Overseas Traders Caught “Layering” The Stock Market

The headline reads “SEC Says New York Firm Allowed High-Speed Stock Manipulation“  but this was not a very sophisticated scam.  This is case where a brokerage firm allowed access to their pipes by groups of overseas traders, primarily located in China, who manipulated the market.  Based on the speed of their activity, it is clear that a human could not have physically been entering the orders.  According to the SEC complaint:

“Certain overseas traders trading for Demostrate (a customer of Hold Brothers) engaged in extensive manipulative activity. Such traders induced algorithms to trade in a particular security by placing and then cancelling layers of orders in that security, creating fluctuations in the national best bid or offer of that security, increasing order book depth, and using the non-bona fide orders to send false signals regarding the demand for such security, which the algorithms misinterpreted as reflecting sincere demand.” 

The main complaint was that these overseas traders were “layering” the book.  The SEC defines layering as:

“Layering concerns the use of non-bona fide orders, or orders that the trader does not intend to have executed, to induce others to buy or sell the security at a price not representative of actual supply and demand.”

Our friends at Nanex dug through the SEC documents and were able to come up with an illustration of exactly how the scam was taking place:

“That day, at 11:08:55.152 a.m., the trader placed an order to sell 1,000 GWW shares at $101.34 per share. Prior to the trader placing the order, the inside bid was $101.27 and the inside ask was $101.37. The trader’s sell order moved the inside ask to $101.34. From 11:08:55.164 a.m. to 11:08:55.323 a.m., the trader placed eleven orders offering to buy a total of 2,600 GWW shares at successively increasing prices from $101.29 to $101.33. During this time, the inside bid rose from $101.27 to $101.33, and the trader sold all 1,000 shares she offered to sell for $101.34 per share, completing the execution at 11:08:55.333. At 11:08:55.932, less than a second after the trader placed the initial buy order, the trader cancelled all open buy orders. At 11:08:55.991, once the trader had cancelled all of her open buy orders, the inside bid reverted to $101.27 and the inside ask reverted to $101.37.”

Not a very fancy strategy.  Not much math with Greek alphabet letters involved.  Just a turbo-charged version of an age old scam.  It’s nice to see that the SEC and FINRA were able to catch these crooks. But where were the exchanges?  Aren’t the exchanges the first line of defense to police such manipulative activity?  The Securities Exchange Act of 1934   clearly states:

The rules of the exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating…securities, to remove impediments to…a free and open market and a national market system, and, in general, to protect investors and the public interest.” 

Maybe the exchanges should worry less about creating conflicted order types and high speed data feeds and focus more on cracking down on this type of manipulative activity.