HFT Stock Manipulation In Action - page 5

 

There will always be somebody that will defend the HFT. It is only logical : as long as the state does not want to admit that it is a fraud there will be alwaysprophets that will find out any kind of moronic excuses for the existence of HFT

 

Nasdaq seeks upside from markets debate as profits rise

Author Michael Lewis' claim that the U.S. stock market is rigged was "irresponsible," but the debate it has sparked could lead to positive change, said Bob Greifeld, chief executive of Nasdaq OMX Group (NDAQ.O), which reported higher earnings on Thursday.

In "Flash Boys: A Wall Street Revolt," Lewis says that high-speed traders bilk billions from the financial system using ultra-fast telecommunications links, microwave towers and special access to exchanges to gain an edge over other traders.

"I think certainly it was an irresponsible piece of work and it served to tell a story without any research or factual checking of what was going on and I think it did a disservice to the industry," Greifeld said in an interview.

The debate over the fairness of the markets and the role of high-speed traders is not new, but Lewis took it mainstream. Shortly before "Flash Boys" was released in late March, New York Attorney General Eric Schneiderman said U.S. stock exchanges and alternative trading platforms provide high-frequency traders (HFTs) with unfair technological advantages that give them early access to key data.

Schneiderman said he had begun meeting with exchanges and alternative trading venues, known as dark pools, to discuss reforms. Last week, Reuters learned that his office had sent subpoenas to at least half-a-dozen HFT firms seeking information on their relationships with exchanges.

Nasdaq has not been subpoenaed, Greifeld said.

The U.S. Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Bureau of Investigation have said they had several active probes into HFT.

HFT AND MARKET MAKERS

There is no agreed upon definition of HFT, but Nasdaq said on Thursday firms it considers to fit into the category add only 1 percent to its total revenues. The transatlantic exchange operator said its first quarter revenue was up 27 percent from a year earlier, at $529 million, helped by new revenue from recent acquisitions, as well as organic growth.

Nasdaq did not include in its HFT definition firms with market making obligations on its exchange, meaning firms that take the other sides of trades in stocks they have been assigned responsibility for. Several such firms are considered by HFT critics to be among the largest high-frequency traders.

"These are people who are providing a two-sided market, who always have to be on the adverse side of the investment decision, providing immediate liquidity to the marketplace, and under our rules have to be within a certain percent of the inside market on a continuous basis," Greifeld said on a call with analysts. "So I think in any construct you talk about, nobody is going to try to restrict that activity. Why would you? The market needs that."

SHINING A LIGHT ON DARK CORNERS

Nasdaq said its net income in the last quarter rose to $103 million, or 59 cents per share, from $42 million, or 25 cents per share, a year earlier. The year-ago results were hit by charges related to problems with Facebook Inc's (FB.O) initial public offering, when a glitch on Nasdaq's exchange led to a collective loss by market makers - which absorbed the losses of other firms - estimated at around $500 million.

Not including one-time items, the New York-based company earned 72 cents per share, beating the average estimate of analysts by a penny, according to Thomson Reuters I/B/E/S.

Non-transaction-related services, such as providing market data and public relations, made up 72 percent of Nasdaq's revenues. Like other exchanges, Nasdaq has had to rely less on trading revenues in recent years as nearly 40 percent of all stock trades now happen on private broker-owned dark pools and other off-exchange venues where trading information is hidden until after trades are executed.

Some academics and former regulators say so much trading now happens on "dark" venues that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is. And this problem could cost investors more than any shenanigans related to high frequency trading.

Greifeld said he has been frustrated by the lack of movement on this issue. But he added that with all of the attention generated from "Flash Boys," he is hopeful progress will be made toward rules that would force brokers to only route trades off-exchange if those trades are of a certain size or could be executed at meaningfully better prices than on a public market.

"We certainly feel increased optimism that with this publicity, we can have maybe an acceleration of the evolution of the market. And with 40 percent of the market trading away from the lit markets, there is certainly great opportunity for us."

