FBI Investigating High-Speed Trading for Insider Information

Tuesday, 01 Apr 2014 12:43 PM

By Melanie Batley

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The FBI is investigating whether high-speed trading firms, such as major Wall Street banks, are illegally gaining information unavailable to other investors by taking advantage of technology used in placing stock market orders.

According to The Wall Street Journal's Market Watch, the investigation was launched about a year ago and is still in its early stages, but it stems from a multiyear crackdown on insider trading which has already seen dozens of convictions.

"There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman told Market Watch. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."

The probe is focused on whether traders are able to take advantage of superfast computerized data feeds by gleaning orders placed by institutional investors within thousandths or even millionths of a second before the order is filled and use the information to place or cancel orders at a different price.

The practice effectively drives up stock prices and gives high-frequency traders an immediate profit, often small, which adds up to tens of billions of dollars over time.

On Sunday, CBS' "60 Minutes" investigated the practice, which was outlined in a new book by Michael Lewis called "Flash Boys."

"Stock market's rigged. The United States stock market, the most iconic market in global capitalism, is rigged," Lewis told "60 Minutes" reporter Steve Kroft. He added that everyone who has an investment in the stock market is being affected.

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The practice stems from the computerization of trading. The vast majority of today's trades, according to CBS, take place inside hundreds of thousands of black boxes located at more than 60 public and private exchanges where billions of dollars in stock changes hands every day with little or no public documentation.

Machines with secret programs are now trading stocks in tiny fractions of a second, and the programs are bought by high-frequency traders, big Wall Street firms, and stock exchanges to enable them to gain advantages in milliseconds before stock-market prices and orders become available to the rest of the market.

"The insiders are able to move faster than you. They're able to see your order and play it against other orders in ways that you don't understand. They're able to front-run your order," Lewis said.

According to "60 Minutes," all of Wall Street's biggest investors were unaware of the practice, though some noticed there was a problem but didn't understand why it was happening.

One hedge-fund manager at a $9 billion hedge fund, for example, told Lewis his firm was losing $300 million a year while making trades, but no one in the market could understand why it was happening.

In 2008, a young trader for Royal Bank of Canada, Brad Katsuyama, noticed that every time he tried to buy a large block of stock for a client, the order would only be partially filled and the price of the stock would increase for subsequent portions of the order, according to "60 Minutes."

Katsuyama assembled a team of experts and discovered the market manipulation was made possible by the way trades were routed through fiber-optic cables in exchanges outside of Manhattan. By sending trades to the farthest possible exchanges, Katsuyama was able to prevent losses from high frequency trading.

He subsequently developed his own exchange, IEX, now used by a number of major hedge funds and investment banks to circumvent the effects of high-speed trading.

In addition to the FBI probe, New York State Attorney General Eric Schneiderman opened a broad investigation into the practice in March.

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