Yesterday we highlighted Scott Patterson’s investigative report detailing how the SEC sub-contracted out the management of its EDGAR corporate action database to data firms, who with the SEC’s knowledge and approval sold the data in tiers to – well – to all kinds of firms. Patterson’s piece was quite predictably attacked by the same predictable defenders of modern market structure.

Batting first was Rosenblatt’s Justin Schack, who on Twitter, within seconds, sent out a few prepared high frequency tweets:

Justin Schack @JustinRBLT

(1/8) Just read @WSJ story about time lag in release of EDGAR documents. A few questions, comments to follow

 (2/8) Who, exactly, subscribes to “faster” feed? Story IDs “hedge funds,” newswires. Any evidence automated prop-trading firms subscribe?

 (3/8) Absent that evidence, why is time lag portrayed as “superfast” traders having unfair “millisecond” edge over “mom-and-pop investors?”

 (4/8) And what’s a “mom-and-pop investor?” Doesn’t this describe pension beneficiaries whose $ managed by hedge funds getting the fast feed?

 (5/8) Who’s most hurt by missing Form 4 filing by a few secs? Long-term holders generally don’t trade b/c CFO just bought/sold 6,000 shares

 (6/8) Real victims: speculative day traders hoping to buy fancier baubles with their winnings. Are these “mom-and-pop investors?”

 (7/8) The time lag certainly merits scrutiny because the information is being released by a government entity. No doubt it’s news.

 (8/8) But twisting that angle into a story of evil #HFT hurting virtuous retail investors does disservice to @WSJ readers & the public.

Batting Second, in a Bloomberg piece, was Manoj Narang:

This is what happens when a technology designed to solve problems in the 1990s becomes the focus of scrutiny so many years later, said Manoj Narang, the chief executive officer of proprietary trader Tradeworx Inc. Thanks to high-frequency trading, every detail of how data is broadcast to U.S. markets is being reviewed in probes by the New York attorney general, the FBI and the SEC itself.

“It’s extraordinarily likely that this is an error of oversight that’s completely unintentional,” said Narang.

Batting Third, Bloomberg’s Matt Levine wrote this editorial.

But when I say it doesn’t matter at all, I mean, it does not matter at all. The idea here is that subscribing to a news service or data terminal gives “professional traders an edge over mom-and-pop investors.” The article really says that. Now, this seems pretty obvious……You and your mom and your pop can just index! It is great, you will beat the majority of professional fund managers every year.⁴

Look: The SEC’s pattern of releasing information early to newswires helps big professional managers…. Actual moms and pops who invest via actively managed mutual funds might benefit…

To be sure, the top of the order was strong: Schack – Manoj – Levine… I mean that is Kansas City Royals strong!

But then Scott Patterson released more information from his investigation in a quick follow up article. It was almost as if he expected the above gentlemen to step up to the plate as they did, so that he could put on his MadBum uniform and mow them down: SEC Warned Before About Early Release Weak Spot.

Apparently a large mutual fund had an order for sale resting in a dark pool, and then – with no news publicly available – got picked off in the dark pool to the tune of dollars (not pennies), as some high speed SEC-subscriber-paying-clients got data early, and went about their business making markets more efficient:

“The fund company had placed 250,000 shares of the stock, Intrexon Corp.XON -0.28%, a biotechnology company, into the dark pool in the afternoon of Feb. 25. At about 2:37:30 p.m. Eastern, trading suddenly picked up sharply and over the course of about 25 seconds the company sold 200,000 shares of the stock.

A filing was posted on the SEC’s website related to the settlement of litigation holding up a pending acquisition…”

And the mutual fund called the SEC! And the SEC declined to respond!

This is very rich. It is also very sad, as the same organization that fined NYSE $5 million in September 2012 for data release inequity had been entrenched in a similar practice at the same time – and even more remarkably – afterwards… to this very day!

Ok. So Scott Patterson wins the SEC EDGAR Early Release Media War. Scott Patterson is MadBum.

However, today’s note is not just to inform and entertain you, or praise Scott Patterson; we think a very important side issue actually is the main issue here – the policing of liquidity pools by their owners, whether they be stock exchanges, independent dark pools, or bank-owned dark pools.

Dark Pools often tout that they have anti-gaming logic, and that they discipline bad actors in their pool. It is good business for them to advertise that, as institutional clients kind of expect it – rightfully so. Do they all deliver though? AG Schneiderman is rumored to be looking into that… What we are interested in knowing is if the dark pool that had Large Mutual Fund’s XON order investigate who bought those shares in its own pool on that February day? Did it question those buyers? Did the dark pool discipline those buyers? Did the dark pool go to those buyers and say something like:

“Look fellas, this is bad. It makes us all look bad. Our pool, and all liquidity pools for that matter, is supposed to be a fair place for capital and risk exchange. We understand that all is fair in love and war, but the markets do at some point have to be differentiated from a game in Vegas. There has to be confidence from the public that at some level we all realize that this marketplace must first and foremost be for investors – as the SEC has stated time and time again. Your actions in XON were not consistent with that, so we must discipline you.”

We hope there is a third part to this story, and that it deals with this last point. Trading is a zero-sum game. If some savvy speedy traders picked off a mutual fund for a couple of hundred thousand dollars, then that is money that came from investors. If we have a market that relies so much on for-profit entities self-policing their sand boxes, then there has to be some line drawn which cannot be crossed. What is that line?