Can the SEC fine itself for facilitating differential market access – in effect encouraging insider trading?
Perhaps it’s time for the SEC’s enforcement division to take a look inside the rabbit warren that is the SEC headquarters. Someone should point Robert Khuzami, the SEC’s head of enforcement, to the office of the Division of Trading and Markets. That division just approved allowing the New York Stock Exchange to profit by charging high frequency traders to “co-locate” their flash-crash causing computers at the NYSE’s data center. That, in turns, allows some investors to get price data before others.
Wait! Before you stop reading this post because it has mind-glazing words like “co-locate” and “latency”, just know this: The NYSE is rigging the market, giving some market participants preferred access to price data before the rest of us – for a large fee. Effectively, the NYSE is setting up a two-tiered exchange: Slide a fistful of money to the maitre d’ and be allowed past the velvet rope into a private room that virtually guarantees you making money. For the rest of us, it’s play by the rules and take your chances.
Most embarassingly, one part of the SEC is blessing that flaunting of the fair access rules, even while the enforcement division fines the NYSE for the same sale of preferred access in a different form. The SEC — or at least part of the SEC — requires the NYSE to maintain fair market access – a fancy way of saying that all buyers and sellers should have an even playing field. Less than a month ago, the SEC fined the NYSE $5 million for sending out price information to some customers in advance of others. “Improper early access to market data, even measured in milliseconds, can in today’s markets be a real and substantial advantage that disproportionately disadvantages retail and long-term investors,” stated Khuzami.
However, less than a month before that, the Division of Trading and Markets approved the NYSE’s request to charge thousands of dollars a month to high frequency traders to “co-locate” computers at the NYSE’s Mahwah, New Jersey data cents. (see http://www.sec.gov/rules/sro/nysemkt/2012/34-67665.pdf) High frequency traders (HFTs) use pre-programmed computers to effectively micro-front-run everyone else’s buy and sell requests. To do this, their computers need to be able to read, process, and understand everyone else’s orders in thousandths of a second. In other words, they need to know the price you’re willing to pay – and the price at which someone else will sell to you or buy from you – before everyone else. And, when you are dealing in thousandths of a second, the distance from the information source to your computer matters; even electrons take some amount of time to travel. The time it takes for information to move through wires is called “latency.” For HFTs, the less latency the better. So, if you are trying to front-run everyone else’s orders, it helps to have your computers adjacent to the NYSE’s, rather than in your own offices, which might be miles away. The NYSE understands this: It has created a thriving business selling co-location. Indeed, the opening line of its sales flyer states the bald-faced unfair market access basis of its co-location business: “High frequency and proprietary trading firms, hedge funds and others who need high-speed market access for a competitive edge.”
But isn’t that exactly what the fine was trying to correct? Selling market access that’s unavailable to the rest of us?
It’s past time for Mr. Khuzami to pay a visit to the Division of Trading and Markets.