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Citadel Blasts Lewis' Flash Boys; Says "Small Investors Have Never Been So Fortunate"

Citadel's head of Execution Services (cough HFT cough) Jamil Nazarali, proclaimed Monday that small investors have never been so fortunate and said, with regard to Michael Lewis' now infamous book Flash Boys, "The most important thing that the market can do is stop... pointing fingers at everyone else." Citadel, who allegedly provides the NY Fed's VIX trading capabilities, are among the very largest high-frequency traders in the market (and the most levered), so it is hardly surprising that Citadel would like us all to stop pointing fingers at them. As Bloomberg reports, Nazarali said yesterday during a panel discussion at the Milken Institute Global Conference in Beverly Hills, California, "things are much better today than they were 10 to 15 years ago."

As a gentle reminder, Citadel is the most levered fund (as an HFT hiding in a hedge fund)...

So it is hardly surprising that the head of execution services - another name for High-Frequency-Trading - would come out swinging against Flash Boys...

As Bloomberg reports, Michael Lewis produced a top-selling book by arguing that the U.S. stock market is rigged. To one of hedge-fund operator Citadel LLC’s top executives, small investors have never been more fortunate.

“It’s one of the few markets in the world where the little guy gets a better deal than the big guy,” Jamil Nazarali, the head of Citadel Execution Services, said yesterday during a panel discussion at the Milken Institute Global Conference in Beverly Hills, California. “Things are much better today than they were 10 to 15 years ago.”

Flash Boys specifically called out the likes of Citadel for the practice of paying for order flow...

Citadel’s role in that discussion stems from Nazarali’s unit, which pays brokerages including TD Ameritrade Holding Corp. for the right to execute orders placed by their customers, who tend to be individuals.

Lewis critiqued that practice, known as payment for order flow. Citadel’s rivals in that business include Citigroup Inc., UBS AG and KCG Holdings Inc. All are bound by rules meant to ensure they get the best price possible for investors.

Nazarali said yesterday thatsmall investors often get better prices for their trades than the biggest firms.

Which is odd, as LiquidNet notes...

“If you are going to buy in bulk, you should get a better price than someone buying retail,” Liquidnet Chief Executive Officer Merrin said during a panel discussion with Nazarali. Giving the smallest investors a better deal than the biggest investors is “screwed up,” he said.

Merrin isn’t alone in arguing that large investors aren’t adequately served by the market’s current structure.

But Nazarali summed it up perfectly, when asked how to improve the perception among investors that the equity market is broken...

...more cohesion is needed...

“The most important thing that the market can do is stop the food fight where everyone is pointing fingers at everyone."

In other words... we need to stick together... stop pointing fingers at us because you know as well as us that if you bring us down, it won't end well.

We remain of the opinion that while HFT has gone off the headlines for the moment - and market rigging has been forgotten now we are rising again - that if and when the next big drop comes, there will be only one scapegoat...

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Goldman Sachs under scrutiny for high speed trading

Goldman Sachs is the latest Wall Street firm to have regulators looking into its high frequency trading practices.

The bank admitted in a filing Friday that regulators have made inquiries.

The disclosure to the Securities and Exchange Commission is the first time the Wall Street powerhouse revealed the probe.

There's been increased focus on high frequency trading since Michael Lewis' book "Flash Boys" came out in March and claimed that the markets are rigged in favor of high speed traders.

The filing doesn't indicate the severity of the inquiries, so it's impossible to say whether regulators are formally investigating the firm for wrongdoing, or simply gathering information about the way the bank does business.

Banks routinely disclose reviews or investigations by regulatory bodies on a number of financial transactions.

Goldman Sachs (GS, Fortune 500) also said in the filing that it is among the defendants in a class action lawsuit pertaining to high frequency trading.

According to a class action complaint filed in mid-April, the City of Providence, Rhode Island alleges that a number of banks, brokerages, high frequency trading firms, and stock exchanges "rigged the market and manipulated the prices at which shares were traded."

Goldman, Fidelity, and the New York Stock Exchange are among the influential companies named in the suit.

The complaint mentions Goldman's "dark pool" electronic trading platform, known as Sigma X. Dark pools, which are operated by various Wall Street firms, make it so buyers and sellers can make trades concealed from the public.

