Compliance

11:40 AM
Larry Tabb
Larry Tabb
Commentary
Connect Directly
LinkedIn
Twitter
RSS
E-Mail
50%
50%

High-Frequency Trading and the Blind Scales of Justice

The Justice Department and SEC's joint investigation into high-frequency trading could be just what the industry needs, writes special contributing editor Larry Tabb.

On Friday, April 29, the Justice Department and the SEC opened a joint investigation into high-frequency trading practices. Bloomberg reported that the investigation will focus on whether high-speed traders are placing and cancelling waves of orders in attempt to manipulate the market.

What can I say? What took so long?

The investigation is a win-win. Either the Justice Department and the SEC find abuse, lock up the scofflaws and throw away the keys, or they don't fine manipulation and give current trading practices a green light. Either way, the market wins.

The market has been struggling to come to grips with high-frequency trading for more than three years now. It has become a he-said, she-said cat fight without any proof on either side or a clear winner. High-frequency trading proponents promote their wonderful liquidity, and the antagonists scorn the creation of a horrible, two-tiered market in which the average investor gets hosed.

Can someone please tell me, am I being pampered, or screwed? While I have tremendous sympathy for the high-frequency trading firms that probably are dealing with the impatient Justice Department's data requests right now and likely are having their computers confiscated as we speak, one way or another, I would love for this fight to be over.

While it would be great if this all had been over yesterday, the reality of the matter is, the investigation will take years. The amount of data created from an HFT/algorithmic trading engine is tremendous. These machines read gigabytes of daily data to determine when to trade and then execute their orders against 50 or so markets simultaneously. Just deciphering one strategy must be difficult enough, but given dozens or hundreds of strategies that must be untangled, analyzed and demystified within our microsecond trading environment, it will drive a bunch of lawyers simply nuts.

A Frightful Task

Think about explaining to a lawyer a complex trading strategy spanning multiple venues. Think about trying to discern the nuances of what a trading engine saw -- what signals it received, how it reacted, why it either tried to place or take liquidity, and how it managed risk across multiple asset classes in microseconds at a rate of thousands of orders per second? Frightful. And firms will need to do this in front of a guy who is more than ready to fine you or throw you in jail if investigators don't like your answers. I'm certainly glad it isn't me.

While analyzing this data will be difficult, it must be possible. If the modelers can tease out the order creation and execution logic, then there must be a way for these same developers, modelers and technologists to vet if the models are trading off of the right signals, or if they are functioning properly or not.

If the process is fair, done under the proper light, and doesn't turn out to be a Spanish Inquisition -- and the HFT firms can survive -- it just may be the kind of insight we need. The best thing may just be to open these models to the light, vet these trading strategies in front of experts and battle it out in a court of law.

If we as an industry cannot pass through the scrutiny of inquiry, the robustness of a trial and the (hopefully) blind scales of justice, then unfortunately we deserve the mistrust, venom and poor press we receive.

Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio
Comment  | 
Print  | 
More Insights
More Commentary
Chief Data Officers: Organization Strategy & Cultural Change
Chief data officers are new to the financial services C-suite, but they are facing a number of challenges, including the need for new data governance and execution strategies, staffing, and new organizational structures to enable cultural change.
New York FinTech Innovation Lab Calls for New Entrepreneurial Applicants
Wells Fargo joins 14 other major financial institutions providing mentoring and guidance to the six chosen startups.
Micro Data Challenges in an Era of Macroprudential Regulation
Research and statistical analysis experts at central banks are tasked with developing sophisticated forecasts and models to identify systemic risk. Yet they are spending most of their time acting as data entry clerks, rather than developing these models.
The Perks of 'SmartSourcing' Shared Services in Financial Industry
A breadth of vital but undifferentiated business processes are still being replicated across the industry. They are all candidates for centralization.
Managing Social Media Risk Strategy: Technology Can Only Go So Far
Advanced analytical technologies are an important part of a social media risk management strategy, an Accenture report says, but the technology must be balanced with training and procedures.
Register for Wall Street & Technology Newsletters
White Papers
Current Issue
Wall Street & Technology - Elite 8, October 2014
The in-depth profiles of this year's Elite 8 honorees focus on leadership, talent recruitment, big data, analytics, mobile, and more.
Video
Stressed Out by Compliance, Reputational Damage & Fines?
Stressed Out by Compliance, Reputational Damage & Fines?
Financial services executives are living in a "regulatory pressure cooker." Here's how executives are preparing for the new compliance requirements.