Tuesday, August 4, 2009

SEC May Ban Unethical Flash Trading

Up until recently certain companies had advanced access to the orders other investors made, ahead of the transaction. Today it looks like the SEC may be making a move to ban the practices.

By placing servers with special detection and fast trade programs on them next to the computers that run exchanges like the New York Stock Exchange, companies like Goldman Sachs could determine very quickly what orders were coming through the system.

Taking an advantage of a delay from when an order is entered by someone like me and when it hits the market, the company could read order and then go in and buy the equity themselves just in time to mark it up a very small amount to then sell it me for a guaranteed, albeit small profit.

This is one form of computerized flash trading. Very recently one company, Goldman Sachs accounted for about 48% of all trade volume on the market through these types of trades, and flash trading in general. The practice allowed the company, to rack up billions in profits that many in the market feel are unethical and against the general principals of free market exchange in that it grants specific players an unfair advantage.

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Matt Heaton said...

Calling high frequency flash trading unethical is an understatement, it's fraud. There are many laws out there that already make the practice illegal, the SEC has just looked the other way and not enforced them.

This maybe an enormous victory against some of the fraud going on in the markets. Of course the cynical (and often correct) side of me things they'll leave an enormous loophole open for a couple of market participants like Goldman Sachs, while eliminating their competition. I'll believe it when I see it.

Colm Gent said...

With the way that this governments economic team has treated these companies so far, I'd be hard pressed to build much excitement up until they actually do it.

GS seems to have ended up with some very good deals out of our recent economic collapse, but the White House is starting to talk in stronger terms about deficit control now that they think we've hit bottom (Matt I know that probably starts you to pulling your hair out, but they really do seem to think that :) ). Maybe they'll toughen up on GS too. Here's hoping anyway.

Caleb Mardini said...

Agreed gentlemen. Which is why I said, "May Ban."

I agree the practice is fraudulent, but I haven't seen it legally defined as such yet.

I am hoping this is in the spirit of the recent indication that we may finally see some changes from older practices, I see the FCC and the FTC starting to step things up, it appears regulators may disagree with Geithner, and be willing to do something about it within their respective powers.

But as you said Matt, I'll believe it when I see it.

Matt Heaton said...

Schapiro said any proposal to ban the transactions would require approval from SEC commissioners and public comment. SEC rule making is typically a two-step process. The agency’s staff proposes a new regulation, and commissioners vote to solicit public feedback for between 30 and 90 days. Once the comment period ends, commissioners then decide whether to hold a second vote to make the rule binding.

Ain't gonna happen anytime soon. Everytime I've seen the SEC decide to put some rule change through this process it's always fallen off the table. When they actually want to do something they do it immediately, for example the short selling bans back in the fall were implemented overnight.