While dark pools have been criticized for obscuring the price of stocks, advocates say they provide a service to large institutional investors who trade huge blocks of stock and don't want other investors to know their strategies until their trade is fully executed.

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All that is going to happen that they are going to pay some fines ... from the money they stole us

And they are going to pay it to the government that is doing the same : stealing money from us for their worthless speeches and "taking care" of us. We would be better of alone in a woods than in a state like this

 

How To Fix High-Frequency Trading

Solution to HFT Debate: Match Based On Price & Quality, Not Time.

The recent public outcry over high frequency trading is pointless. Solutions exist. Virtually every comparable market in the world uses them already.

But, some electronic exchanges may not willingly adopt them. Doing so may disrupt their current business model. The incentives are misaligned, and competitors or regulators may need to force the issue to see change. Luckily, the issue to be forced is far simpler than most think.

It’s time to add quality to the matching process. Over thousands of years, every naturally evolved market has headed this direction – from the ancient Greeks to Alibaba.com. It’s time for Wall Street to realize what they lost along the way, and how it can fix far more than just HFT.

In 500 BC, the Greeks were auctioning off war plunder, grain, livestock, even ‘wives’. Sellers set the price, tossing out descending ask prices until a bidder emerged or the price got too low.

2500 years later, little’s changed. The world’s financial exchanges auction livestock and grain, just the same. They just added stocks and bonds instead of wives. But, the biggest real change came when the order books went electronic. The programmers who created these systems copied everything they understood from the auctions of yore, in Greece, on the streets of lower Manhattan, and in the massive exchanges that emerged from them. But, the auctioneer cannot scale to serve millions of customer around the world, so they replaced him with a “matching algorithm”, the piece of software that selects buyers and sellers.

It is that bit of logic at the heart of a national debate on the merits of high frequency trading. It is that bit of logic that lost something critically important. HFT traders are not sidestepping rules to gain advantage. Finding alpha in information advantages is exactly what they’re paid to do. And most, even among HFT firms, do so within the rules set by the exchanges. Rules set by the design of the matching engine. I know because I was once one of these traders.

The big problem in the electronic exchanges is not agents searching for inefficiencies. The problem is structural. It’s that the matching engine rewards speed and encourages the proliferation of order types that act as trap doors. That’s because when those programmers copied the auctions they saw, they lost the implicit decisions – the ones made by auctioneers deciding who to do business with or floor traders deciding which yelled bid to acknowledge.

Those traders weren’t just concerned with speed; they were making a judgment on quality too. Low latency trading is complex. Network, hardware and software optimizations -- all designed to reduce the time to send messages. Time is absolutely money. But only because the exchanges timestamp orders and rank them in the order book according to price AND time. They incentivize being at the front of the line.

Understanding where your orders are queued in relation to all the others at the same price is an advantage. It’s like being first in line to get a box that might have gold or might have a grenade. Better if there’s ten other guys behind you willing to take the box after you peek inside. The guy at the end of the line is at a significant disadvantage, he has no one left to transfer the risk to. Low latency trading is all about being first so you have the option to “scratch”, or exit for little or no loss in an adverse movement, and to profit from favorable price action.

Exchanges operating time based matching engines have inspired the low latency arms race. And they’ve been profiting from it for almost 20 years. Over time it’s grown into a tangled web of liquidity pools, data center ‘cross connects’, and low latency microwave towers. Transaction fees collected from low latency trading firms are substantial and have the exchanges bending over backwards to support the industry.

What began as a simple and logical idea – the only conceivable ‘fair’ way to do things when computers had 4K of memory and couldn’t do all that much actual computation -- ranking participants as first-in-first- out, has devolved into a technological war that dilutes the concept of providing liquidity. Instead it creates a low concentration liquidity vacuum where volume results not from the exchange of risk but from mere tinkering with the rules to see what loopholes can be found.

What if one more measure could be added that would specifically discourage that kind of tinkering? It’s been done before, many times over.

eBay is the most successful auction in the history of mankind, with over 300 million users. But, does time play much role? Not really. In fact, time extends as late players come to the bidding. Instead, eBay operates on price and quality.

