The SEC needs to put the SEC on its list of entities to investigate when it comes to high frequency trading.
On Wednesday, The Wall Street Journal reported that a pair of recently released studies showed that the Securities and Exchange Commission is allowing high frequency traders to get sneak peaks at corporate financial fillings before the general public. The lag time between when the high frequency traders—or, more accurately, their computers—get the filings and the rest of the public is at most a minute, and often as little as 10 seconds. Still, the authors of the studies maintain that even a 10-second head start is a big advantage for the computer traders, who measure trade times in milliseconds.
One of the studies found that when good or bad news (so, really, news) got to high frequency traders before others, stock trading volumes in those shares tended to jump. According to the WSJ, the findings suggest the regulator’s own system is giving professional traders an edge over mom-and-pop investors. Ouch!
An SEC contractor charges direct subscribers about $1,500 a month to access this feed. “The SEC receives no fees from the EDGAR Public Dissemination System (PDS),” says a spokesperson for the regulator. “The SEC does not pay the contractor to run and maintain PDS, nor does the contractor pay the SEC to run and maintain PDS.”
The SEC says about 40 companies subscribe to this service, most of which are data services or websites that publish the information they get from the SEC, and then give access to the information to their own subscribers. One of the subscribers to this service is Morningstar.com, which runs a website geared to average investors. Another is the Washington Service, which has hedge fund clients, including one that uses “quantitative models to drive trading strategies,” which sounds like it could be high frequency trading, but it could also be a lot of other things.
The story is not all that different from a number that have come out about high frequency traders over the last year or so. HFT traders agree to pay for a service—like having their computers closer to an exchange’s servers, or a slightly shorter data line between Chicago and New York, or early looks at the consumer confidence report or press releases—that the rest of Wall Street, and perhaps the service provider itself, assumes is worthless. And that goes on for a while, until someone figures out that that small advantage is worth a lot, if you are a high frequency trader. Outrage and, at times, lawsuits, then ensue. Usually, the service provider is forced to stop providing the special access to the high frequency traders (which, like plenty of other special services in all fields, the high frequency traders are paying a high fee for) because it seems unfair.
The difference here is the entity handing out that advantage is the SEC, which is supposed to regulate the market, should know something about what would give the HFT firms an advantage and is charged with making sure markets are fair. So, on the face of it, this looks bad, not just for us individual investors trying to compete with high frequency traders, but also for the SEC.
However, SEC documents are typically hundreds of pages long and written in legalize. The most important financial information, earnings results, are typically released by companies in press releases long before they are filed with the SEC. It’s not typically information that computers can digest quickly. But there are exceptions. One study looked at filings of insider transactions—when executives trade in their own shares. That’s something that is first reported in SEC filings.
It’s not all that surprising that the SEC would be slow to realize that selling a service that was giving an unfair advantage to high frequency trading was a bad idea. Then again, I bet that the SEC was unaware it was actually handing out an advantage. But even the SEC should have realized that the optics of actively assisting HFT firms would be bad.
Still, the SEC has been helping HFT firms in less direct ways. Despite harsh speeches from SEC Chair Mary Jo White and a few fines, the regulator has been slow to curtail high frequency trading. The SEC knew about the issues in Michael Lewis’ Flash Boys, which contends that HFT has rigged the market against individual investors, long before the book came out. Many of Lewis’ sources went to the SEC with their information long before they started talking to the journalist.
The SEC’s response? “Meh.” That might not be just because the SEC is a weak regulator. It comes down to the differences between what Lewis and the SEC think is important. If your No. 1 care is that the market be a fair and a level playing field, then Lewis’ outrage seems on target. High frequency traders do have an advantage.
The SEC, though, seems more concerned about bringing down the cost of trading. And at least in the ways that are easy to measure—trading costs, or the spread between what buyers pay and sellers get—high frequency trading does appear to have lowered costs for the average investor.
Of course, that’s not the only way to measure fairness, but it seems like a reasonable one, and an achievable one. That’s different than Lewis’ fairly naive notion of fairness, which I guess is that the market should be a completely level playing field between even the most sophisticated of high speed computerized professional traders and a guy like me with a Vanguard account.
Someone is always going to have an advantage. Even if the SEC did distribute its filings to Average Joes and high-speed traders at the same time, their computers would still be able to trade far faster than regular investors like you and me could even blink. HFT firms trade in milliseconds. I haven’t made a single trade all year. High frequency traders invest millions of dollars for the technology to be able to take advantage of that single-minute lead. I pay nothing to get access to my Vanguard account.
But the general public is not going to understand that last part, which is really the heart of the SEC dilemma when it comes to figuring how it should regulate high frequency trading.
If you believe that lowering trading costs is the most important thing, and that HFT firms lower trading costs, helping HFT firms is probably the fairest thing you can do. Until, of course, the The Wall Street Journal or Michael Lewis finds out about it. Then you have to stop, and the SEC surely will, because, to the average investor, this is never going to seem fair.
Editor’s note: A previous version of this story incorrectly stated that the SEC provides a subscription service to a direct feed on corporate financial filings. In fact, the feed is provided by a contractor of the SEC. The regulator does not receive any remuneration from the contractor that operates this feed.
