(The opinions expressed here are those of Alison Frankel, a
columnist for Reuters.)
By Alison Frankel
NEW YORK, April 14 - A class action in Chicago federal court
presents a new theory of liability for exchanges, claiming that
the Chicago Mercantile Exchange peddled inside information on
price data and unexecuted orders to high-frequency traders. But
didn't we know that already?
For all of the outrage kicked up by Michael Lewis's
depiction of fundamentally rigged securities exchanges in his
book "Flash Boys," there's a giant obstacle standing in the way
of punishing high-frequency traders or the exchanges that
facilitate them: the blessing of federal regulators.
As Dealbook's Peter Henning wrote in his White Collar Crime
Watch column on why high-frequency trading is unlikely to result
in criminal charges, securities exchanges openly sell access to
high-speed data feeds and to physical proximity that increases
trading speed by milliseconds. Exchanges are, in the words of
Andrew Ross Sorkin, "the real black hats" of high-frequency
trading, since they unabashedly profit from differentiating
access to trading information.
That may be true, but exchanges do so with the full
knowledge of the Securities and Exchange Commission and the
Commodity Futures Trading Commission.
FIRST-CLASS OR COACH
Georgetown University professor James Angel, who specializes
in the structure and regulation of financial markets, told me
Monday that as long as securities exchanges don't discriminate
in the sale of high-speed access, they're acting within their
He compared the system to airlines selling different tiers
of service: It's perfectly fine to sell first-class seats to
high-frequency traders as long as people in coach had the same
opportunity to sit up front and opted instead for the cheap
seats. I had called Angel to ask his opinion of a new class
action against the Chicago Mercantile Exchange.
Filed Friday in federal district court in Chicago, the suit
claims that the Merc's parent, CME Group Inc, has
defrauded the derivatives market by representing that it's
providing real-time market information when, in fact, it has
entered into "clandestine" contracts to provide order
information to high-frequency traders before anyone else.
Angel's take? "This is a bogus case," he said after reading
the suit. "This is clearly about somebody who bought a coach
ticket and is now complaining that they didn't get first class
ANGEL: OLD FACTS
The class action's theory is new: that the Merc deceived
ordinary traders and the market at large by selling upgraded
access to high-frequency traders. The problem, according to
Angel, is that the new theory is based on old facts that have
already been examined and re-examined by the SEC and CFTC.
The complaint doesn't include any specifics about the
supposedly improper dealings between the Merc and high-frequency
traders, except to say that they date back to 2007.
It's not clear, in other words, whether the class is
claiming that the exchange secretly offered extra-fast access
only to specially selected high-frequency traders or just that
the Merc sells enhanced high-speed data to anyone willing to pay
for it. If the former is true - and if, of course, the class has
much more substantial evidence than its complaint suggests - the
Merc would be in trouble.
But based on my conversation Monday with Tamara de Silva of
The Law Offices of R. Tamara de Silva, the lawyer who filed the
class action on behalf of everyone who relies on the exchange's
assurances of real-time futures market data, it appears that the
suit is based on the exchange's much-discussed sales of enhanced
De Silva said she didn't want to disclose her evidence, but
she contends the general public isn't aware that exchanges sell
superior access to high-frequency traders willing to pay a
premium price. The Chicago exchange, she said, misleads the
market when it represents that price and order information
available to the general public is undistorted, when it's
actually out-of-date by the time ordinary market participants
De Silva told me it doesn't matter that the CFTC has blessed
the Merc's sale of differentiated streams of information. "I
don't think regulators have any idea of what's happening," she
said. "Regulators are behind the times." (Given the recent furor
over high-frequency trading, they'd have to be living in sensory
deprivation chambers not to be aware of differentiated access
ANY NEW EVIDENCE?
I don't think de Silva's case has much of a shot unless she
has evidence of heretofore secret and discriminatory deals
between the exchange and select high-frequency traders - and
unless she describes that evidence more specifically in an
Maybe in 2007, when de Silva alleges the Mercantile Exchange
first began selling ultrafast data streams, the derivatives
market wasn't generally aware that high-speed traders could
benefit from the split-second time difference. But if any
derivatives traders are still in the dark about time arbitrage,
they've got bigger problems than winning this case.
The Merc's parent put out a statement on the class action:
"It is devoid of any facts supporting the allegations and, even
worse, demonstrates a fundamental misunderstanding of how our
markets operate," it said. "It is sad when plaintiffs' lawyers
bring a suit based on a desire for publicity, and in the rush to
file a suit fail to undertake even the most basic effort to
determine if there is any basis for their allegations."
De Silva obviously isn't alone in wishing that regulators
would clamp down on exchanges to assure the fairness and
transparency of the markets. Georgetown's Angel, for one, has
said that federal regulators need to refine their consideration
of high-frequency trading to "tell the good from the bad and
keep the bad guys out."
Eric Schneiderman, the New York Attorney General, doesn't
have oversight of federal securities laws but he's managed to
pressure information providers other than securities exchanges
(including my company, Thomson Reuters) not to sell early access
to traders who can profit from even a tiny time advantage. The
SEC and CFTC are also both supposedly examining high-speed and
other forms of electronic trading.
I'm all for any additional transparency they can bring to
the markets. But a private suit claiming that derivatives
traders and investors didn't know about high-speed trading? I
have to agree with Angel: We might not like it that high speed
traders are sitting in first class, but right now, they have a
right to be there.
(Reporting by Alison Frankel; Editing by Kevin Drawbaugh)