The business media on wash trades

The markets are going through another revolution in the form of wash trades, which can be used to manipulate the markets.

The Wall Street Journal had this story:

U.S. regulators are investigating whether high-frequency traders are routinely distorting stock and futures markets by illegally acting as buyer and seller in the same transactions, according to people familiar with the probes.

Such transactions, known as wash trades, are banned by U.S. law because they can feed false information into the market and be used to manipulate prices. Intentionally taking both sides of a trade can minimize financial risk for the trading firm while potentially creating a false impression of higher volume in the market.

The Commodity Futures Trading Commission is focused on suspected wash trades by high-speed firms in futures contracts tied to the value of crude oil, precious metals, agricultural commodities and the Standard & Poor’s 500-stock index, among other underlying instruments, the people said.

The agency is looking at potential wash trades by multiple high-speed firms, although it isn’t known which ones investigators are scrutinizing. Firms found guilty of intentionally distorting the market through wash trades could face hefty fines.

Investigators also are looking at the two primary exchange operators that handle such trades, CME Group Inc. and IntercontinentalExchange Inc., the Atlanta company that in December agreed to purchase NYSE Euronext  for $8.2 billion, the people said. Regulators are concerned the exchanges’ systems aren’t sophisticated enough to flag or stop wash trades, the people said.

“We actively enforce rules prohibiting wash trading, and we’re in the process of developing technology to prevent wash trades as prohibited by CME and CFTC at the trading-engine level,” a CME spokeswoman said. CME plans to introduce new technology the middle of this year, she said.

The problem with these trades is that they manipulate the prices for regular investors. So, there’s really little chance that the markets will be fair. Here’s more:

The investigations highlight how regulators continue to struggle with today’s complex high-speed markets and the ties between exchanges and their valued high-frequency customers. Securities and Exchange Commission investigators have been probing whether stock exchanges have provided certain advantages to sophisticated firms that allow them to trade at the expense of regular investors.

Exchanges say such advantages allow the firms to trade aggressively and provide better prices for regular investors who are trying to buy or sell.

Regulators also have pressed exchanges to improve their oversight in the wake of a flurry of computer-driven glitches last year, including the debacle that caused Knight Capital Group to suffer losses of more than $450 million and the flubbed Facebook Inc.  public offering by Nasdaq OMX Group Inc.

“High Frequency Trading-Controlling the Risks” was the first agenda item in a nonpublic meeting of CFTC commissioners and international regulators last week at the closely watched Futures Industry Association conference in Florida, a copy of the meeting agenda reviewed by The Wall Street Journal shows.

European and U.S regulators questioned industry representatives on whether high-frequency traders hurt or helped the markets, people at the meeting said.

With wash trades, one difficulty regulators face is proving the suspect trading is intentional, a standard required by many securities and commodities laws. In today’s fast-moving markets, some firms say it is relatively easy for their buy and sell orders to cross by mistake.

But the scale of the suspicious trading activity is so large that it appears to some market watchdogs to be intentional, said people familiar with the matter. Futures-trading data from 2012 being scrutinized by CFTC examiners show that often, several hundred thousand potential wash trades occur a day on futures exchanges, the people said. Regulators have zeroed in on CME, where the majority of the potential wash trades have occurred, the people said.

It’s just another layer that individual investors have to navigate before making money. More importantly, at least the regulators are finally on top of another market issue. Let the reviews begin!