In the latest round of regulatory action involving high frequency trading and dark pools, the SEC announced yesterday that it reached a settlement with ITG, Inc., and its affiliate Alternet Securities, Inc., imposing a $20.3 million sanction based on ITG’s misuse of confidential order information to benefit the firm’s proprietary high-frequency trading.
high frequency trading
SEC Rule Change Would Require High-Frequency Traders to Register with FINRA
On March 25, 2015, the SEC proposed an amendment to Rule 15b9-1 that would require high-frequency trading firms to register with FINRA. According to the SEC, the proposed amendment will better align the scope of Rule 15b9-1 with today’s market structure.
Rule 15b9-1, as presently written, exempts certain market participants from the requirement under the Securities Exchange Act that broker-dealers become a member of a registered national securities association. Specifically, Rule 15b9-1 exempts broker-dealers from the membership requirement if they (1) are a member of a national securities exchange, (2) carry no customer accounts, and (3) derive $1,000 or less in gross annual income from securities transactions conducted outside of a national securities exchange of which they are a member (the “de minimis allowance”). Under the current Rule, income derived from trading for the broker-dealer’s own account with other broker-dealers does not count against the $1,000 limit.
Proposed FINRA Rule Would Require Associated Persons Who Develop Algorithmic Trading Strategies To Register as Equity Traders
In the latest regulatory action addressing high frequency and other algorithmic trading, a recent FINRA Regulatory Notice seeks comment on a proposed rule change under which persons associated with a member firm would be required to register as Equity Traders under Rule 1032(f) if they are primarily responsible for the design, development or significant modification of an algorithmic trading strategy that generates orders routed to an exchange or traded over the counter. Persons responsible for supervising this type of activity must also register.
The proposed rule change addresses FINRA’s stated concern that persons responsible for developing or modifying trading algorithms may lack adequate knowledge of the securities rules and regulations and that this lack of knowledge could result in trading algorithms that do not comply with applicable rules. The Regulatory Notice states, for example, that FINRA has observed algorithmic trading strategies that generated trading activity apparently violating Regulation NMS, Regulation SHO, Rule 15c3-5 and other market and investor protections.
New York AG May Face A Tough Road In High Frequency Trading Case Against Barclays
Ruling on Barclays’ motion to dismiss the action brought by the New York Attorney General regarding Barclays’ alternative trading system (“ATS”), Justice Shirley Kornreich suggested that the AG may face substantial hurdles in proving its case, although the Court narrowly upheld the Martin Act claim as a matter of law.
The AG based its claim on statements allegedly made to ATS participants regarding restrictions on use of the ATS for certain types of high frequency trading activity, which the complaint alleged to be false. The case raised the novel legal issue of whether New York’s Martin Act applies to these statements, which did not relate to the purchase or sale of any particular security but addressed the nature of the trading venue that might be selected for securities transactions.
SEC Sanctions Two Exchanges for Failing to Accurately Describe Order Types and Making Preferential Disclosure to High Frequency Traders
On January 12, 2015, the Securities and Exchange Commission announced that it had obtained a $14 million settlement against two exchanges formerly owned by Direct Edge Holdings, EDGA and EDGX (the “Respondent Exchanges”) for their failure to file Exchange Rules that accurately described the order types they offered, and for providing preferential disclosure to certain high frequency traders. This recovery constitutes the largest penalty ever levied by the SEC against a national securities exchange and appears to be the first action focusing primarily on exchange order type issues.
According to the SEC’s Order, the official Rules filed by both Exchanges only described a single price sliding order type, while each Exchange actually offered three variations to their members: Hide Not Slide, Price Adjust, and Single Re-Price. The SEC claims that the Rules failed to describe each order’s functionality and their priorities relative to each other and other order types. Moreover, although this information was not available to all members, the Exchanges provided it to a select few customers, including several high frequency trading firms. The SEC also claims that that two of these order types were developed in response to requests from high frequency trading customers and that both Exchanges would rotate which order type was used by default without filing the necessary Rule Amendment or providing notice to anyone except these “preferred” members.
FINRA’s 2015 Examination Priorities Zero In On Abusive Trading Algorithms and Other Issues Involving Trading Technology
FINRA’s recently-released Regulatory and Examinations Priorities Letter for 2015 reflects substantial regulatory interest in high-frequency trading and other issues arising from trading technology. Regulatory concern over these issues has been previously reported on this blog here and here.
The 2015 Letter states that FINRA has adapted its surveillance program to identify potentially violative conduct such as trading by “abusive algorithms” made possible by advances in technology and changes in market structure. Abusive algorithms, according to FINRA, include trading algorithms that seek to manipulate the market through layering, spoofing, wash sales, marking the close, or other manipulative techniques.
SEC Working Papers Suggest Market Benefits From Certain Types of High-Frequency and Low-Latency Trading
Bringing quantitative analyses to the debate over high-frequency trading, two working papers recently made available by the SEC’s Division of Economic and Risk Analysis present economic models suggesting that there are market benefits from certain forms of high-frequency and low-latency trading. In light of the on-going interest in high-frequency trading among various regulators, the recognition of market benefits is an important development.
The first paper, Automated Liquidity Provision, by Austin Gerig, an SEC staff economist and David Michayluk of the University of Technology, Sidney, addresses automated systems designed to provide market liquidity by trading at high frequency across different exchanges and securities. These automated liquidity providers have largely replaced traditional market makers, and the authors studied the effects of this automation on pricing and transaction costs.
Regulators Continue To Address High-Frequency Trading
Regulators across markets continue to show interest in high frequency trading and algorithmic trading generally. Recent developments in this area include:
- On October, 16, 2014, the SEC imposed a $1 million sanction on a high frequency trading firm, Athena Capital Research, which allegedly placed large numbers of rapid-fire orders in the final two seconds of trading to manipulate the closing prices of thousands of NASDAQ-listed stocks. According to the settlement documents, the trading algorithm, code-named “Gravy,” purportedly allowed Athena to overwhelm the market’s available liquidity at the close, and artificially move the market in Athena’s favor.