High-Frequency Trading: Whistleblower Aids Investigations

Posted April 2, 2014

The buzz on Wall Street this week has been all about high-frequency trading and Michael Lewis’ new book on the topic, Flash Boys. As Lewis explains, high-frequency trading typically works by exploiting a powerful combination of speed and information: high-frequency traders use sophisticated computer programs to see and analyze trade orders that are placed by other stock market participants, then quickly make their own trades based on that data before the original orders can be filled. Known as “front-running,” these advance trades often mean that traditional, slower traders – including some pension funds and other institutional investors – receive less favorable terms for their own stock sales and purchases.

Such front-running can represent a securities violation in some, but not all, circumstances – for example, a violation would likely occur if a stock exchange gave high-frequency traders access to order information that it had promised to keep confidential. SEC rules also prohibit national exchanges from distributing market data in an “unreasonably discriminatory” manner, as reflected in a recent enforcement action against the exchange Euronext.

While Lewis’ book is likely to open many investors’ eyes to the realities of modern stock trading, he is not the first to identify the dangers (and potential illegality) of high-frequency trading. In fact, as reported in the Wall Street Journal, a Goldman Sachs trader-turned-whistleblower, Haim Bodek, disclosed many of these abusive practices to the SEC in 2012. Bodek apparently told the SEC that certain exchanges offered high-speed traders the right to “jump ahead” of other investors’ trades – for an extra fee.

According to the Journal, both the SEC and the FBI are actively investigating such practices, likely based at least in part on Bodek’s whistleblowing. Bodek’s case is yet another example of the ways in which whistleblowers can help the SEC and other law enforcement agencies to understand and successfully police even the most complex and rapidly-changing corners of the financial markets.

Read more examples of stock manipulation, or see our Securities Law Primer.

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