The FT article picked up on this issue, too: “If you don’t speak the language, the specifics are already lost,” a source involved in the collaboration reportedly told the FT.
HFT, Algo Trading, and Artificial Intelligence Under the Microscope
The article discusses a few specific areas where the SEC and FBI will focus their attention:
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Quote Stuffing: The practice of flooding the market with quotes that are instantly cancelled to drive others to trade in ways that benefit the HFTs has been an area of investigation for three years, ever since the flash crash of May 2010. Even the exchanges have trouble identifying nefarious manipulation. Think the FBI has a shot of figuring out where the real manipulation is occurring?
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News Aggregation: According to the Financial Times article, apparently, if a firm is aggregating news at high speeds and making trading decisions based on the news before anyone else, “They might be violating insider trading rules.” Huh? If it came from a news aggregator, how can it be considered insider trading?
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Alpha Capture: The SEC and FBI will be looking at alpha capture systems and systems that allow sell-side firms to share information with the buy side to see if research was distributed selectively to “best clients” before it was distributed to all clients, which could create front running or insider trading violations. The SEC was doing a sweep of these systems back in 2011, but I’m not sure if any regulatory actions surfaced.
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Artificial Intelligence: The regulatory team also will focus on systems that predict market reactions based on historical data. I’m not sure what they think these systems are guilty of doing -- unless they assume that the systems are being used to generate signals in the market rather than trade on detected patterns. I know there are several start-ups trying to create systems like this, but are these AI systems in production anywhere, or is this still somewhat in the realm of science fiction?
Successful Indictments in Market Manipulation Cases
The FBI has had some recent success in market manipulation cases. Just last month, the agency secured indictments and arrested 14 people for market manipulation. But these schemes relied much less on technology, with plenty of smoking guns.
In one of the cases, the crooks picked a handful of thinly traded, cheap companies and bought up most of their stock. Then they issued press releases with bogus claims about growth, recent successes, and growth potential. They even hired actors to handle press conferences. They then bribed online stock pickers to recommend the stock, and as the stock prices rose, dumped their holdings. Frankly, this would be MUCH easier to identify and prosecute than some of the perceived manipulations by HFT.
I Have My Doubts
Personally, I’d like to see more criminal prosecutions against the people who have done so much damage to our economy. Too many people get off while shareholders pay the fines. But these cases are notoriously hard to prove, and the FBI would have to make a rock-solid criminal case, demonstrating intent to manipulate a stock.
So while I hope the SEC and FBI are successful in identifying and prosecuting market manipulation so they can help restore confidence and stability in the markets, I have my doubts about whether this is going to work.
What do you think?
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Comments | Post a Comment
14 Comments to "Can the FBI and SEC Stop Market Manipulation Together?":
kennymcb
08 March 2013
At its most basic, isn't front running orders you have from a client the most basic market manipulation you can have?
Comments (49)
crammond1964
08 March 2013
market abuse can be captured very simply but it comes at a price .......... Sadly perhaps the guilty parties may be our main players as in LIBOR .
Until we are able to regulate real time manipulation the problem will continue ; I think the exchanges have alot of explaining why they have ignored these issues ?
Comments (252)
Anonymous
08 March 2013
The lawyers at the SEC and the cops at the FBI exhibit lacking both natural and artificial intelligence.
drjohnbates
08 March 2013
They've got to be kidding! Unless they create a specially equiped new division that actually understand what's going on. Otherwise they are like cavemen trying to operate in a "Minority Reports" world!
Comments (6)
candyce
08 March 2013
@Drjohnbates: Good analogy! It's like a chase scene from Minority Report where the FBI and SEC are foot pedaling in Fred Flintstone's car.
