In an increasingly digital society, innovative technology that yields speed and efficiency can serve to spark industry-wide trends and influence future practice for years, even decades, thereafter. When Steve Jobs introduced the first iPod in 2001, for example, Apple earned worldwide acclaim and provoked an incredible proliferation of similar devices.1 What, then, can be made of the innovative technology being widely implemented in securities trading in the 21st century?
There has been a meteoric rise in the use of algorithmic supercomputers to trade securities at rapid-fire in the capital markets. This innovative practice, known as “high-frequency trading,” allows traders to aggressively buy and sell securities in a matter of milliseconds to exploit small intraday price fluctuations and discrepancies. (Irene Aldridge, What is High-Frequency Trading, Afterall?, Huffington Post (July 8, 2010, 11:36 AM), http://www.huffingtonpost.com/irene-aldridge/what-is-high-frequency-tr_b_639203.html.)) While they capture just fractions of a penny on every transaction, high-frequency traders rely on advanced computer programming to constantly place orders by the millions.2 As these trades accumulate, so too do the profits. It is a strategy for extracting significant financial gain over a staggeringly small amount of time, but those who engage in high-frequency trading claim it functions to “reduce volatility and help make markets better.”3 According to a growing list of critics, though, high-frequency trading constitutes predatory behavior that unfairly manipulates markets and reaps billions of dollars at the expense of other investors.4 Worse yet, it is claimed to dampen investor confidence in the operation and legitimacy of capital markets.5 Some go as far as calling it “a growing cancer” in the business sector.6 Because of this mounting discourse, and in light of recent action by the Securities and Exchange Commission, market participants share concern about the murky future of high-frequency trading.7
At its core, the practice of high-frequency trading “involves minimizing risk and posting small deal sizes that enable [traders] to move in and out of trades extremely quickly, arbitraging between spreads available on different exchanges and platforms, and even between the speed of trading available on them.”8 It has exploded in popularity in recent years, as highly skilled computer programmers link up with business savvy investment firms on Wall Street. Whereas high-frequency trading accounted for less than 25% of stock-trading volume in the United States just five years ago, today its use has more than doubled.9 Experts estimate that these automated transactions make up “as much as two-thirds of daily volume” in U.S. stock markets.10 This is part of the reason why so many market observers are calling for stronger regulatory measures to control high-frequency trading activity. For those in charge at the SEC, it is “difficult to draw the line between acceptable trading strategies and manipulation because of the complexity of the strategies.”11
Just last month, however, regulators found a way to draw such a line – announcing a settlement against a New York-based high-frequency trading firm for carrying out a fraudulent and manipulative trading scheme.12 This represented the first strong response from government officials about the use of trading algorithms to rapidly buy and sell stocks. Athena employed a strategy whereby the firm’s computers “fired a stream of orders during the last two seconds of most trading days” over the course of six months.13 The scheme functioned to manipulate closing prices of NASDAQ-listed stocks to an artificially high point that was in Athena’s favor.14 According to regulators, given that Athena was not in the market as a long-term investor, it simply designed a program with the goal of manipulating prices at the expense of other investors.15
If the SEC is to follow its own lead in pushing back against high-frequency trading practices, the fight will be full of uncertainty. Current laws on price manipulation require a showing that the trading firm acted with intent to artificially change prices.16 In Athena’s case, this condition was only met through happenstance, as regulators luckily uncovered email exchanges among traders to that effect.17 Certainly it will not always be so easy for the SEC. Meanwhile, the inherent secrecy behind the nature and methods of high-frequency trading only leads to investors losing confidence in the efficiency of capital markets.18 And until tighter and more detailed regulations are enacted, this highly specialized and ultra-lucrative technology seems poised to continue filling the pockets of investment funds.
Matt Hartley, How the iPod changed everything, The Globe and Mail (May 12, 2009, 4:10 PM), http://www.theglobeandmail.com/technology/digital-culture/how-the-ipod-changed-everything/article556167/?page=all. ↩
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Bart Chilton, No Need to Demonize High-Frequency Trading, N.Y. Times (July 7, 2014, 2:59 PM), http://dealbook.nytimes.com/2014/07/07/no-need-to-demonize-high-frequency-trading/. ↩
Charles Duhigg, Stock Traders Find Speed Pays, in Milliseconds, The N.Y. Times (July 23, 2009), http://www.nytimes.com/2009/07/24/business/24trading.html?adxnnl=1&adxnnlx=1414778465-8od+/B/m9fs1JVFdUlYwTA. ↩
Sital S. Patel, Charles Schwab, Jack Bogle join the debate on high-frequency trading, MarketWatch (April 3, 2014, 7:12 PM), http://blogs.marketwatch.com/thetell/2014/04/03/charles-schwab-jack-bogle-join-the-debate-on-high-frequency-trading/. ↩
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Peter J. Henning, Why High-Frequency Trading Is So Hard to Regulate, N.Y. Times (Oct. 20, 2014, 1:40 PM), http://dealbook.nytimes.com/2014/10/20/why-high-frequency-trading-is-so-hard-to-regulate/. ↩
Michael Mackenzie, High Frequency Trading Dominates the Debate, Fin. Times (Oct. 20, 2009), http://www.ft.com/cms/s/0/fa347c26-bc41-11de-9426-00144feab49a.html. ↩
Geoffrey Rogow, Rise of the (Market) Machines, Wall St. J. (June 19, 2009, 12:29 PM), http://blogs.wsj.com/marketbeat/2009/06/19/rise-of-the-market-machines/. ↩
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Henning, supra note 9. ↩
Bradley Hope and Scott Patterson, High-Frequency Trader Athena Capital Settles Stock-Manipulation Charges, Wall St. J. (Oct. 16, 2014, 5:05 PM), http://online.wsj.com/articles/athena-capital-settles-stock-manipulation-charges-with-sec-1413486055. ↩
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Henning, supra note 9. ↩
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Pital, supra note 7. ↩