Quality is determined by user feedback. Participants rate each other’s behavior, like the ability to honor terms and deliver the goods promised, failure to pay for an item won, etc. It was a simple upgrade, meant to assuage the fear of doing business with strangers a world away. But, it put all participants on equal footing, punishing those who would game the system by excluding them the next time.

The world’s electronic exchanges need to take a page from eBay’s playbook and start measuring the quality of their participant’s liquidity and factoring that into the matching process, rather than how few microseconds it took them to submit it. And, it can be completely automated, using data like the a user’s historical accept/decline ratio, or quotes/fill ratio, to determine where in the order book queue a participant is placed. Orders can then be ranked and sorted by price and quality, i.e… the likelihood that a participant will actually stand firm on the price submitted thereby creating an order book with very ‘sticky’ liquidity gravitating toward the top of the book.

Floor brokers and floor traders operated just like this, with a price+quality matching algorithm, albeit in their heads. The best price was always honored. But, given a choice of bidders, if the broker didn’t believe you would honor your quote someone else would get the trade and you’d be sent to the back of the proverbial queue. Bust a trade enough times, and even your highest prices wouldn’t reliably win.

Voice brokered OTC markets implicitly work like this today too. Traders who frequently ‘flake’, or back away from quotes, don’t get a phone call the next time a deal is available to be done. This encourages integrity among participants, something that was not transferred to the electronic order books.

Quality-based matching is the next logical step for the global electronic marketplaces looking to restore the depth and concentration of their liquidity in the wake of the national HFT debate. In doing so the regulators and exchanges will reward those for providing a real service, punish those who attempt to

manipulate the order book, and help restore market confidence.

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The Memorial Day Gold Massacre - When HFTs Forget The World's On Vacation

As the rest of America began to relax last Monday with a patriotic beer in their hand and a never-forget-hotdog stuffed in their mouth, the machines that run the gold manipulation market appeared to forget that the world was on vacation. The WTF moment that we described here, appears - thanks to Nanex detailed analysis - to have been the actions of yet another rogue HFT algorithm roller-coastering through an after-hours order book in gold futures. Un-rigged?

Via Nanex,

HFT Roller Coaster Algo Runs in After Hours Gold

1. June 2014 Gold (GC) Futures Top and Depth of Book.

The cumulative size of orders in explodes from a normal 250 to over 2,500 contracts and most of this size is at the top of book (best bid/ask).

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High Frequency Trading

IS HIGH FREQUENCY TRADING ETHICAL?

What is High Frequency Trading?

High Frequency Trading (HFT) involves the execution of complicated, algorithmic-based trades by powerful computers. The objective of HFT is to take advantage of minute discrepancies in prices and trade on them quickly and in huge quantities. These practices have been around as long as computer systems have been in our lives. As computers get more technically advanced, trading practices have increased in size and algorithms have become more sophisticated. The trades are done at close to the speed of light. Remarkably, HFT firms have moved their server farms near an exchange computer to further increase trading speeds.

HFT firms design a variety of strategies to take advantage of various market scenarios. Algorithms trade on price movements past a certain threshold, corporate actions, price ceilings, price floors, and discrepancies in bid/ask spreads. The trades are executed without any human action except for initial programming. In most cases, the trades are executed before individual investors know the quotes of prices, or that the trades happened at all.

For instance, a computer recognizes when one exchange quotes an ask price of one cent more than the quote on another exchange. This computer then trades in extraordinarily large volumes on this information, taking advantage of the arbitrage opportunity in a split second. Before individual and other investors who do not possess the same sophisticated technology realize, the one-cent spread between the two exchanges is erased and the stock price trades at the same level.

In the past, large investment firms who had proprietary trading arms experimented with HFTs as a way to supplement their human traders’ activities. Now there are entire hedge funds devoted to this strategy. Managers pool capital based on a proven computer technology and allow the program work for them. In addition, large trading shops incorporate these HFT strategies as part of their overall practice. Such large volumes of HFT trades are being executed that most of the liquidity in daily trading is a result of these trades. By some estimates, HFT makes up 60 to 70% of all trades done in the US on a daily basis. Other estimates project that if these strategies keep proliferating at their current rate, 80% of trades will be HFT trades by 2012.

