FBI Investigating High-Speed Trading

Examination Centers on Possible Trading on Nonpublic Information

By

Scott Patterson and
Michael Rothfeld

Updated March 31, 2014 9:59 p.m. ET

The Federal Bureau of Investigation is probing whether high-speed trading firms are engaging in insider trading by taking advantage of fast-moving market information unavailable to other investors.

The investigation, launched about a year ago, involves a range of trading activities and is still in its early stages, according to a senior FBI official and an agency spokesman. Among the activities being probed is whether high-speed firms are trading ahead of other investors based on information that other market participants can't see.

Among the types of trading under scrutiny is the practice of placing a group of trades and then canceling them to create the false appearance of market activity. Such activity could be considered potential market manipulation by encouraging others to trade based on false orders.

Another form of activity under scrutiny involves using high-speed trading to place orders to conceal that the transactions are based on an illegal tip.

"There are many people in government who are very focused on this and who are concerned about it and who think it breaks the law," an FBI spokesman said. "There is a big concern that high-frequency traders are getting material nonpublic information ahead of others and trading on it."

Ultimately, federal prosecutors would have to decide whether the facts of a specific case warrant bringing charges, the FBI official said.

The probe, which has picked up steam in recent months, comes amid heightened scrutiny of computerized trading. New York Attorney General Eric Schneiderman is investigating whether high-speed trading firms have gained advantages that aren't available to regular investors, such as access to superfast data feeds.

The Commodity Futures Trading Commission and the Securities and Exchange Commission are looking into ties between high-speed traders and major exchanges, examining whether the firms are getting preferential treatment that puts other investors at a disadvantage, said people familiar with the probes.

Since the beginning of the investigation, the FBI, working with the SEC, has developed fact patterns of potentially illegal trading and run them by prosecutors to determine if they could be used in a criminal case.

For the FBI, the investigation marks a new and unusual phase of its focus on insider trading. Because high-speed trades are executed by computer programs, it is often more difficult to detect nefarious activity and to prove that it was executed intentionally.

FBI officials said they are looking for patterns in the market that can reveal whether any trading activities in question violate the law. They would then have to be able to prove that those trades were made with fraudulent intent.

The FBI said it has dedicated a large number of agents to the investigation. FBI officials are looking into whether some brokers trade on information about client orders before executing them, and whether brokers use information about after-hours trading to beat the market when it opens the next morning.

Among those being probed are proprietary-trading outfits, which trade strictly for their own account, as well as fast-moving broker operations that buy and sell orders on behalf of clients, such as mutual funds and pension plans.

The push comes after a long-running focus on more traditional insider trading by federal prosecutors and the FBI in New York.

Speed in the Spotlight

Scrutiny has been growing on fraction-of-a-second differences in access to information. Recent highlights:

The U.S. attorney's office in Manhattan has charged 90 people with insider trading using confidential information about earnings reports, mergers and other market-moving news since October 2009. So far, 79 of those people have pleaded guilty or been convicted at trial and none have been acquitted.

The Justice Department said it is working with other regulators on the probe, including the SEC, CFTC and Financial Industry Regulatory Authority, which oversees broker-dealers. The investigation, which the FBI calls the High-Speed Trading Initiative, is also focusing on whether the waves of orders that flood the market from high-frequency firms are being used to manipulate prices to their benefit.

Investigators are also seeking leads from traders or others who may have participated in illegal activity. "People will benefit to varying degrees by calling us at an early stage," he said.

Market regulators have been investigating whether high-frequency traders have unfair advantages over other investors for several years. SEC enforcement officials continue to probe whether high-speed firms were using so-called order types—directions traders use to tell an exchange how to handle their orders—to jump ahead of less savvy investors. In a page-one article in September 2012, The Wall Street Journal reported that a former high-frequency trader, Haim Bodek, blew the whistle to the SEC on how certain order types could hurt other investors.

CFTC investigators are probing whether high-frequency firms are routinely distorting futures markets by acting as buyer and seller in the same transactions, illegal trading activity known as wash trades. Such trades are banned by U.S. law because they can feed false information into the market and manipulate prices.