(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.
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 regulatory bounds.
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 service.”
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 data streams.
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 see it.
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 streams.)
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 amended complaint.
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)