Arguments in Favor of HFT

1. Liquidity

For markets to function properly and for investors to have confidence putting their money into the stock markets around the world, there must be an adequate amount of liquidity. Investors want to know when they put their money into the market they will be able to sell their investment at a later time. HFT strategies improve market liquidity. The amount and volume of the trades using this strategy ensure a liquid market. HFT traders act as makeshift market makers who buy and sell when no one will. In fact, the spreads they make off their trades are “likely less than what was taken out of the system previously by traditional market makers.”1 As HFT trades can make up as much as 70% of the trading volume in a given day, investors have a greater ability to be matched up with a counterparty i.e., the HFT trader, willing to either buy or sell at their desired price. Currently, especially for highly followed companies, it is relatively simple to buy or sell a reasonably large amount of shares.

2. Market Efficiency

HFT contributes to market efficiency. According to the efficient market hypothesis stock prices already have all public and non-public information priced into them. HFT takes advantage of price discrepancies and arbitrages any discrepancies away. Many believe that, “Narrow spreads mean the market is working better.”1 Without the large HFT trades that take advantage of the market’s inefficiencies, there would be larger bid/ask spreads. Consequently, investors may be less satisfied with the prices they get in their trades.

3. Reduced Costs

Increasing liquidity and market efficiency may, some argue, also contribute to falling trading costs for smaller investors. A major cost to mutual funds results from the bid/ask spread.1 This cost may be mitigated by the activities of HFT that narrow bid/ask margins. Narrower spreads also reduce costs that arise from large fund transactions that affect the final price of a security. HFT traders are able to break these big trades into a many small trades to reduce the effect of a large buy or sell order.

4. Profitability

One last benefit provided by HFT strategies is their profitability. There is no reliable information on the profitability of HFT firms. Hedge funds do not like to disclose their strategies or profits.[3] Despite the lack of concrete information, HFT profit potential can be inferred from statistical data. The below chart shows the Sharpe ratio potential on a typical HFT strategy as opposed to slower implemented trades.

As shown, the potential for higher returns exists based on the strategy alone. In fact, the Sharpe ratio is over 200% higher for the 10 second trading frequency than for the 1 minute frequency. The ratio indicates the enormous potential of these strategies and how they can be used to take advantage of market events without significant man-hours spent on research and other due diligence.

But HFT can be Used Unethically

1. Market Manipulation: Trillium Capital

HFT can give traders an unfair advantage if they engage in market manipulation. HFT computers can influence the market for the trader’s own advantage. Take the case of Trillium Capital.

Trillium Capital is an HFT firm in New York that engaged strictly in HFT trades. Trillium entered many trades that were considered non-bona fide because Trillium had no intention of following through on these orders. The placement of the orders was to deceive the market into thinking there was a large amount of activity happening in certain securities. These orders induced other traders to trade based on the mirage of demand or supply created by Trillium. Before these non-bona fide trades were entered, Trillium had limit positions, which executed as a result of ther traders creating buy or sell side demand which moved the prices in certain directions. Once the real trades were executed, Trillium immediately cancelled their non-bona fide trades and profited from their limit orders.These types of trades are illegal and cause market movements or prompt market activity that would not have happened had these HFT traders not manipulated the market to their advantage. Thus, investors and regulators rightly worry about the opportunity for these types of illegal and unethical trading activity that HFT provides.

2. Unfair to Small Investors

Another argument against HFT practices is that they are unfair to small investors. Small investors do not operate on an even playing field because they lack resources to do so. They also are unable to see information as quickly as HFT computers. Arguably, this resource and informational imbalance creates inequity. Charles Schumer, a New York Democratic Senator, is actively campaigning against HFT practices. He argues that the markets work because small investors have just as much of a chance to be successful, and this opportunity is severely diminished with the proliferation of HFT.Senator Shumer is strongly against HFT traders having access to information milliseconds before other market participants and, by virtue of their size and opacity, unfairly influence the market.

