High-speed traders’ advantages

Talking about high-speed trading may be complicated, meaning that much of the coverage is done by larger news outlets and not picked up in local business news. But it’s important for investors and day traders looking to make quick money to understand how the markets work and when they might be at a disadvantage.

On Tuesday, the New York Attorney General raised the issue at a Bloomberg conference, making headlines around the financial world.

Here’s the Bloomberg story:

Elite investors with high-speed trading systems who gain early access to sensitive information are a growing threat to the integrity of U.S. financial markets, New York Attorney General Eric Schneiderman said.

Schneiderman said today at the Bloomberg Markets 50 Summit in New York that his office is looking into combating the advantages won by securing early access to market-moving data. Calling the issue “Insider Trading 2.0,” Schneiderman said the combination of high-speed trading and early data access unfairly sets up a small group of investors to reap enormous profits.

“A new generation of market manipulators has emerged,” Schneiderman said. Average investors aren’t “going to invest if they think the markets are rigged,” he said.

Faster technology and regulatory changes aimed at spurring competition among exchanges have allowed for rapid increases in the speeds at which stocks change hands. Trades now can occur within a fraction of a second of when market-moving information is available.

Securities and Exchange Commission Chairman Mary Jo White said the “jury is still out” on whether high-frequency trading, which now accounts for more than half of U.S. volume, is helpful or harmful to the market.

The Wall Street Journal led with Schneiderman’s call for regulators to look into and put a stop to early access to information:

New York Attorney General Eric Schneiderman called on officials in Washington to take action to prevent high-speed traders from making investments based on early peeks at market-moving data and analyst reports in what he called “Insider Trading 2.0.”

Mr. Schneiderman said that when high-frequency traders have access to soon-to-be-released information, it creates something “far more insidious than traditional insider trading.”

“Comprehensive action is required,” Mr. Schneiderman said in prepared remarks for delivery Tuesday at the Bloomberg Markets 50 Summit. “This new form of market manipulation ultimately requires action from Washington.”

Mr. Schneiderman criticized an arrangement between Thomson Reuters Corp. and the University of Michigan that allowed paying customers to get the results of the university’s consumer confidence survey before it was released to the public.

Under the arrangement, which was the subject of a front-page article in The Wall Street Journal in June, Thomson Reuters paid the university about $1 million a year to get early access to the data. Thomson Reuters would then give the survey results to a top tier of paying customers five minutes before the university released the monthly survey on its website.

An even more elite group of high-frequency traders paid a higher fee to get the survey results two seconds earlier than the first group, according to a contract between the university and Thomson Reuters that was reviewed by the Journal.

Spokesmen for the University of Michigan and Thomson Reuters didn’t immediately respond to requests for comment.

The New York Times reported that the inquiry was ongoing and that Schneiderman was trying to restore trust in the markets:

At Tuesday’s conference – which was sponsored by a main rival of Thomson Reuters – Mr. Schneiderman emphasized that his inquiry into this matter was continuing. He cited concerns about the practice by investment banks of releasing analyst research to select clients.

The point of this inquiry, Mr. Schneiderman said, was to create a level playing field and restore public trust in the markets. “When blinding speed is coupled with early access to data, it gives people the power to suck value out of the markets before it even hits the Street,” he said.

Speaking to an audience of financial professionals, Mr. Schneiderman encouraged Wall Street to call his office hot line with any leads.

“I see little being done from the industry to address this clear and present danger,” he said. “I would urge you to get this on the agenda of any trade association group or at your own firm.”

While market credibility doesn’t seem to be hurt right now, reports that the Federal Reserve is looking at ways to make sure traders don’t get information early point out that it is quickly becoming a more widespread problem. As stock trading becomes more of a commodity, looking for an edge is natural. Let’s just hope that traders don’t drive retail investors away in the quest for nanosecond advantages.