Stockbroker Joe Saluzzi knows as much about high-frequency trading as anyone. Not from using high-speed techniques, but from seeing them used on him. "You’ll see a trade go through and then the price jumps half a penny,” he says. “Leakage is being siphoned out to a proprietary trader who’s really not adding anything to the market.”
Regulators have struggled to track these kinds of anomalies through the many nooks and crannies of the market. But the shadowy world of high-frequency trading might soon see a little more light. The Securities and Exchange Commission proposed new rules this week that would close a long-standing loophole, forcing high-speed traders to register openly with a single financial regulator.
Saluzzi, co-founder of the firm Themis Trading and coauthor of the book “Broken Markets,” welcomes the proposal, as do others looking to bring more accountability to high-frequency trading operations. Such firms use automated technologies to buy and sell stocks thousands of times faster than humans, creating what Michael Lewis famously called a “rigged” market in his 2014 book “Flash Boys.”
But not everyone is convinced that the new rules would have a tremendous effect.
“It’s more window dressing than anything,” says Christopher Nagy, a market consultant at KOR Trading, which advises high-frequency firms. “Will it change anything major from a market-structure perspective? No, not at all.”
If the rules pass, high-frequency firms would have to register with the Financial Industry Regulatory Authority (Finra), Wall Street’s national self-regulating organization.
The authority would give Finra a broader view of a field currently spread across dozens of trading platforms, from mainstays like the New York Stock Exchange to “dark pools” stalked by anonymous high-speed predators looking to take fractional cuts off of large stock orders.
The current state of affairs would be unrecognizable to the regulators who last amended the rules, in 1983. At the time, exchanges were physical places populated by flesh-and-blood human traders. Exemptions created in that era for certain market specialists have now become massive loopholes.
Today, roughly half the activity on alternative trading systems – which are more lightly regulated than mainstream exchanges – comes from high-frequency firms, many of whom don’t fall under Finra’s regulatory umbrella.
In the complex new landscape, opportunities for lightning-fast malfeasance have multiplied. “Certain market participants disperse their trading activity across multiple markets in an attempt to hide various forms of market abuse,” said SEC Commissioner Luis Aguilar in a statement Wednesday.
To Saluzzi, the highly fragmented modern market system presents unseen dangers to ordinary traders and daunting challenges to regulators. He thinks rules are a good start, but far from adequate. “Finra is out there at a gunfight with a knife,” he says.
The proposals follow months of increasing regulatory scrutiny over algorithmic trading. The Department of Justice last year indicted a New Jersey commodities trader over “spoofing.” The illegal practice involves pumping an exchange full of false orders to move prices, then yanking the orders and profiting from the temporary price anomaly.
But not all high-frequency trading is predatory. Nagy points out that many high-frequency firms perform the boring work of market-making: greasing the market's gears by moving large volumes of securities and profiting off the tiny commissions each transaction brings. This function can make the overall cost of trading cheaper for ordinary investors.
“High-frequency trading has permeated every aspect of the marketplace,” says Nagy, who thinks the proposed regulations are unnecessary. Many high-speed traders currently fall under various regional authorities, whose data Finra can request. “It’s the regulator’s responsibility to surveil them,” Nagy says.
Whether or not the rules ultimately pass, however, the market structure will remain just as convoluted and opaque as it is today, presenting ever more opportunities for less scrupulous flash boys to escape notice.