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:
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?
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?
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.
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?