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High Frequency Insider Trading – And It’s Completely Legal!

July 9, 2013 Blog

There is yet one more inside game on Wall Street to which Mom and Pop investors are not invited. Retail investors, it turns out, are being damaged by trades based on classified, private information that insiders pay for and – in just a matter of seconds – use to boost the returns on their trades.

Indeed, it’s kind of like being a “coach” passenger at the airport and watching the big shot “first class” passengers board first and being handed the best perks, all for a price. Except that passenger in coach wouldn’t even know how to make a bid on that luxurious seat in first class.

The Securities and Exchange Commission and certain states are scrutinizing how certain “High Frequency” traders might have received potentially market-moving information from the Institute for Supply Management ahead of the public.

ISM, which produces a closely watched manufacturing survey, said it has taken steps to close what is sometimes a 10-second gap between the time its report gets to traders and when a press release containing the survey’s results is received by a broader audience.

The Wall Street Journal last month reported the various ways high-frequency traders and other investors can pay to get access to market-sensitive information before the public. While it sounds shady, it’s all perfectly on the up and up, at least for now.

According to a team of Wall Street Journal reporters from an article on June 12, the practice works to the advantage of professional traders. “Economic reports from public universities, trade groups and other nongovernmental organizations can move markets as surely as official data from the U.S. government,” according to the Journal’s team of four reporters: Brody Mullins, Michael Rothfeld, Tom McGinty, Jenny Strasburg. “But unlike government reports, where pains are taken to make certain no one gets them ahead of time, few rules control release of nongovernmental economic reports. Unknown to many investors, selling early access is routine.”

Access to this highly valuable information is the key. And such access comes at a price. Rapid traders pay information companies like Thomson Reuters thousands of dollars each month for a look at such reports, moments before they are widely disseminated. And it’s in those few key seconds, that they make their killing.

Again, from the Journal’s report: “This is a ‘blind spot’ in U.S. law, said Richard Painter, a former Republican White House ethics lawyer. Groups, he said, should ‘not be allowed to selectively disclose market-moving data to people who pay more money—that is not right.’”

“But it is legal, and so is trading on the advance peeks,” the Journal reported. “Even as securities rules bar companies from selective data disclosure, and as authorities vigorously pursue insider trading in all its forms, no law prevents investors from trading on nonpublic information they have legally purchased from other private entities. Trading would be illegal only if the information was passed through a breach of trust, said securities lawyers.”

For example, investors who have paid $5,000 month plus a $1,025 connection charge have received a consumer-confidence survey produced by the University of Michigan two seconds early.

One state regulator on Monday dealt that unfair practice a blow, according to news reports.

“Thomson Reuters Corp. (TRI) will suspend the early release of a consumer survey to select traders as part of an agreement with the New York Attorney General’s office, which is probing the matter,” according to Bloomberg Businesweek reporter David McLaughlin.

“New York Attorney General Eric Schneiderman is investigating the release of the Thomson Reuters/University of Michigan index of consumer sentiment to high-frequency traders two seconds ahead of other Thomson Reuters subscribers, the state said today,” Bloomberg Businessweek reported. ”The two-second advantage is enough time for traders to take “unfair advantage” of access to the information, the attorney general’s office said in a statement.”

“The securities markets should be a level playing field for all investors and the early release of market-moving survey data undermines fair play in the markets,” Schneiderman said.

We applaud such efforts by Attorney General Schneiderman and the SEC. It’s not quite the advantage Steve Cohen and SAC Capital derive, but such high frequency inside traders can beat the market all day, just with a few seconds head start.

Let’s hope the states and the SEC make a big push against such unfair practices. If not, it leaves one with the feeling that yet again that the market is rigged in favor of the big players.

Disclosure: Zamansky LLC are securities fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.