Comments (27)
amartinez
08 March 2013
Interesting article - market manipulation is not as hard to detect as proving it. Detection involves a stock moving up or down when there appears to be an effort to dominate and control the market so volume observation is needed as well as price movement. The difficulty is that as long as the purchases are paid for or sales delivered, it is difficult to suggest that their was intent to move the stock price. HFT actually may offer the opportunity to establish patterns which assist in proving manipulation. If the FBI joins the SEC in this effort it could make a significant difference by bringing into play certain helpful investigative techniques not available to the SEC but they also need to have the capability to review HFT algorithms to determine whether there is an iherent attempt to take advantage of current market conditions in individual securities that would be manipulation friendly and the algorithm is itself manipulative - very difficult but not impossible.
Frontrunning should be considered a form of insider trading and not market manipulation. Someone frontrunning a trade or trades, positions themselves ahead of the market move he/she knows is imminent. This behavior usually occurs with the knowledge (insider trading argument) that significance supply or demand is entering the market and the frontrunner will either usually either buy or sell into that supply and demand thus realizing the profits. Frontrunning does not include the frontrunner pushing/moving the market.
Comments (17)
Anonymous
08 March 2013
@amartinez, you sure have faith in the Keystone Cops. I won't argue your points because as long as the Keystone Cops are involved it's all moot.
candyce
08 March 2013
@drjohnbates and @anonymous: Surely they can attract some hotshot quants and developers from prop firms. Nobody in this industry cares about payscales, right?
Comments (27)
Anonymous
08 March 2013
@candyce, the SEC interviews "hotshots" but prefers to hire lawyers fresh out of law school.
candyce
08 March 2013
@amartinez: perhaps your point about front running is where AI plays a role. I have not read Scott Patterson's book yet, but it's on my desk and should make for an interesting read this weekend.
Comments (27)
amartinez
08 March 2013
@Candyce - I tend to agree with you and I confess I have not read Scott's book either.
@drjohnbates and @anonymous -- good comments. I am just commenting on the possibilities and potential benefits - people have to make it happen and one needs the right resources and action plan to accomplish it.
Thank you for your responses
Comments (17)
John Harris
08 March 2013
This is a spectacle for public consumption and nothing more. Meanwhile, the real market manipulation scandal - the one that hurts almost everyone the world except for the tiny minority that orchestrate and profit from it - the one run by the Fed on behalf of its patrons - goes unchecked.
Manipulating the price of penny stock - criminal.
Manipulating the price of money - government as usual.
Front running the Fed's QE programs - free money for primary dealers.
amartinez
08 March 2013
John - I do understand your frustration and the currency issue is a matter of international consequences with the alternatives posing even greater economic threats. Although in comparison, a penny stock manipulation may seem minor but the impact of investors not trusting the integrity of our markets also provide great threats to our economy because investors will play in other investment arenas depriving our businesses of needed capital.
Seems to me that you are trying to say that since our market structure has changed so radically within the last 8 to 10 years, regulation needs to also change to better meet the challenges and threats of today. If that is what you are saying, I do agree with you, however, market manipulation, insider trading and frontrunning will continue to be of prime significance to regulators because these abuses, if not checked, will erode the confidence of investors with dire consequences to our way of life.
One thing I have experienced, that nothing is perfect - we've all heard ot before: a life time of being right 3 out of 10 times in baseball will take one to the Hall of Fame :)
Enjoy the weekend
Comments (17)
John Harris
08 March 2013
Thank you, Mr. Martinez. Actually, some things are perfect - love, beauty, integrity, and honesty, to name a few. Virtue is perfect. We have the word "perfect" in our language because it describes some things.
But if you mean that the world isn't perfect, then of course you are correct. It never will be. But embracing foolishness to cure imperfection is...foolish. And "regulation," which is nothing more than a euphemism for prior restraint, is the ultimate foolishness. To violate the rights of the law-abiding because some will not be law-abiding is to make everyone a victim, when otherwise only a few would be victims.
The SEC is itself a fraud. Its first chairman was a known stock manipulator. As FDR said when he nominated Joseph Kennedy, "It takes a criminal to know a criminal" (or words to that effect).
The SEC deserves the scorn, not the respect, of every honest person.