FINRA Evaluating High Frequency Trading

by Christopher J. Gray on September 12, 2011

in Arbitration,FINRA Regulation,SEC,Stock Manipulation

High-frequency trading — a process in which computer algorithms are used to trade shares, foreign exchange and derivatives at superfast speeds — earns profits by extricating tiny price differences thousands of times a day, across trading platforms. The algorithms being used are treated by their owners as top secret; in fact, many have taken legal action against ex-employees who have allegedly stolen them. But this high-frequency trading may be a threat to market security.

Banks and other members of exchanges, along with broker-dealers, are being asked by the Financial Industry Regulatory Authority (FINRA) to hand over their high-frequency trading strategies and/or the software code so that the agency might watch for unusual trading patterns. Proponents of high-frequency trading claim that these strategies tighten the spread of market prices, but FINRA is concerned that they could hide potential market abuse.

FINRA, along with other securities authorities, has been trying to evaluate how high-frequency trading affects capital markets, and this request for strategy details and software code is just one more step toward that end. It would be possible for this technology to manipulate share prices, and so it is necessary for authorities to evaluate potential threats to prevent market abuse.

A worldwide concern, the European Securities and Market Authority, launched a probe into automated trading firms five months ago, requesting the same information now being requested by FINRA. The SEC is following a similar course of action, though they describe high-frequency trading as “not yet clearly defined.”

Executive vice-president of FINRA’s market regulation unit, Tom Gira, assures the public that requests for this information are not without cause and are usually in response to complaints. Because of the complexity and the massive amount of information sent by algorithms, market abuse is becoming increasingly more difficult to identify. Possible manipulation strategies that could result from high-frequency trading are quote stuffing, layering and spoofing. As FINRA collects more information from firms and broker-dealers, the public could see a rise in securities arbitration dealing with high-frequency trading schemes.

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