The SEC is Investigating Electronic Trading

The SEC's new investigations could lead to electronic market reform

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The Financial Industry Regulatory Authority and the Securities Exchange Commission have begun investigating the strategies and secret computer algorithms of high-trading firms on Wall Street, Reuters reports. FINRA are investigating suspicious market activity, like if there was a surge of trading for a stock that normally doesn't attract that much attention. They're investigating something specific that happened in the market, but they aren't saying what. "It's not a fishing expedition or educational exercise. It's because there's something that's troubling us in the marketplace," said Tom Gira, executive vice president of their market regulation division. The SEC are confiscating the strategies behind the compter code from financial firms, "as part of its authority to examine financial firms for compliance with U.S. regulations, according to agency officials and outside lawyers."

The "flash crash" of May 6, 2010, triggered an upswing in the SEC's interest in hedge funds and brokerage dealers' computer-trading operations. Requests for the companies' computer algorithms' strategies have skyrocketed this year, and some traders are starting to worry the secrets from their little black books are going to be released into the wild. One executive from a high-frequency trading firm told Reuters they would be "disappointed and upset" if the SEC asked them for their information. "I mean, are these people all going to work at the SEC forever?" he asked.

The fear that an SEC staffer could walk out the door with trading secrets from competing trading firms, and then auction them off is leaving some traders sweating. An attorney told Reuters his clients were worried, if they had to turn over their code, that a regulator might, "remember something he saw in an exam and use it down the road." The SEC is "rarely" asking for the actual algorithms, according to a rep. Instead, the SEC, "has been asking for research papers containing sensitive information about trade reasoning and proprietary formulas."

Reuters thinks the SEC will use the information they discover from the algorithm strategies to carve out new regulations on the electronic market.

The way the algorithms react to certain market conditions is what the SED is trying to look at, to prevent any potential manipulations or catastrophes. They're worried firms may try to manipulate the market's activity with a bevy of underhanded tricks, that could cause another financial disaster from false information, like the crash on May 6:

Last year, SEC Chairman Mary Schapiro said regulators were investigating whether traders manipulated prices, encouraged volatility, or committed fraud by flooding the market with rapid-fire orders that were almost immediately canceled.

This article is from the archive of our partner The Wire.