* Investors, researchers expressed concerns over HFT in 2010
* SEC advisor says it can't impose limits on HFT without
* Some traders are trying to build HFT-free trading zone
* Retail investors looking for SEC to lead on HFT reform
By Emily Flitter and Sarah N. Lynch
NEW YORK, Sept 30 More than two years ago, the
Federal Reserve Bank of Chicago was pushing the U.S. Securities
and Exchange Commission to get serious about the dangers of
superfast computer-driven trading. Only now is the SEC getting
around to taking a closer look at some of those issues.
Critics of the SEC say the delay is part of a pattern of
inaction in dealing with the fallout from high frequency trading
and shows that the regulator does not yet fully appreciate how
fears of machine-driven market meltdowns are driving investors
away from U.S. markets.
Even as the SEC gears up for a meeting on Tuesday to discuss
how to tame rapid-fire trading - the eighth public forum it has
had in two years on market structure issues - regulators in
Canada, Australia and Germany are moving ahead with plans to
introduce speed limits to safeguard markets from the machines.
One item up for discussion is whether regulators should
require trading firms and exchanges to deploy a "kill switch" to
shut down a runaway high-speed computer program. That is one of
the seven recommendations the Chicago Fed made to the SEC in its
March 25, 2010 letter.
Less than two months later, the Dow Jones Industrials
would plunge 700 points in a matter of seconds. The May 6, 2010
"flash crash" sparked a national debate over the merits of stock
trading that takes place in fractions of a second, but it only
led to modest action from the regulators.
Since then, there have been a series of smaller - though
still frightening - events for investors, including the near
collapse of major market maker Knight Capital after a
software glitch led to violent price swings on Aug. 1 in more
than 100 stocks. And still the move toward reforms has been
"So far, the SEC hasn't seemed to think high frequency
trading is a problem," said Edward Kim, a former senior vice
president at the NASDAQ Stock Market and now a consultant with
auditing firm Grant Thornton.
Kim, who testified on Sept. 7 before an SEC panel in San
Francisco on the potential pitfalls of high frequency trading,
said he has seen firsthand the fallout the flash crash has had
on investor confidence. Kim noted his father was so rattled by
the rapid market meltdown, he subsequently sold most of his
Institutional buy-and-hold investors also remain frustrated.
Mutual fund manager O. Mason Hawkins, who met with the SEC a
month after the flash crash in June 2010 to provide evidence
about how rapid-fire machine trading was destabilizing the
market, has the same view today, according to a representative
for his firm, Southeastern Asset Management.
Even proponents of algorithmic trading, which uses
sophisticated computer programs to trawl the markets for orders
to trade on, are coming out and saying speed isn't everything.
High frequency trading effectively treats orders from retail
investors like a tip sheet to be harvested and discarded said
Andrew Van Hise, managing director at the investment management
firm SEQA Capital Advisors in New York and the designer of the
algorithmic trading program for Steven A. Cohen's $16 billion
SAC Capital Advisors hedge fund.
"By the time a standard retail or institutional order
reaches an exchange, it's been looked at in essence by a number
of algorithms which have cherry picked it," said Van Hise. "What
finds its way to the traditional exchanges is viewed by market
participants as exhaust."
To be sure, it is not as if the SEC has simply stood idly by
and allowed the machines to run amok. The agency did put in
place some new safeguards, such as circuit breakers on stocks,
after the May 2010 flash crash.
The circuit breakers are intended to prevent a marketwide
crash by briefly halting trading in particular stocks displaying
sharp price moves within a five-minute window, giving the
algorithms a chance to let go of trading patterns that may have
turned into vicious cycles.
In a move that some say is long overdue, the SEC has begun
setting up a new analytical and research team to examine the
trading patterns of high-frequency firms. The new group, which
will receive and process the same data feeds that high frequency
traders get, will enable the SEC to better police the markets.
