In our February 2013 article “Stay Afloat in the New Wave of High-Frequency Trading Actions” (published in the New York Law Journal on February 25, 2013),1 we addressed the magnified regulatory and legislative interest in the practice of high-frequency trading, and outline new defense tactics suited to high-frequency trading.
High-frequency trading – computerized trading based on complex algorithms designed to rapidly analyze the financial markets and execute orders – now accounts for approximately one-half of all U.S. equity trading volume and approximately sixty percent of futures contracts trading on the Chicago Mercantile Exchange. Proponents of high-frequency trading argue that the strategy improves market efficiency, liquidity, and lowers transaction costs. Critics contend that it has led to a two-tiered marketplace: highfrequency traders, and “everyone else.”
The Securities Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and the Commodities Futures Trading Commission (CFTC) have begun to question whether high-frequency trading strategies are in conflict with principles of market integrity. In addition, the Senate Banking Committee on Banking, Housing, and Urban Affairs has conducted hearings to determine whether legislative reform targeted at high-frequency trading is warranted.
The initial findings of these investigations have revealed abusive momentum-driven trading and instances of “layering,” “quote-stuffing,” “spoofing,” and “pinging” – practices that involve entering bids with no intention of completing the transaction in order to artificially manipulate security prices. While the investigations are still in their early stages, the SEC, FINRA, and the CFTC have already admonished such conduct and taken enforcement action against high-frequency trading firms for engaging in these practices. As regulators and legislators continue their drive to expand surveillance and regulation of high-frequency trading practices, and the CFTC leverages its new SEC-like anti-fraud enforcement authority, we believe there will be a substantial increase in enforcement activity aimed at curbing unfair and manipulative practices in high-frequency trading.
As discussed further in our article, firms employing these sophisticated, advanced technologies should pay close attention to regulatory and legislative developments during what is likely to be a period of intense scrutiny.