The recent financial crisis has led to heightened scrutiny across the financial markets. After the markets collapsed in 2008 there were calls for increased regulation of the financial markets, which led to the passage of the Dodd Frank Act. Despite the increased scrutiny and regulation, not every aspect of the financial markets is sufficiently covered and grey areas exist where it is unclear how the law will affect certain practices. One such practice is that of high-frequency trading.
High-frequency trading is the use of sophisticated technological tools and computer algorithms to rapidly trade securities. High-frequency trading uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second. It is said that this form of trading benefits the markets by moving supply and demand among long-term investors quickly and efficiently thereby reducing volatility and increasing liquidity.
However, opponents of high-frequency trading have identified numerous perceived problems associated with the practice. One such problem is that securities exchanges have been selling access to market data to high-frequency traders in such a way that they have access to the information a very short period of time before other investors. Opponents claim that high-frequency traders then use this information to improperly influence the financial markets – at the expense of other investors that lack this “earlier” access to the market data provided by the exchanges.
The trouble in attempting to root out any potential violations associated with these problems lies in the current regulatory scheme governing the financial markets. For example, the SEC has the power under §11A(c) of the Securities and Exchange Act of 1934 to adopt rules relating to “distribution or publication” of financial information applicable to exchanges. However, in order to prove fraud on the part of the high-frequency traders the government must prove intent to artificially affect stock prices or to defraud others. Further, exchanges enjoy special regulatory status that shields them from certain legal challenges – they are self-regulators, which means they are protected from liability for damages that clients suffer as a result of their actions.
Thus, the current regulatory state governing high-frequency trading poses potential difficulties in rooting out “real” violations of the law in this domain, but too much regulation will likely serve to deter investors from partaking in high-frequency trading, and thus destroy the value added by this practice. It will be interesting to see how the law is shaped and/or adapts to these challenges in the future.