NY Attorney General Probing HFT "Fairness & Predatory Behavior": Did He Just Kill The Virtu IPO?

Tyler Durden's picture

It seems the blatant unveiling of the HFT market's Holy Grail trading - Virtu (1 loss in 1238 days) - has raised some attention as Bloomberg reports, NY AG Eric Schneiderman has opened a broad investigation into whether U.S. stock exchanges and alternative venues provide high-frequency traders with improper advantages. As one European lawmaker noted, "the area of high-frequency trading is lacking suitable regulation," and Schneiderman warned "this new breed of predatory behavior gives a small segment of the industry an enormous advantage over all other competitors."  We wonder how this will affect Virtu's IPO given regulation is risk factor #1!

 

As a reminder, here is Virtu's trading record:

From the S-1: "The chart below illustrates our daily Adjusted Net Trading Income from January 1, 2009 through December 31, 2013. As a result of our real-time risk management strategy and technology, we had only one losing trading day during the period depicted, a total of 1,238 trading days. "

 

Let that sink in: one trading loss day and 1237 days of profits. And that, ladies and gentlemen, is the Holy Grail of the New Normal broken, manipulated markets.

 

How is this statistical anomaly possible? For those who have been following our narrative on the market-manipulating, endless crime that is HFT will know all too well. When you have a "strategy" whose only mission is to frontrun order flow, and scalp pennies from every market order - that would be billions of market orders in a period of four years - there is no risk, as confirmed by the chart above. Furthermore, since all HFT really does is accentuate momentum but making the bid chase NBBO ever higher, in a market that is manipulated top down by the Fed itself, all HFTs really do is simply enable the Fed's policy at the micro level, and thus such crimes are not only ignored, but welcomed by the New Normal overlords.

 

It also explains why fundamentals haven't mattered in years - the only thing that does matter is to quickly open one's own HFT stop, frontrun as much order flow as possible, and scalp pennies ahead of the bid and ask... billions and billions of times, leading to the statistically improbable chart pictured above.

 

This, ladies and gentlemen, is why retail has given up - when companies want to go public and no longer even hide the "secret sauce" which confirms beyond a reasonable doubt that there is a two-tier market: one in which the HFTs just never lose, and one for everyone else, well: who would want to play in a casino so explicitly rigged?

Simpy put - Virtu's boasting of its trading record was the final straw for regulators...

Via Bloomberg,

New York’s top law enforcer has opened a broad investigation into whether U.S. stock exchanges and alternative venues provide high-frequency traders with improper advantages, a person with direct knowledge of the matter said.

 

Attorney General Eric Schneiderman is examining the sale of products and services that offer faster access to data and richer information on trades than what’s typically available to the public, according to the person. Wall Street banks and rapid-fire trading firms pay thousands of dollars a month for these services from firms including Nasdaq OMX Group Inc. and IntercontinentalExchange Group Inc.’s New York Stock Exchange.

 

The attorney general’s staff has discussed his concerns with executives of Nasdaq and NYSE and requested more information, said the person, who asked not to be named because the inquiry hasn’t been announced. Schneiderman’s office is also looking into private trading venues, known as dark pools, and the strategies deployed by the high-speed traders themselves.

 

This new breed of predatory behavior gives a small segment of the industry an enormous advantage over all other competitors and allows them to use new technologies to reap huge profits based on unfair advantages,” according to a draft of Schneiderman’s speech delivered today at New York Law School.

 

...

 

The investigation threatens to disrupt a model that market regulators have openly permitted for years as high-speed trading and concerns about its influence have grown. Trading firms pay to place their systems in the same data centers as the exchanges, a practice known as co-location that lets them directly plug in their companies’ servers and shave millionths of a second off transactions. They also purchase proprietary data feeds, which are faster and more detailed than the stock-trading information available on the public ticker.

 

...

 

Schneiderman has previously voiced disapproval of services that cater to high-speed traders and give them a potential edge. When Business Wire, the distributor of press releases owned by Warren Buffett’s Berkshire Hathaway Inc., said last month it would stop sending the statements directly to high-frequency firms, Schneiderman called it “a tremendous victory.”

 

Taking his concerns public may help Schneiderman push the exchanges to alter practices, as Business Wire did, even without enforcement action. Among the powerful tools at his disposal is the Martin Act, an almost century-old law that gives him broad powers to target financial fraud in the state.

 

...

 

Targeting the exchanges could be the most straightforward way to deal with any ill effects of speedy trading, said James D. Cox, a securities law professor at Duke University in Durham, North Carolina...“They have a broad statute to maintain orderly markets and to do so in an ethical manner.”

 

“The SEC wants to protect investors, but also strengthen and promote U.S. capital markets,” Cox said. “These twin functions conflict with each other, which is why they have so far turned a blind eye on this issue.”

Of course, the big headline will be the effect this has on Virtu's "Holy Grail" IPO - their #1 Risk Factor is...

In addition, certain market participants have requested that the U.S. Congress and the SEC propose and adopt additional laws and rules, including rules relating to restrictions on co-location, order-to-execution ratios, minimum quote life for orders, incremental messaging fees to be imposed by exchanges for "excessive" order placements and/or cancellations, further transaction taxes, tick sizes and other market structure proposals. The SEC recently proposed Regulation SCI, which could impose significant compliance and other costs on market centers that may have to pass such costs on to their users, including us, and could impact our future business plans of establishing a market center to avoid or reduce market center costs for certain of our transactions. Similarly, the consolidated audit trail, which the SEC is requiring SROs to propose a plan for and implement, is expected to entail significant costs both on market centers, which may pass these costs along to their users, and broker-dealers directly.

 

Any or all of these proposals or additional proposals may be adopted by the SEC, CFTC or other U.S. or foreign legislative or regulatory bodies. These potential market structure and regulatory changes could cause a change in the manner in which we make markets, impose additional costs and expenses on our business or otherwise have a material adverse effect on our business, financial condition and results of operations.

Seems "lobbying costs" might be about to become a much bigger line item...

It appears Virtu really does have a problem!

This also explains why the gigaHFT firm has finally stepped out of the shadows and its founder and equity owners are finally willing to cash out - the music is slowly ending. Even for those who have discovered the Holy Grail of the New Normal market.