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March 10, 2013 6:53 pm
US authorities examining high-frequency trading are facing an uphill battle to combat potential market manipulation, from incomplete records to interpreting volumes of trades executed in milliseconds.
The FBI joined up with the Securities and Exchange Commission recently to focus on high-speed, algorithmic trading.
The SEC has been investigating possible manipulative trading strategies since the 2010 “flash crash” and has hired more than a dozen quantitative analysts across three of its divisions.
The efforts have yielded some civil enforcement actions, including two unrelated “layering” cases, against brokers Hold Brothers On-Line Investment and Biremis for allegedly allowing customers to submit orders that they did not intend to execute in order to trick others into buying or selling stocks at artificial prices.
Both firms and executives settled without admitting or denying wrongdoing. In those cases, the SEC was aided partly through emails and internal documents raising questions about potentially manipulative trades.
While some of the alleged tactics are the same as those used in the past, the new challenge is how they are executed. Algorithm-driven trades are issuing thousands of quotes in microseconds across numerous trading platforms, including “dark pools” that are off-exchange.
“Unless there is evidence of intent to manipulate, it’s hard to derive intent from raw trading data,” said one government official.
To bring a manipulation case, the government would have to find a way to show a person programmed the code to manipulate trades.
“How people will pull those signals apart will be complex,” said Tyler Moeller, chief executive of Broadway Technology, which builds electronic trading platforms.
“Determining if the trades were related and were actually manipulative and that there was malicious human intent behind them can be extremely difficult,” he said.
Among the challenges authorities face is a lack of comprehensive market data to work from. Until recently, the SEC had relied on official trade confirmations from what is known as the consolidated tape, a record of all transactions executed that does not include cancelled orders.
Since 2011, high-volume traders are required to report their equity trade data to the SEC. The SEC began using tools from Tradeworx, a high-frequency trading group, at the end of last year to provide it a real-time glimpse into stock trading.
But a plan to build a so-called consolidated audit trail is not expected to be completed for several years. The SEC’s team of quantitative analysts will help decipher the data received from the high-volume traders.
“It’s a cat-and-mouse game,” said the government official. “The question is, who will build the next best trap?”
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