FBI Fraud Investigation Asks HFT Firms To Come Forward

FBI Fraud Investigation Asks HFT Firms To Come Forward
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As Michael Lewis’ book Flash Boys shines a public spotlight on high frequency trading (HFT), the Federal Bureau of Investigation is almost immediately following the book’s release by examining if the trading practice violated US laws.

The issue officially came to light when the Wall Street Journal published an article detailing the investigation near 6 p.m. EST Monday.  According to the article, the probe was launched one year ago, is in its early stages and involves a variety of strategies.  This morning Bloomberg, however, is reporting the investigation is part of a multi-year crackdown on insider trading.  Earlier Monday morning, ValueWalk published an article that discussed speculation of a criminal investigation into HFT, noted the “Flash Boys” book was leaked to key Wall Street players, regulators and law enforcement well before the publishing date and said a campaign to bring HFT in line was underway.  At that time we speculated law enforcement officials could use the public spotlight to their advantage in pressing the case.

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Non-public information and bait and switch at issue

Both the Wall Street Journal and Bloomberg articles agree that a key focus of the investigation is considering if HFT traders are benefiting from non-public information.  The charges being considered include wire fraud, securities fraud and potentially insider trading.  The Journal article noted that one HFT practice of placing bids and offers in the market, making the market appear to the public to have a given price, and then canceling the orders once a large order would seek to execute a trade.  Other activities being investigated include HFT firms having the ability to trade on non-public information.

As if on cue, before the FBI leaked news of the investigation New York Attorney General Eric Schneiderman had made it clear Goldman Sachs and Morgan Stanley were not to blame for the suspect HFT activity.  Speaking on Bloomberg TV, Schneiderman, who had been key in negotiating with BusinessWire and Thompson Reuters on the issue of HFT firms being given access to market moving information before the general public, noted that HFT is not all bad and is key to providing liquidity.  “There are some things here that may be illegal,” he said in the interview. “There are some things that may now be legal that should be illegal or that the markets have to be changed.”  For its part the Securities and Exchange Commission is “studying market structure,” according to a CNBC report.

Proving criminal intent may be difficult, call to come forward

In proving a fraud case in court, the FBI may face a tough hurdle of proving fraudulent intent, which means prosecutors could be required to prove HFT firms knew the activity in question was illegal.  Part of the FBI strategy appears to be encouraging HFT firms to come forward.  “People will benefit to varying degrees by calling us at an early stage,” one investigative source was quoted as saying in the Journal article.

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com
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