September 17, 2012

After a year of botched IPOs, rogue algorithms and insider trading scandals, you'd think the bad behavior on Wall Street might subside. That traders, bankers and exchanges would cool it and behave for just a little while.

You'd be wrong.

On late Friday we learned that the Securities and Exchange Commission fined the New York Stock Exchange (NYSE) for improperly feeding market data to certain customers before sending it to the public. Yes, a select few Wall Street giants got price quotes before Mr. and Mrs. Average Trader. Although this may have simply been an error by the exchange, and not the result of malicious activity, this revelation couldn't have come at a worse time.

The SEC said NYSE gave some customers a head start on market data that ranged from single-digit milliseconds, to multiple seconds in some cases. With transaction speeds becoming so fast, the tiniest leg up on the competition provides a golden advantage for some, while damaging the prospects for long-term and retail investors in the process.

The regulator said this practice began in 2008, and that its investigation found that NYSE's compliance department was kept out of the loop on important technology decisions, including the design, implementation and operation of NYSE's market data systems. Considering that market data is the lifeblood of an exchange – and all our markets – this is more than an eyebrow raiser. It's a gross oversight, and NYSE should feel fortunate that it got away with a mere $5 million fine.

Why Trading Volumes Are Low

There's no good time for a confidence-shaking scandal to emerge but 2012 might be the year that Wall Street threw out the rulebook. All year long, the question of why stock trading volumes have been in the doldrums has lingered over the marketplace like a dark cloud. Retail investors, who've traditionally been a steady source of much of the volume that's traded every day, have been sitting on the sidelines or turning their attention to other asset classes.

There's no doubt that political and economic uncertainty in the U.S and Europe has also played a role in this, even as the bull market that began in 2009 persists. But the number of high-profile incidents we've seen this year, from the Facebook IPO, to the rogue algorithm that nearly sank Knight Capital Group, surely has shaken investor confidence, and has the usual volume drivers thinking twice before betting on equities.

Meanwhile, the stormy weather that Goldman Sachs forecast to its clients is perhaps another reason for investors to eschew the stock markets. Last month, the firm advised its customers to get out of equities before the U.S. falls off the so-called fiscal cliff, a scenario that could plunge the teetering U.S. economy back into recession. Severe government spending cuts – and tax cuts - are on tap starting in 2013 as a result of the disastrous deficit negotiations of August 2011.

Goldman doesn't expect lawmakers to address this in time, and it predicted that the Standard & Poor's 500 index would plunge 12 percent as a result. The Congressional Budget Office also warned of a deep recession should this scenario come to fruition.

For investors to return to the market and renew their investment in equities, they will have to begin to trust their broker dealers, the men and women who execute their trades and the exchanges where the trades take place again. So far, there doesn't seem to be any sector of the market that hasn't been tainted by bad behavior or incompetence. If investors decide to store their money in gold or in cash, who can blame them?

ABOUT THE AUTHOR
As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced ...