John Coffee has an interesting piece on the Columbia CLS Blue Sky Blog, High Frequency Trading Reform: The Short Term and the Longer Term.
The article highlights two cases, one brought by (but yet to be resolved) N.Y. Attorney General Schneiderman against the dark pool operated by Barclays (the press release is here and the complaint is here) and a private action (also yet to be resolved) against a number of stock exchanges alleging that customers received from exchanges the proprietary data feeds before the information reached the SIP. See Lanier v. BATS Exchange, Inc. (alleging that "[o]n average, the data is received by the Processor approximately 1,499 microseconds after the Preferred Data Customers receive it.").
The two actions are united in that they both involve practices that affect high frequency traders. Other than that, however, they are quite different in what they indicate about market structure.
In the Barclays case, the complaint mostly alleges misrepresentations by Barclays with respect to its dark pool (partly by understating the presence of HFT in the dark pool). See Barclays Complaint ("Barclays falsely marketed the percentage of aggressive high frequency trading activity in its dark pool, asserting to clients and to the investing public that less than 10% of the trading activity in the pool was 'aggressive,' while at the same time secretly indicating to at least one high frequency trading firm that the level of such trading activity was at least 25%").
The Lanier case (and by the way, the case is against a number of exchanges, not just BATS), which is a contract action, involves allegations that the proprietary data feeds provided by exchanges reached customers (such as high frequency traders) before reaching the SIP. The distribution of proprietary data feeds is regulated under Regulation NMS. See In re NYSE, Exchange Act Release No. 67857 (admin proc 2012) ("This rule prohibits an exchange from releasing data relating to quotes and trades to its customers through proprietary feeds before it sends its quotes and trade reports for inclusion in the consolidated feeds."). The SEC has sanctioned exchanges for violating this rule. See Id. (sanctioning NYSE for vioaltions of Rule 603 of Regulation NMS by failing to distribute market data information to market participants on terms that were “fair and reasonable” and “not unreasonably discriminatory.”).
Barclays is mostly interesting because it sheds potential light on practices in dark pools. But in the end it is a claim of misrepresentation. Nothing in the existing structure of the market needs to be changed to prohibit materially false statements to investors. Of course, the alleged misrepresentation was in part facilitated by the lack of transparency in dark pools. The SEC has recognized this. See Speech by Chair White, June 5, 2014 ("Dark venues lack transparency in other important respects. Although the trades of dark venues are reported in real time, the identity of participants in the dark venue is not disclosed to the public. And dark venues generally only provide limited information about how they operate. ATSs, for example, file a form with the SEC on some aspects of their operations, but the forms are not publicly available under current rules."). As a result, increased transparency for dark pools is on the regulatory agenda.
Lanier raises more intriguing issues. The case involves allegations that do not turn on the release time but the arrival time of the data feed. This is a consequence, at least in part, of technology. According to the complaint:
- The Exchange Defendants sell advance access to market data to the Preferred Data Customers that is transmitted using Private Feeds faster than the data is transmitted to the Processor. The Exchange Defendants use transmission lines for the Private Feeds that carry the data to the Preferred Data Customers in a fraction of the time it takes for the slower transmission lines to deliver the same market data to the Processor.
As a result of the differences in transmission lines, according to the allegations in the complaint, the information reached preferred customers first.
- While it may take less than two thousand microseconds for the market data to initially arrive at the Processor through which the Subscribers receive the data, the Preferred Data Customers receive the data directly in as fast as one microsecond.
Similarly, the complaint alleges that co-location services provided to preferred customers with "valuable additional microseconds because the data travels a shorter distance than the data travels from the exchanges to the Processors."
Rule 603(a) of Regulation NMS requires the distribution of market data on terms that are “fair and reasonable” and “not unreasonably discriminatory.” Lanier at least raises the question as to whether it is fair and non-discriminatory to release data that is made available to the customer before it is available to the SIP. Moreover, the SEC in the adopting release for Regulation NMS spoke not in terms of "release" but in terms of availability. See Exchange Act Release No. 51808 (June 9, 2005) ("These requirements prohibit, for example, a market from making its 'core data' (i.e., data that it is required to provide to a Network processor) available to vendors on a more timely basis than it makes available the core data to a Network processor.").
To the extent that the appropriate focus should be on the arrival of the information (that is, information cannot be provided to customers until it arrives at the SIP) there will be a serious oversight issue. Given the short time periods involved (milliseconds and, invariably, microseconds), the need to have information arrive simultaneously is likely to pose a technological challenge. Moreover, monitoring a system that operates at these speeds is also likely to pose a challenge, particularly for regulators.
Of course, if exchanges could not distribute proprietary data feeds prior to disclosure in the CTS, the problem would essentially go away.