December 19, 2015
The problem that equity investors face when executing on our current exchanges is now a problem that the SEC must acknowledge and act upon in favor of longer term investors.
Ultimately, in my opinion, the issue is not about whether High Frequency Trading is good or bad it is about whether one group of participants is gaining an unfair advantage over all others and whether or not this advantage violates the SEC's own regulations regarding order protection.
The answer is a clear and simple "yes".
The single most important factor in this entire debate, again, in my opinion, is how the Securities Information Processor (SIP) is being illegally taken advantage of.
The SIP, as I am sure the Commission is fully aware, was established by the SEC's own Reg NMS (2007) and its intent was to offer a level playing field by providing protected quotes (order protection) to form a National Best Bid and Offer (NBBO). All exchanges in the National Market System are required to pool their prices into the SIP so that ALL participants see the exact same view of the market with regards to the NBBO.
That bears repeating: So that ALL participants see the EXACT SAME VIEW OF THE MARKET with regards to the NBBO.
To be fair, the SIP in fact IS being used to quote and execute orders - for RETAIL investor orders. And that, members of the Commission, is currently a big part of the problem.
High Frequency Traders are quoting and executing (and cancelling) at speeds which are must faster than the SIP. How? Because the Exchanges are allowing and enabling them to do so through the lucrative sale of Direct Feeds and Co-Location.
The system, as defined by the SEC's own regulations, is broken. It does not offer all participants a level playing field as the Reg NMS intended. It has been undermined by both traders with a speed advantage (High Frequency Traders (HFT)) and the Exchanges themselves through these practices.
Additionally, payment for order flow and Internalizers created by HFT firms to execute the vast majority of these orders has effectively created a prime source of dark liquidity comprised almost entirely of retail order flow. In other words, orders from investors executing through major brokerage houses. And just to make sure, retail orders currently get a special identifier letting HFT algorithms instantly pinpoint them. Why? The reason is clear, to take advantage of them using a speed advantage.
In this process, Direct Feeds are being used to trade against these retail orders - which are priced using the much slower SIP - to profit from the speed difference (a form of Latency Arbitrage).
Direct Feeds are also being used to effectively get out of the way of slower participants (who don't have access to these expensive feeds) who attempt to execute against liquidity displayed by HFT algorithms. By fading their quotes, they are essentially showing bids or offers that they have no intention of filling.
One has to ask: "How is this any different from Spoofing or Layering which is illegal and prosecuted by the SEC?"
In fact, since this quote fading is being executed by HFT algorithms, this behavior is written into the code - ie: IT IS INTENTIONAL. Why is SEC not focusing on illegal activity that is not "isolated" but is in fact structurally ingrained into ALL trading activity in the equities markets?
The answer to this preferential treatment of a small group of participants is the approval of the IEX exchange application.
The IEX approach allows non HFT participants the ability to have their orders sent to a venue where they will not be preyed upon by predators such as High Frequency Traders.
By allowing retail investors to choose to route their orders through IEX via mainstream brokerage houses, they will be given a choice not to be a victim of Internalizers who only seek the risk free profits of Latency Arbitrage.
Most importantly, the IEX Exchange will begin to bring back fairness and the word of law to our markets in the form of a SIP which fulfills the SEC's own requirements through Reg NMS.
It's time for change.
It's time for our regulators to cease acting on behalf of a small group of market participants who rely on skirting laws and regulations and hiring expensive Lobbyists to protect the status quo.
Approving the IEX application will send a strong signal to the world that the SEC now acts on the behalf of the MAJORITY of investors and favors longer term investors as is mandated by the Securities Act and the Exchange Act.
It will hopefully also open the door to eliminating other unfair practices in our markets such as Legal Immunity for Exchanges and Payment for Order Flow (something incidentally Bernie Madoff was instrumental in bringing about).
Investors worldwide, from the entire spectrum of participants demand access to a fair market environment.
IEX is that venue.