3. The Cascading Effect of HFT

The best example of the cascading effect happened on May 6, 2010 in what has become known as the “flash crash.” In this instance, there were a series of global events that made investors nervous about equity markets. This unease contributed to the dramatic fall that day. Initially, the Greek debt crisis led to a market decline early in the afternoon. Other traders bet on a continuous decline in the market by executing short trades on the market. The wave of activity triggered HFT models that track this kind of activity resulting in a further sell-off. The large number of orders overloaded the exchange systems. Information became delayed, which caused many trading firms to exit the market altogether. The simultaneous exit caused a serious liquidity problem. The last straw occurred when a trade for securities known as E-minis was entered (by Waddell and Reed), causing the stock market to crash. Although the market eventually gained most of the losses back investors were scared and shaken by this incident. Below is a chart showing the massive price movements in a day.

This event shows how much of a snowball effect HFTs have on the markets. When one big sell-off occurs, HFT traders using similar strategies sell off as well with dangerous implication for markets.

The Ethics of HFT

Instead, the aim of HFT is to give its users a competitive advantage. Yet, HFT strategies affect more parties than just HFT traders – small investors, large trading firms, analysts, brokers, and other market participants may also be affected. Is HFT good for the majority? May 6, 2010 is an example of how HFT can adversely affect markets. The intense and steep market fall touched all market stakeholders in a negative way. One could argue that the flash crash was a singular and rare event. However, singular market events, like magnitude 7 earthquakes, can be catastrophic. The possible disastrous consequences of the cascading effect of HFT call for early warning and prevention systems. There should be a way to stop the cascading effect. Circuit breakers are a first defense. More should be put in place.

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NY AG Sues Barclays For HFT Fraud

In what appears to be the first real action post-Flash Boys, NY AG Eric Schneiderman will announce at 4pm ET that Barclays will be sued over fraud allegations related to its Dark Pool's preferential treatment of high-frequency traders. As Bloomberg notes, Barclays runs one of the market's largest dark pools. This comes 2 months after the NY AG sent requests for information to various major HFT shops. It seems, just as we noted here, that a potential scapegoat is being primed 'just in case' this 'market' can't withstand the Fed's pullback.

As Bloomberg reports,

Barclays is being sued by New York State attorney general over fraud allegations related to marketing and operation of its dark pool, person familiar with he matter tells Bloomberg’s Keri Geiger.

Mark Lane, a spokesman for Barclays, declines to comment

NOTE: Barclays runs one of Wall Street’s largest dark pools, an alternative trading venue where investors can trade mostly anonymously

As we concluded previously,

when reality reasserts itself - a reality which Rick accurately points out has been suspended due to 5 years and counting of Fed central-planning - HFT will be "addressed." How? As the scapegoat of course. Because since virtually nobody really understands what HFT does, it can just as easily be flipped from innocent market bystander which "provides liquidity" to the root of all evil.

In other words: the high freaks are about to become the most convenient, and "misunderstood" scapegoat, for when the market finally does crash. Which means that those HFT-associated terms which very few recognize now, especially those on either side of the pro/anti-HFT debate who have very strong opinions but zero factual grasp of the matter, such as the following...

  • Frontrunning: needs no explanation
  • Subpennying: providing a "better" bid or offer in a fraction of penny to force the underlying order to move up or down.
  • Quote Stuffing: the HFT trader sends huge numbers of orders and cancels
  • Layering: multiple, large orders are placed passively with the goal of “pushing” the book away
  • Order Book Fade: lightning-fast reactions to news and order book pressure lead to disappearing liquidity
  • Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it.

... will become part of the daily jargon as the anti-HFT wave sweeps through the land.

Why? Well to redirect anger from the real culprit for the manipulated market of course: the Federal Reserve. Because while what HFT does is or should be illegal, in performing its daily duties, it actively facilitates and assists the Fed's underlying purpose: to boost asset prices to ever greater record highs in hopes that some of this paper wealth will eventually trickle down, contrary to five years of evidence that the wealth is merely being concentrated making the wealthiest even richer.

