Chasing Computerized Ghosts

Yesterday, the CFTC Technology Advisory Committee held a meeting titled, “Defining, Classifying, and Observing High Frequency Traders“. We listened in and heard something very interesting from Tom Gira, Executive Vice President for Market Regulation of FINRA. He started talking about things that FINRA monitors for in the market particularly from the HFT crowd. What could he possibly be looking for?

We all know that HFT is benign and is simply market making evolved, right? We all know that they have bestowed upon the market the gifts of tight spreads and ample liquidity, right? But we listened anyway. Mr. Gira is concerned that some of these well intentioned HFT’s may be participating in a few market manipulation schemes. Shocking! Mr. Gira outlined a few examples of momentum ignition strategies that FINRA was looking into. One example was cross asset categories.  An HFT may trade equities, lose money but move the market and make money on a related derivative position. He also talked about situations where HFT’s were painting the tape. They would put out large blocks below the bid, then do a wash sale to make it appear like real trades were occurring in order to have the algos chase volume.

It’s nice to see that the CFTC is holding a hearing about this kind of stuff and that FINRA is hot on the trail. But it does seem they are going to a gunfight with a butter knife. HFT has been around for over a decade and our regulators are still struggling with way to define it. There has been talk of a Consolidated Audit Trail but the truth is that our regulators are not anywhere near developing an audit system that could catch cross market manipulation. Here is what Bloomberg quoted Mr. Gira as saying:

“More coordination is needed because strategies designed to deceive may operate across asset classes”, Thomas Gira, executive vice president for market regulation at Finra, said today at a meeting sponsored by the Commodity Futures Trading Commission. “That means having all the equities markets” in the surveillance program, Gira said in Washington. “It also means having all the options markets. At some point, I think, it would make sense for futures to be in there as well because this type of activity is going across products and it’s important for regulators to have a holistic view.”

Sounds pretty confident? Sounds like FINRA has the Consolidated Audit Trail ready to hit the market any day now. Not really. FINRA is chasing computerized ghosts throughout the day. And Mr. Gira admitted yesterday that many of their investigations are started by tips from HFT’s who are upset about what another HFT did to them. Gira said that “some of the more abusive strategies that employ high- frequency techniques are a “crime of pennies”.” Crimes of pennies except that when it is done millions of times per day it starts to add up to real money.