the market,” said Andrew Haldane, executive director of the Bank of England responsible for financial stability. “There are many questions begging.”

The industry and others say that the vast majority of trading is legitimate and that its presence means many extra buyers and sellers in the markets, drastically reducing trading costs for ordinary investors.

James Overdahl, an adviser to the firms’ trade group, said that they favor policing the market to stamp out manipulation and that they support efforts to improve market stability. The traders, he said, “are as much interested in improving the quality of markets as anyone else.”

Some academic studies show that high-frequency trading tends to reduce price volatility on normal trading days.

And while a recent analysis by The New York Times of price changes in the Standard Poor’s 500-stock index over the past five decades showed that big price swings are more common than they used to be, analysts ascribe this to a variety of causes — including high-speed electronic trading but also high anxiety about the European crisis and the United States economy.

“We are just beginning to catch up to the reality of, ‘Hey, we are in an electronic market, what does that mean?’ ” said Adam Sussman, director of research at the Tabb Group, a markets specialist.

High-frequency trading took off in the middle of the last decade when regulatory reforms encouraged exchanges to switch from floor-based trading to electronic. As computers took over, daily turnover of stocks rose to 8 billion shares in the United States from about 6 billion in 2007, according to BATS Global Markets.

The trading, done by independent firms or on special desks inside big Wall Street banks, now accounts for two of every three stock market trades in America.

Such trading has expanded into other markets, including futures markets in the United States. It has also spread to stock markets around the world where for-profit exchanges are taking steps to attract their business.

When British regulators noticed strange price movements in a range of shares on the London Stock Exchange, they tracked them to a Canadian firm issuing thousands of computerized orders allegedly designed to mislead other investors.

In August, regulators fined the firm, Swift Trade, £8 million, or $13.1 million, for a technique called layering, which involves issuing and then canceling orders they never meant to carry out. The action was challenged by Swift Trade, which was dissolved last year.

Susanne Bergsträsser, a German regulator leading a review of high-speed trading for the International Organization of Securities Commissions, said authorities have to be alert for “market abuse that may arise as a result of technological development.”

The organization will present its recommendations to G-20 finance ministers this month.

In the United States, the Financial Industry Regulatory Authority last year fined Trillium Brokerage Services, a New York firm, and some of its employees $2.3 million for layering.

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DealBook: New Scrutiny for S.E.C. and Trades at SAC Capital

Steven A. Cohen, the billionaire who runs SAC Capital Advisors.ReutersSteven A. Cohen, the billionaire founder of SAC Capital Advisors.

6:40 p.m. | Updated

Senator Charles E. Grassley, Republican of Iowa, has stepped up his inquiry into trading at the hedge fund SAC Capital Advisors.

In a letter sent Tuesday, Mr. Grassley asked the Securities and Exchange Commission to explain how it handled past referrals about SAC’s trading activity.

Mr. Grassley is examining 20 stock trades by SAC that were provided to him by the Financial Industry Regulatory Authority, Wall Street’s own regulatory body. Last month, Mr. Grassley asked the agency, known as Finra, for information about the “potential scope of suspicious trading activity” at the hedge fund, which is run by the billionaire investor Steven A. Cohen out of Greenwich, Conn.

The SAC transactions, which took place after Jan. 1, 2000, had been previously referred to the S.E.C. by Finra. They included stock sales and purchases made around the time of merger announcements or other market-moving events. Mr. Grassley did not provide details about which SAC trades were involved, at the request of the investigative agencies.

Mr. Cohen’s firm, which manages about $12 billion in assets, has become entangled in the government’s insider trading investigation at hedge funds. Two SAC portfolio managers pleaded guilty this year to making illegal trades based on confidential information. Neither SAC nor Mr. Cohen has been accused of wrongdoing. A spokesman for the firm has said that SAC was “outraged” by the conduct of the two portfolio managers, Noah Freeman and Donald Longueuil.

Mr. Grassley has been a leading critic of the S.E.C., saying it was not vigilant enough in protecting investors, including the agency’s failure to uncover frauds like the Ponzi scheme perpetrated by Bernard L. Madoff. In 2009, the senator pursued a similar inquiry to the one involving SAC when he examined Pequot Capital Management, a prominent hedge fund that has since shut down.

Mr. Grassley asked Mary L. Schapiro, the S.E.C. chairwoman, to respond to his recent request by June 7 by providing a written explanation as to how the S.E.C. had resolved Finra’s referrals, how the number of referrals compared with other hedge funds and whether a so-called Wells notice had ever been drafted with regard to any of the referrals. A Wells notice from the S.E.C. is an indication that the agency is considering an enforcement action.

“The function of Congressional investigations is not to establish whether any private firms have violated the law, but rather to examine particular facts and circumstances in order to assess how well the agencies created by Congress are executing the authorities granted to them,” Mr. Grassley wrote in his letter to Ms. Schapiro. “Looking into specific examples is essential for Congress to understand how effectively the S.E.C. pursues referrals such as these.”

This month, SAC executives met with staff members in Mr. Grassley’s office to discuss his inquiry.

“We welcomed the opportunity to meet with the staff to educate them about the firm and our compliance efforts, and had an entirely appropriate, professional and cordial meeting. We will continue to cooperate in any way we can,” SAC said in a statement.

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