Amusingly some get it, such as the former chairman of Morgan Stanley Asia, Stephen Roach, who in the clip below laid it out perfectly in an interview with Bloomberg TV earlier today (he begins 1:30 into the linked clip), and explains precisely why HFT will be the next big Lehman-type fall guy, just after the next market crash happens. To wit: "flash traders are bit players compared to the biggest rigger of all which is the Fed." Because after the next crash, which is only a matter of time, everything will be done to deflect attention from the "biggest rigger of all."

So, dear HFT firms, enjoy your one trading day loss in 1238. Those days are about to come to a very abrupt, and unhappy, end.

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Barclays Shares Are Tumbling After NY Hits It With A High Frequency Trading Lawsuit

The New York Attorney General on Wednesday filed a securities fraud lawsuit against Barclays PLC for misrepresenting the safety of its U.S.-based alternative trading system, or "dark pool," to investors.

The lawsuit alleges that in order to increase business in its dark pool, Barclays has favored high-frequency traders and has actively sought to attract them by giving them systematic advantages over other investors trading in the pool.

"Barclays grew its dark pool by telling investors they were diving into safe waters," said Attorney General Eric Schneiderman. "According to the lawsuit, Barclays' dark pool was full of predators - there at Barclays' invitation." 

Barclays declined to comment.

Broker-run trading systems known as dark pools, where participants are anonymous and trading information is hidden until after the trades are completed, are a key focus of Schneiderman's sweeping investigation into the U.S. stock market.

His office is looking into whether dark pools operate in a way that is consistent with how they market themselves, that they have the interests of investors in mind and that brokers directing trades to their own dark pools do so in a way that does not present conflicts of interest.

OPEN DOOR

The probes have been going on for up to a year, but scrutiny has intensified in recent months following the release of best-selling author Michael Lewis' new book, "Flash Boys: A Wall Street Revolt." In the book, Lewis contends that high-frequency traders have rigged the stock market, profiting from speeds unavailable to others.

The Barclays complaint, which is based on internal communications provided by former employees, says while the firm told its clients it would keep high-frequency traders that engage in "predatory" trading practices out of its dark pool, it never actually prevented any trader from participating. In other words, Barclays underrepresented the concentration of high frequency trading.

For instance, Barclays falsified marketing material it said showed the extent and type of high-frequency traders in its dark pool by not including high-frequency trading firm Tradebot Systems, the complaint said. Barclays had already identified Tradebot, which at the time was the largest participant in the dark pool, as having been engaged in aggressive trading behavior.

A spokeswoman for Tradebot, of Kansas City, Missouri, said the firm had no comment.

Barclays actually courted high-frequency trading firms by disclosing detailed, sensitive information to major such firms to help ensure their aggressive trading strategies were effective, the complaint said. HFT accounts for around half of all U.S. trading volume.

NO AIRBAG, NO BRAKES

Barclays also told its clients it does not favor its own dark pool when routing client orders to trading venues, when in reality it was doing just that, the complaint said. One former Barclays employee told the Attorney General's office that based on the high amount of client orders Barclays was sending to its own dark pool, better trading opportunities may have been missed elsewhere.

There was a lot going on in the dark pool that was not in the best interests of Barclays clients, one former director said. "The practice of almost ensuring that every counterparty would be a high-frequency firm, it seems to me that that wouldn't be in the best interest of their clients . . . It's almost like they are building a car and saying it has an airbag and there is no airbag or brakes."

The U.S. Securities and Exchange Commission has also taken an increased interest in issues surrounding dark pools and high-frequency trading. SEC Chair Mary Jo White earlier this month said her agency is developing a series of rules that would seek to make markets more transparent and fair for all investors.

One potential measure would require dark pools and firms that match customers' orders internally to tell regulators and the public how they operate. The SEC has also stepped up enforcement actions, including a civil lawsuit filed in early June against dark pool operator Liquidnet for allegedly improperly using its subscribers’ confidential trading information to market its services.

The SEC declined to comment on the lawsuit.

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