Regs Investigate Whether High-Frequency Traders Are Distorting Markets

Regulators continue to struggle with oversight over complex high-speed markets, the controversial ties between exchanges and their high-frequency customers, as well as the potentially unfair advantage high-speed trading firms have over regular investors.

Regulators have launched an investigation into whether high-frequency traders are distorting stock and futures markets by illegally acting as buyer and seller in the same transactions, known as wash trades, according to the Wall Street Journal.

The CFTC is currently scrutinizing potential wash trades by high-speed firm in futures contracts tied to the value of crude oil, precious metals, and the S&P’s 500-stock index, among others, the WSJ’s sources say.

CFTC Commissioner Bart Chilton plans to speak about issues around wash trades today in a speech in San Francisco to a commodities-industry group, the WSJ, who saw the prepared comments, said.

Chilton reportedly plans to say high-frequency traders engage in wash trades "in voluminous instances.” He will also call for "more review" of algorithmic trading firms and exchanges to “better understand the effect of improper trades and how they are allowed to happen.”

Wash trades are banned by U.S. law because they can feed false information into the market and be used to manipulate prices. The upside for firms who take part in the practice is that by taking both sides of a trade they can minimize financial risk while potentially “creating a false impression of higher volume in the market,” the WSJ points out.

Meanwhile, some observers suggest wash trades are due to inefficient trading infrastructure, rather than malicious trading strategies.

“The arbitrage strategies driving most HFT trading strategies would result in wash trades only in instances where an HFT market maker attempts to cancel an existing bid, for example, and enter an offer, but instead ends up trading against its own uncanceled bid,” one WSJ reader commented.

“Therefore, the most likely scenario is the occurrence of HFT wash trades is the result of a slow, or inefficient trading infrastructure on the venues where HFT "wash trades" are occurring.”

In the meantime, regulators also are focusing on the two primary exchange operators that handle futures trades that have been called into question - CME Group and ICE, the company that recently agreed to purchase NYSE Euronext for $8.2 billion. Regulators are apparently worried that the exchanges' systems aren't sophisticated enough to flag wash trades.

"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," the CME said. CME plans to unveil new technology by the end of the second quarter, a CME spokesperson said.

An ICE spokeswoman said the exchange operator has used wash-trade filters for years.

Separately, FINRA is reportedly also looking into issues relating to high-speed trading firms' transactions in stocks. And the SEC has been scrutinizing exchanges to see whether they provided certain advantages to high-speed trading firms that allow them to trade at the expense of regular investors.

Regulators are also pressing exchanges to improve their oversight of high-speed trading firms, following a series of high-profile technology glitches by electronic trading firms last year, including the debacle that saw Knight Capital lose more than $440 million in a frenzied half-hour of erroneous trading back in August.

Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio