For all of the outrage kicked up by Michael Lewis’s depiction of fundamentally rigged securities exchanges in his book “Flash Boys,” there’s a giant obstacle standing in the way of punishing high-frequency traders or the exchanges that facilitate them: the blessing of federal regulators. As Dealbook’s Peter Henning wrote in his White Collar Crime Watch column on why high-frequency trading is unlikely to result in criminal charges, securities exchanges openly sell access to high-speed data feeds and to physical proximity that increases trading speed by milliseconds. Exchanges are, in the words of Andrew Ross Sorkin, “the real black hats” of high-frequency trading, since they unabashedly profit from differentiating access to trading information.
That may be true, but exchanges do so with the full knowledge of the Securities and Exchange Commission and the Commodity Futures Trading Commission. Georgetown professor James Angel, who specializes in the structure and regulation of financial markets, told me Monday that as long as securities exchanges don’t discriminate in the sale of high-speed access, they’re acting within their regulatory bounds. He compared the system to airlines selling different tiers of service: It’s perfectly fine to sell first-class seats to high-frequency traders as long as people in coach had the same opportunity to sit up front and opted instead for the cheap seats.
I had called Angel to ask his opinion of a new class action against the Chicago Mercantile Exchange. Filed Friday in federal district court in Chicago, the suit claims that the Merc’s parent, CME Group, has defrauded the derivatives market by representing that it’s providing real-time market information when, in fact, it has entered into “clandestine” contracts to provide order information to high-frequency traders before anyone else. Angel’s take? “This is a bogus case,” he said after reading the suit. “This is clearly about somebody who bought a coach ticket and is now complaining that they didn’t get first class service.”
The class action’s theory is new: that the Merc deceived ordinary traders and the market at large by selling upgraded access to high-frequency traders. The problem, according to Angel, is that the new theory is based on old facts that have already been examined and re-examined by the SEC and CFTC.
The complaint doesn’t include any specifics about the supposedly improper dealings between the Merc and high-frequency traders, except to say that they date back to 2007. It’s not clear, in other words, whether the class is claiming that the exchange secretly offered extra-fast access only to specially selected high-frequency traders or just that the Merc sells enhanced high-speed data to anyone willing to pay for it. If the former is true – and if, of course, the class has much more substantial evidence than its complaint suggests – the Merc would be in trouble. But based on my conversation Monday with Tamara de Silva of The Law Offices of R. Tamara de Silva, the lawyer who filed the class action on behalf of everyone who relies on the exchange’s assurances of real-time futures market data, it appears that the suit is based on the exchange’s much-discussed sales of enhanced data streams. De Silva said she didn’t want to disclose her evidence, but she contends the general public isn’t aware that exchanges sell superior access to high-frequency traders willing to pay a premium price. The Chicago exchange, she said, misleads the market when it represents that price and order information available to the general public is undistorted, when it’s actually out-of-date by the time ordinary market participants see it.