Insider trading 2.0: Menace of high-speed trading, early data peaks

New York: Small investors have always been at a disadvantage to the trading community which has sought advantages - whether it was whispered information, or having access to a Bloomberg terminal a decade ago. Amid signs that high-speed traders are now getting early access to key market-moving data and analyst reports, New York Attorney General Eric Schneiderman is cracking down on what he calls “Insider Trading 2.0.”

“When blinding speed is coupled with early access to data, it gives small groups of traders the power to manipulate market movements in their own favor before anyone else knows what’s happening,” said Schneiderman at the Bloomberg Markets 50 Summit in New York on Tuesday.

“They suck the value out of market-moving information before it even goes public.”

[caption id=“attachment_1132109” align=“alignleft” width=“380”]  New York Attorney General Schneiderman in New York. Reuters[/caption]

Schneiderman may have been talking mainly of the menace of high-frequency trading on Wall Street, but it’s not an isolated problem. The eight-fold surge in options turnover since 2008 in India is now luring hordes of computer-driven traders as transaction costs fall. More and more global automated trading firms are coming to India as they have the super computers and algorithms that can accurately identify a pricing mismatch or trading opportunity.

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Schneiderman on Tuesday criticized an arrangement that allowed Reuters to provide the monthly Thomson Reuters/University of Michigan consumer sentiment survey report to a small group of well paying high-frequency trading clients two seconds prior to its scheduled release for everyone else.

Now take into account that high-speed traders can react to news faster than individual investors; after all they use trading systems that are lightening fast - trading speeds are measured in milliseconds (thousands of a second), and, increasingly, in microseconds (millionths of a second).

“To put it in terms of a race, old-fashioned insider trading involved a few people sneaking over the starting line,” Schneiderman said.

“These guys are moving the starting line halfway to the finish before their competitors even have their feet in the blocks. Traditional insider trading is small potatoes compared to these new high-speed race-rigging practices,” he added.

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When high-frequency traders have access to soon-to-be-released public information, Schneiderman said, individual investors invariably get hurt.

“We are aware that others are engaged in similar practices and are looking into those as well,” he said, adding that his office is investigating the early release of Wall Street analyst recommendations to high frequency traders.

“A firm with access to analyst assessments before they are officially released can front run the market,” Schneiderman said. When used with high-frequency trading systems, the combination can result in “an enormous windfall” for traders, he said.

Schneiderman’s office is cracking down on this “new form of market manipulation” and seized on a term used by traders referring to average investors as “the dumb money.”

“A lot of us here are probably part of the ‘dumb money’ because that includes everyone who doesn’t have a supercomputer capable of flipping tens of thousands of shares in nanoseconds and access to market-moving information just a tiny bit ahead of everyone else,” said Schneiderman.