Yesterday, the Financial Times ran a front page article titled “SEC Probes Computer Failures At Electronic Trading Platforms” Read FT article here.With all the hype surrounding the LinkedIn IPO yesterday, this article hardly got any attention at all. However, we think it was probably one the most important articles written on market structure in the past few years. In addition to investigating whether internal controls at stock exchanges are sufficient, the FT said that the data feeds that exchanges offer are the subject of the SEC investigation (which is being handled by their enforcement division’s market abuse unit). The FT states:
“One area under scrutiny is whether exchange operators are complying with SEC rules that require quote feeds to be delivered to all investors at the same time, these people say. The agency is interested in whether exchanges are transmitting proprietary feeds that are sold to private investors faster than they are distributing feeds to the consolidated tape.”
The data feeds, as all readers of our blog know by now, are the fuel that runs the jet. Regardless of how fast an HFT computer is or how close it is co-located to an exchange server, it still needs access to the data feeds that the exchanges control. As we have described in the past, these data feeds contain a tremendous amount of information. In addition to quotes and trade information, the data feeds have information on when an order was cancelled or when an order gets revised and what price its revised to. The data feeds also have unique order id numbers that are attached to all orders. A year ago, we wrote a paper titled “Exchanges and Data Feeds: Data Theft on Wall Street” Read White Paper here, where we highlighted that exchanges were supplying information in these data feeds that helped subscribers identify hidden and reserve book orders. After our paper was written, institutional outrage forced the exchanges to change this practice. But what else is in these data feeds that investors don’t know about? Apparently, the SEC thinks more monkey business is going on. The FT wrote:
“SEC investigators are also looking at whether the for-profit exchange operators are following their own rules and describing them accurately to the public. For example, they are looking at whether exchanges have notified the SEC of changes to their platforms such as execution priority, so they can be scrutinized and so investors are fully informed, people familiar with the matter say.”
These are some serious allegations and we are looking forward to the results of the SEC investigation. Unfortunately, in the hyper competitive, low margin business of for-profit stock exchanges, the quest for the bottom line seems too often to conflict with investor protection and fairness.