Senator Schumer Calls for Ban on "Flash Orders"

New York Senator Charles Schumer is weighing in on the use of flash orders by high frequency traders, and even asking the Securities and Exchange Commission to ban the practice. If Schumer gets his way, so-called "flash orders" could soon be a flash in the pan!In a press release, issued by his office on Friday, Schumer warned that if the SEC fails to act, he would consider introducing legislation to stop flash order trading.

"This kind of unfair access seriously compromises the integrity of our markets and creates a two-tiered system where a privileged group of insiders receives preferential treatment, depriving others of a fair price for their transactions. If allowed to continue, these practices will undermine the confidence of ordinary investors," stated Schumer in the release.

The move suggests that high frequency trading is becoming the latest political lightening rod as the government continues to scrutinize the financial industry and overhaul regulation in the wake of the system almost collapsing.

The controversy over flash orders began to ignite in June when the Nasdaq Stock Market introduced two versions of the flash order to a segment of its customers using a proprietary data feed. Other exchanges offering the program inlude BATS and Direct Edge, an electronic equity platform, that's applying for exchange status.

The New York Stock Exchange has written to the SEC saying that flash orders are in violation of Reg NMS, which requires that orders be sent immediately to the market displaying the best price. SEC Chairman Mary Schapiro told Congress last month that the regulatory agency is examining aspects of the strategy. But from the tone of the press release, Schumer is impatient.

It can't be a coincidence that Schumer swung into action the same day the New York Times ran a front-page article explaining how powerful computers give fast traders a millisecond advantage over slower orders sent in by mutual funds representing individual investors. In the article, "Stock Traders Find Speed Pays, In Milliseconds," the reporter explains that high frequency traders send millions of orders at lightening speed and reap profits at everyone else's expense.

Later on, the piece talks about how "loopholes in market rules give high-frequency traders a glance at how investors are trading." In one example provided to The Times by an investor at a Wall Street firm, slow traders submitted orders for Broadcom, a semiconductor company. They divided their orders into smaller batches so they wouldn't leave footprints. Evidently these buy orders were shown to high frequency traders who bought up Broadcom and then sold it back to the slow traders at higher prices. The high frequency trading software automatically issued thousands of cancel and replace orders to gauge how much investors were willing to pay for the stock. Investors ended up paying $7,800 more than if they had been able to act as quickly as the high frequency traders.

While the article is informative in revealing the mysterious world of high frequency trading, it tells one side of the story. It mainly conveys how the high frequency trading world is front running investors and how Wall Street is using technology and loopholes in regulations to rip off the public. (Tabb Group estimates that rapid traders are capturing $21 billion in profits in 2008). But there is another side to the story. Exchanges that offer flash orders claim that high frequency trading adds liquidity, and that investors whose orders are flashed may end up getting better prices and experience less market impact than if they were routed to the public markets. Yet, by holding the orders a fraction of a second, are the proponents of flash orders depriving the public markets of valuable liquidity? There are pros and cons to flash orders and high frequency trading. Let's hope that Sen. Schumer engages in the debate and studies all sides of the issue before he hastily moves to change the rules.New York Senator Charles Schumer is weighing in on the use of flash orders by high frequency traders, and even asking the SEC to ban the practice. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio