A new study from a Commodities Futures Trading Commission official has fired a shot across the high-frequency trading ship’s bow, openly questioning the legality of certain trading practices that speedy traders use in their daily execution strategies.
Published in the Connecticut Law Review this month, “The (Questionable) Legality of High-Speed “Pinging” and “Front Running” in the Futures Markets” penned by Gregory Scopino, who works in the CFTC’s Division of Swap Dealer and Intermediary Oversight, noted the two practices of “pinging” and “front running” could be illegal and violate the Commodity Exchange Act.
If so, the implications could be huge for HFT as these same practices could come under further regulatory scrutiny in the equities market.
Pinging and front-running are both methods that HFTs, as well as other traders, use to get a better look at larger institutional orders in the market. Both practices are executed similarly – by entering small tradable orders to learn about larger hidden orders in dark pools.
Scopino noted that since many of HFT orders, such as “pinging orders” involve sending out hundreds or thousands of orders to a venue that are mostly canceled, and thus the handful of trades that do get executed are “non-bona fide.” Non Bona-fide prices are prohibited by the exchange’s covenants and law.
Scopino explains HFT and their strategies as such:
“The big game in this hunt became known as a whale-an order from a leviathan fund company such as Fidelity, Vanguard, or Legg Mason. If the algos could detect the whales, they could then have a very good sense for whether a stock was going to rise or fall in the next few minutes or even seconds. They could either trade ahead of it or get out of its way. The bottom line: Mom and Pop’s retirement accounts were full of mutual funds handing over billions of dollars a year to the Bots.”
Scopino wrote that intentional high-speed pinging and related tactics are quite possibly illegal in the markets for futures and derivatives, based on existing provisions of the Commodity Exchange Act and CFTC Regulations promulgated thereunder. As such, mutual funds and other market participants could bring claims against firms that engage in such tactics. Rather than comparing high-speed pinging and similar order anticipation strategies to front running, these tactics are best viewed as variations of trading practices such as banging the close, wash trading, and spoofing,37 which courts and regulators have found to be illegal, manipulative, deceptive, and disruptive activities in both the futures and securities markets.
“Given the high cancellation rates of trading by HFT firms, that behavior is arguably a component of many high-speed trading strategies, all of which are presumably illegal,” the study said.
In his conclusion, Scopino said that despite the common perception that high-speed pinging and related tactics are legal, four CEA provisions and one CFTC Regulation arguably prohibit at least some of those kinds of trading practices.
“HFT firms might arguably be the fastest sharks swimming in the oceans of financial data, but the CFTC and private plaintiffs might have nets-in the form of relevant statutory and regulatory provisions-capable of catching them,” Scopino said.