And recently, the SEC fined the New York Stock Exchange's
operator, NYSE Euronext, $5 million for allegedly giving
some customers "an improper head start" on proprietary trading
But U.S. securities regulators, noting that high frequency
trading has brought trading costs down for many investors by
pumping more liquidity into the system, do not seem to be
operating under any sense of urgency.
"We are into a space now where there aren't any massive
changes to be made," said Daniel Gallagher, a Republican
commissioner at the SEC who also previously worked in its
Trading and Markets division. "There are fine-tuning and dials."
In January 2010, the SEC published a 74-page "concept
release" on restructuring the markets, in part because of the
rise of high frequency trading. The SEC uses concept releases as
a blueprint for future regulation.
The concept release included ideas like a "trade-at" rule,
which would give preference to the price in a proposed trade
rather than to its position in the queue, as well as limitations
on when high frequency traders could suddenly pull out of the
The proposal generated more than 200 comments, including
many from money managers complaining that high frequency trading
was making stock trading more volatile. The Chicago Fed
submitted its letter to the SEC in response to the proposal. But
the concept release has not given rise to much new regulation.
Gregg Berman, a nuclear astrophysicist who is one of the
SEC's leading experts on stock market structure, said regulators
found most of the complaints from the public and money managers
about high frequency trading to be anecdotal.
"I've heard many suggestions for how we might slow down the
markets. But I think some ideas have ignored the fact that we
have markets in which investors demand the ability to trade on
an immediate and continuous basis, not at discrete intervals,"
He continued: "It's like saying 'Let's use the rules of
train travel, in which every train is on a specific track, to
try to dictate how cars should behave, even though cars can
drive between the lanes and on the shoulder.'"
A more aggressive approach by the SEC on high frequency
trading cannot come soon enough for those who say the SEC's
inaction is hurting both Main Street and Wall Street. They note
that even as the Dow Jones creeps closer to its all-time high,
trading volumes remain near the low levels seen during the
2008-09 financial crisis.
Retail investors have withdrawn more than $313 billion from
the U.S. stock market since 2008, meaning ordinary investors
have not participated broadly in the market recovery. Some
market experts attribute fear of another flash crash as well as
concerns that the playing field is far from level for making
investors wary of stocks.
RAGE AGAINST THE MACHINE
A few enterprising high frequency trading pioneers are
taking matters into their own hands by designing new trading
platforms that are being billed as trading zones that are
protected from high frequency programs.
But that could lead to further fragmentation of the market,
given U.S. stocks are now traded on a myriad of exchanges and
Keith Ross Jr, a former chief executive officer of GETCO,
one of the largest high frequency firms, is now running a
trading platform that bills itself as one that is not subject to
abusive trading by high frequency firms.
Ross' company, PDQ ATS, processes orders by imposing a
20-millisecond delay on them and then holding an auction. The
delay may not seem like much, but it is enough to deter high
frequency traders from jumping in front of other traders, or
trying to influence trading by flooding the market with bids and
offers for stocks they don't actually intend to trade.
PDQ, which launched in 2008, is gaining traction with both
asset managers and high frequency firms that Ross says are
willing to play by the rules and still see room to make a
profit. But the new platform is small, processing just under 100
million shares of marketable orders a day, 30 percent of which
"My expectation and my hope would be that the market has an
opportunity to solve the problem itself," Ross said.
Similarly, Bradley Katsuyama, a former top trader in the
U.S. for RBC Capital Markets, recently left the bank to launch
an exchange he says will employ a strategy that will prevent
high frequency trading firms from gaining an unfair advantage
over mutual funds and other retail investors. He declined to
provide specifics on his start-up firm, IEX Group Inc.
Still, plenty of individual investors are looking for the
SEC to do something more.
One of those is Jim Sutton, who has been managing his own
pension payout for the past 12 years. The 69-year-old Des
Moines, Iowa, resident wrote a letter to the SEC on July 4
asking for a new rule that would slow down trading in the stock
market to keep it within the realms of human perception.
He said slowing down the markets, just a bit, would improve
investor confidence. But Sutton says he is still waiting for a
response from the regulator.