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High-Speed Trading Firms Face New U.S. Scrutiny
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High-Speed Trading Firms Face New U.S. Scrutiny

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High-Speed Trading Firms Face New U.S. Scrutiny

Regulators are taking aim at the relationship between high-frequency trading firms and major exchanges, examining whether the preferential treatment market operators offer the firms puts other investors at a disadvantage.

The Commodity Futures Trading Commission is investigating deals between large high-speed firms and the two futures-exchange operators, CME Group Inc. and IntercontinentalExchange Group Inc., according to people familiar with the matter.

The probe is focused on complicated, often opaque incentive programs that give high-volume trading firms financial benefits such as discounts on fees the exchanges charge to execute trades, the people said.

Separately, Securities and Exchange Commission enforcement officials are investigating whether stock exchanges provide advantages to certain clients, including high-frequency traders, by designing software programs that can give preferential treatment to their orders, and whether such details have been fully disclosed, people familiar with that inquiry said.

The probes come amid heightened concerns among institutional investors, lawmakers and regulators that superfast traders have access to advantages on stock and futures exchanges not typically available to regular investors.

Regulators are concerned that less-savvy or less-influential investors aren't aware of the benefits and advantages that exchanges are providing to certain clients, making it difficult for them to compete fairly, according to people familiar with the investigations.

High-speed firms use sophisticated computer systems to move rapidly in and out of markets in fractions of seconds.

So far, market watchdogs have done little to curb such trading, which has boomed and now makes up about half of all stock-market volume. Computerized trading has come under scrutiny in recent years and has been tied to market mishaps such as the May 6, 2010, "flash crash," when stocks nose-dived and then recovered in a matter of minutes.

The CFTC probe is looking at whether the exchanges created discount programs that benefited financially important customers in ways that disadvantaged other customers, people familiar with the probe said. The CFTC has asked for communications between the futures exchanges and certain customers, as well as trading firms' internal documents on pricing discounts and related transactions, according to the people.

Spokeswomen for CME and IntercontinentalExchange, or ICE, declined to comment. ICE last year purchased NYSE Euronext, making it one of the world's largest operators of exchanges, including the New York Stock Exchange and Liffe, a London futures exchange.

The CFTC probe is focusing on contracts tied to high-volume commodities such as crude oil, among other trading, and whether exchanges are pressuring some clients to trade such contracts exclusively on their venue, according to the people familiar with the probe. It also is targeting deals struck privately between exchanges and trading firms that aren't disclosed to other trading outfits.

"There shouldn't be secret deals," said Mark Gorton, chief executive of Tower Research Capital, a U.S. high-frequency trading firm. "The big players shouldn't have better rates than the little players."

Among the firms in focus are New York high-speed giant Virtu Financial Inc., which last week disclosed in a regulatory filing that the CFTC is "looking into our trading during the period from July 2011 to November 2013 and specifically our participation in certain incentive programs offered by exchanges or venues during that time period." Virtu, which plans to go public this year, said in the filing it doesn't believe its trading "violated any statute or CFTC regulatory provision."

The CFTC has also questioned Jump Trading LLC, a Chicago high-speed trader, about its trading strategies and ties with exchanges, according to people familiar with the investigation. A spokesman for Jump didn't reply to a request for comment.

Incentive programs are common across markets. Stock exchanges offer a range of financial discounts including rebates for high-volume customers, but traders say they are uniformly disclosed in equities markets. Futures exchanges regularly introduce incentives to encourage trading in new or highly competitive products or to cover gaps in lightly traded contracts to help maintain markets. Incentives can be based on trading volume, trading behavior or a combination of both.

Defenders say such programs help boost the number of orders on the exchanges, making it easier for other investors to buy and sell futures contracts.

Among the CFTC's concerns is that the programs can encourage traders to engage in strategies that boost volumes but harm other investors, the people familiar with the matter said. For instance, the reduced costs might give firms an incentive to pay higher prices than other firms, making it tougher for the other traders to compete.

A CFTC investigation into so-called wash trades, first disclosed by The Wall Street Journal a year ago, has now morphed into the larger probe over whether high-speed firms are using such trades to boost volumes and exploit the exchange's discount programs.

SEC officials, meanwhile, continue to probe relationships between exchanges and trading firms over so-called order types, which are sets of programmed instructions that dictate how trades are routed on an exchange, according to the people familiar with that investigation.

The agency has asked for trading records and about five years' worth of emails from Tradebot Systems Inc., a Kansas City, Mo., high-speed trader, the people say. Tradebot Chairman Dave Cummings said in a recent interview that the firm has done nothing wrong. "Order types are well-documented for everyone," he said. Mr. Cummings founded BATS Trading Inc., an electronic stock-trading venue popular with high-speed traders. BATS earlier this year merged with Direct Edge Holdings LLC., forming BATS Global Markets.

Mr. Cummings said he sees nothing inappropriate about Tradebot speaking regularly with exchanges and requesting order-type features it believes would be useful. "Tradebot is treated the same as any other customer," he said.


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