- The Washington Times - Wednesday, June 18, 2014

The next steps in regulating high-frequency trading will not be legislation, but a push from the Senate to the Securities Exchange Commission to study how the phenomenon affects smaller publicly-traded companies and smaller investors.

In a hearing Wednesday before the Senate banking committee’s Securities, Insurance and Investment subcommittee, representatives of academia and investment banking suggested different approaches to curb some of the negative effects of the practice. But all agreed that structural issues in the market allowed for some high-frequency trading (HFT) to harm less advantaged investors.

“Disruptive HFT strategies are akin to a tax loophole that has been exploited and needs to be closed,” Andrew Brooks, vice president and head of U.S. equity trading for T. Rowe Price, said in his testimony. “Participants utilizing such strategies are essentially making a riskless bet on the market, like a gambler who places a bet on a race that’s already won, and for which he knows the outcome.”

HFT is a relatively new phenomenon, in which firms use computer programs to rapidly buy and sell securities on the open market. HFT deals occur so quickly that a company employing an HFT algorithm might only hold a stock for a few seconds — or a fraction of a second — and potentially make huge profit on large-volume trades and minuscule price changes.

For Sen. Elizabeth Warren, Massachusetts Democrat, abuse of HFT represented a threat to open markets.

“This isn’t trading. Traders have good days and bad days,” Ms. Warren said. “High-frequency traders have only good days.”

HFT also depends on the movements of larger buyers and sellers in a stock exchange. Some firms using the tactic aggressively wait for large movements from big brokers; if a large order of a stock sells, the market will usually overreact and continue to sell for a short period of time after, fearing a collapse in the price of that security.

The stock’s price usually rises again, coming back to stability. But in a few seconds of overreaction, HFT traders can buy low, sell high and make a profit.

HFT traders may also rapidly place orders for securities, only to cancel them immediately after observing the reactions of other large sellers to their orders.

This strategy, and the potential for not just HFT’s speed but its ability to gather detailed information about the movements of competitors, caused the most concern for Mr. Brooks and Jeffrey Solomon, CEO of investment bank Cowen and Company.

Mr. Brooks and Mr. Solomon said they were ready for the government to test whether measures limiting current HFT practices might let smaller investors and smaller companies gain more chances to participate in the open market.

Mr. Solomon was also eager for legislation from Congress on the issue, and said structural issues outside HFT would be the easiest to tackle.

“Well within an hour, you could have it laid out,” he said. “It’s actually pretty straightforward if you start on some basic premise: simpler. Simpler markets.”

However, Hal Scott, a professor specializing in international financial systems at Harvard Law School, suggested further research by the SEC before any large regulatory test was imposed on open markets.

“This is one of the most complex areas you will ever encounter,” Mr. Scott said. “I think that says caution to legislation before we have the experts do their best job to formulate what the problems are and what the solutions are. I think your role, for the time being, is to make sure that the SEC goes forward on this.”

HFT has been a common topic in the regulatory world since the March 31 release of “Flash Boys: A Wall Street Revolt,” a book by Michael Lewis that explored the phenomenon. Though Mr. Lewis was not present at the hearing, witnesses and senators mentioned his book several times.

• Chloe Johnson can be reached at cjohnson@washingtontimes.com.

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