By Karen Freifeld
NEW YORK, March 18 (Reuters) - New York state's attorney general on Tuesday said U.S. stock exchanges and alternative trading platforms provide high-frequency traders with unfair technological advantages that give them early access to key data.
The stock exchanges allow traders to locate their computer servers within trading venues, armed with extra network bandwidth and high-speed switches that give them pricing, volume and order information ahead of others, said New York Attorney General Eric Schneiderman.
"Rather than curbing the worst threats posed by high-frequency traders, our markets, as structured today, are increasingly too focused on catering to them," he said on Tuesday in a speech at New York Law School.
Schneiderman has begun meetings with the exchanges and alternative trading venues to discuss reforms, according to a person familiar with the situation.
A spokeswoman for the New York Stock Exchange declined to comment. Spokesmen for Nasdaq OMX Group and BATS Global Markets also declined to comment.
Representatives of Credit Suisse Group's Crossfinder and Goldman Sachs Group's Sigma X, two of the biggest alternative trading platforms, or "dark pools," also declined to comment.
But according to Manoj Narang, chief executive of Tradeworx in Red Bank, New Jersey, which operates a high-frequency trading business, Schneiderman's perspective on the high-speed technology is backward.
"The arms race is dead," Narang told Reuters. "This much-hyped advantage technologically savvy players may have is just not there."
Speed has become less important since the gap between fast and slow players has narrowed to milliseconds, he said.
Among the practices Schneiderman called into question in his speech were "co-location," a practice which allows firms who pay a fee - typically thousands of dollars a month - to locate their computer servers within the exchanges' data centers.
Co-location reduces by milliseconds the time it takes to transmit, long enough for so-called predatory high-speed traders to benefit and for the markets to suffer, he said.
For instance, the traders look for arbitrage opportunities between and among trading venues to capture momentary differences in stock prices.
The firms also artificially inflate prices by detecting a big trade from an institutional investor and positioning themselves on the other side, Schneiderman said.
Institutional investors have been forced to develop strategies to hide their orders from these traders, he said, such as by routing the orders into "dark pools," which are less regulated.
Schneiderman has suggested reforms, such as a proposal by University of Chicago economists that stock exchanges process orders in batches rather than continuously. Such a change would help ensure that price trumps technology in deciding who obtains a trade, he said.
Narang said the proposed "batch auctions" could be "extremely dysfunctional" to how the market functions. He also said co-location, which is regulated, has been unfairly maligned and represents equal access.
Schneiderman also called for tougher regulation.
"We are working on these and a wide range of issues as part of our ongoing review of our current equity market structure," said John Nester, a spokesman for the U.S. Securities and Exchange Commission, which regulates U.S. stock exchanges and alternative trading sites.
James Angel, a professor at Georgetown University who specializes in the regulation of financial markets, said that many high-frequency traders do things that benefit low-frequency investors like himself, such as making sure the exchange trade fund he buys is priced the same as the basket of stocks that go into it.
"Not everyone with a fast computer is a bad guy," Angel said. "Rather than restrict all fast computers, we need regulators who can tell the good from the bad and keep the bad guys out."
Nasdaq OMX shares fell as much as 4 percent during the trading day on Tuesday, their biggest single-day drop since April 2013. The shares ended down $1.23, or 3.1 percent, at $38.50.
Evercore analyst Chris Allen suggested Schneiderman's comments were weighing on the shares. "Anytime you have an attorney general investigating something, people get worried about what the outcomes are going to be," he said.
Other observers suggested Nasdaq shares were down on news that the New York Stock Exchange was in the lead in getting the listing for Alibaba, the dominant force in China's $1.6 trillion e-commerce market.
Schneiderman's investigation is the latest focus in a probe of Wall Street practices that gives elite groups of traders access to information at the expense of other participants. He also has scrutinized the early release of analyst and consumer sentiment data as well as market-moving press releases.
As part of the probe, Thomson Reuters Corp agreed to suspend its early release of the widely watched Thomson Reuters/University of Michigan consumer sentiment data to a small group of clients.