In the blink of an eye, high-frequency trading systems can engage in a staggering number of securities transactions. The subject of Michael Lewis’s popular book, Flash Boys, high-frequency traders seek to maximize profits by capitalizing on speed in buying and selling securities and adjusting to market data before their competitors. Critics, however, contend that agreements between public exchanges and high-frequency traders allowing for co-location and proprietary data feeds violate federal law, and some have filed lawsuits against exchanges based on the exchanges’ alleged role in high-frequency trading. As Lanier v. BATS Exchange, Inc. shows, those claims face an uphill battle.
High-frequency traders rely on algorithms and physical proximity to achieve their competitive advantage. The latter is premised on the fact that data feeds are only as fast as the speed of light through a fiber optic cable and that the shorter the distance between systems, the less time is required for a data transfer. Accordingly, one focus of high-frequency traders has been to reduce data latency as much as possible—including by entering into agreements with exchanges to place their computer systems as close to the data feeds as possible, known as “co-location,” where the traders’ systems are placed directly in the exchange facilities. High-frequency traders’ success in gaining a competitive advantage has drawn the ire of critics who contend that no one should get this advantage in the market.
The plaintiff in Lanier v. BATS Exchange, Inc., 2015 WL 1914446 (S.D.N.Y. Apr. 28, 2015), was one such critic. The plaintiff sought to bring a class action on behalf of subscribers to the electronic market data services offered by U.S. exchanges. The plaintiff sued these exchanges and alleged that the conduct enabling high-frequency trading allowed discrimination by U.S. exchanges among data recipients and that this conduct violated the contracts and internal policies governing such relationships. In particular, the plaintiff’s complaint alleged that the lion’s share of subscribers operate on a different playing field, receiving common feeds at a latency of up to 1,500 microseconds, while preferred data customers received this information in as little as 1 microsecond. Under the SEC’s Regulation NMS, which is incorporated into each exchange’s operating policies and subscriber agreements, the exchanges are required to distribute information on “terms that are fair and reasonable” and that are “not unreasonably discriminatory.” On the basis of these allegations, the plaintiff asserted claims for breach of contract, constructive trust, and unjust enrichment.
The defendants in Lanier moved to dismiss, arguing, among other things, that the court lacked subject-matter jurisdiction, that the claims were preempted by federal law, and that the plaintiff failed to state a claim. U.S. District Judge Katherine B. Forrest granted the motion and held that the plaintiff’s claims were preempted. Judge Forrest stated that “the SEC and not this Court must determine whether the [exchanges] have provided information in a manner that violates their obligations under Regulation NMS.”
Judge Forrest further explained that, in promulgating Regulation NMS, the SEC had interpreted federal securities law to require the exchanges to transmit data to processors at the same time that the exchanges submit this data to the preferred proprietary feeds. Judge Forrest highlighted an SEC statement during rulemaking that provided that exchanges are not required to “synchronize the delivery of its data to end-users.” Because the SEC and its interpretation of federal securities law preempted this particular breach of contract action, Judge Forrest concluded that she lacked subject-matter jurisdiction over the state-law claims.
In her opinion, Judge Forrest also held that the plaintiff could not sustain a breach of contract action under the subscriber agreements, as such agreements included express disclaimers of any warranty as to timeliness or accuracy. Noting that such agreements tracked the language of Regulation NMS, Judge Forrest cited this as an additional grounds for dismissal.
The vast profits obtained by high-frequency traders—and the scrutiny the profits have prompted—could mean that additional lawsuits will be brought attacking the practice. Judge Forrest’s opinion in Lanier, however, suggests that plaintiffs may find success on those claims elusive.