These days a surprising number of people have sprung up to defend the integrity and the role of High Frequency Trading in maintaining an orderly and efficient market (some of these are legitimate and bring good ideas to the table, many of them alas are simply deplorable, arising from the frontal cortex of tabloid journalists who have never seen a VWAP algo in action yet staunchly repeat whatever the mantra de jour is with the steadfast determination of a kamikaze bomber). Yet, for one reason or another, two former employees of multi billion quant fund Renaissance had other ideas when in the summer of 2007 they filed a lawsuit against the East Setauket purveyor of 2600 processing cores, alleging major fraud and illegal market activity related to various of RenTec's trading strategies. While the market in 2007 was, ironically, much more rational (if just a "little" overvalued), now that HFT has crept to dominate virtually every vertical of trading, it bears recalling some of the details presented by Alexander Belopolsky and Pavel Volfbeyn, at the time employed by yet another quant fund in all but name (which has and always will compete with Stevie Cohen's SAC for the fund with the fastest revolving door policy), Israel Englander's (he of 740 Park fame) Millennium Partners.
While much of the details of the original lawsuit are shrouded in secrecy due to "trade secret disclosure", the redacted, public version still contains some very curious pieces of information, which some of our more astute readers may be able to pick up and connect an occasional dot.
The lawsuit, which was essentially a response to a prior lawsuit filed by RenTec for trade secret porting by the two MIT Physics Ph.D's into Millennium, in some ways almost reads like a smear campaign. We will ignore any substantive conclusive claims (as these events were likely settled quite amicably), and instead will focus on the snapshot of time afforded by this one unique filing.
Curiously, some of the names and concepts touched upon back in 2007, which incidentally refer to a time when the two MIT grads were still employed by RenTec, a period between 2001 and 2003, read like the who is who of the Flash, HFT, and program trading funny pages in the Mainstream Media nowadays.
From the filing:
130. While employed by Renaissance, Dr. Volfbeyn's superiors repeatedly asked him to assist Renaissance in conducting securities transaction that Dr. Volfbeyn believed to be illegal.
The illegality of these activites touched upon three main topical areas:
ITG-POSIT (The Dark Pool angle)
131. In particular, Dr. Volfbeyn was instructed to devise a strategy to defraud investors trading through the Portfolio System for Institutional Trading ("POSIT"). POSIT is an electronic trading system operating by Investment Technology Group ("ITG" ). POSIT collects buy and sell orders from large traders and attempts to match them.
132. On information and belief, POSIT is completely confidential. It does not reveal information about orders to anyone. For its customers, this confidentiality is an essential aspect of the system.
133. Renaissance asked Dr. Volfbeyn to create a computer algorithm to reveal information that POSIT intended to keep confidential [REDACTED]
134. Renaissance intended to, and did, use this trading strategy [the POSIT strategy] to profit [REDACTED]
135. Dr. Volfbeyn believed that [REDACTED] [the POSIT strategy] violated securities laws. He expressed his opinion to his superiors at Renaissance and refused to build the computer algorithm as they requested.
Limit Order Strategy [Stealing Liquidity]
139. Renaissance asked Dr. Volfbeyn to develop a computer algorithm [REDACTED] [the "limit order strategy"]
140. A limit order is an instruction to trade at the best price available, but only if the price is no worse that a "limit price" specified by the trader. Standing limit orders are placed in a file, called a limit-order book. Limit-order books on the New York Stock Exchange and NASDAQ are available to be viewed by anyone.
141. By [REDACTED], Renaissance intended to profit illegally.
142. Dr. Volfbeyn refused to participate in such activities. He explained that his refusal was based on his belief that the proposed transactions violated securities laws [2nd time RenTec allegedly used an illegel strategy]
143. Senior Renaissance personnel, including Executive Vice President Peter Brown and Vice President Mark Silber, attempted to persuade Dr. Volfbeyn to engage in the [REDACTED] limit order strategy, despite his objections. Mark Silber is the compliance officer for Renaissance, responsible for implementing systems to ensure that Renaissance does not violate the securities laws, and for protecting employees who complain about potentially illegal conduct.
144. On information and belief, Renaissance did not implement the [REDACTED] limit order strategy prior to Dr. Volfbeyn's termination. [What about after?]
Swap Transactions [The Naked Short Scam]
145. At all times relevant to this action, Rule 3350 of the NASD, prohibited NASD members, with certain exceptions from effecting short sales in any Nasdaq security at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid in the security.
146. At all times relevant to this action, Rule 10a-1 under the Securities Exchange Act of 1934 provided that, subject to certain exceptions, an exchange-listed security could only be sold short at a price above the immediately preceding reported price or at the last sale price if it is higher than the last different reported price.
147. During the period when Dr. Volfbeyn and Dr. Belopolsky were employed at Renaissance, plaintiff engaged in a massive scam [REDACTED] [the "swap transaction strategy"]
150. Renaissance conducted [REDACTED] in violation of Rule 3350 and Rule 10a-1. Renaissance also intentionally [REDACTED] in violation of SEC and NASD rules. [REDACTED] Renaissance profited from the strategy [REDACTED].
151. Researchers at Renaissance expressed their concern to Executive Vice President Peter Brown and other officials of Renaissance about the legality of these swap transactions, including concerns that the transactions violated the tax laws and securities laws. Renaissance failed to halt the transactions. On information and belief, the swap transactions are continuing and generate substantial profits for Renaissance.
Zero Hedge makes no claim to the validity of any of these claims: we merely report what a former employee of Renaissance claimed the quant fund was doing in violation of a variety of securities laws. Keep in mind, that while Renaissance is the undoubted master of controlling market liquidity (presumably legally, however this filing indicates extensive premeditated illegality), all this was occurring back in 2001, when HFT, PT, Flash, etc. were still fledgling strategies, accounting for far below 20% of total market volume, compared to the current 70% [ref: AITE Group]. As more attention focuses on potential abuse by HFT players and strategies, it is critical to keep in mind that contrary to what proponents may claim repeatedly in various venues, HFT is rife with potential abuse, which in many times likely crosses the threshold of what is considered legal, all at the expense of less sophisticated institutional and, by implication retail, investors.
Once again: one can hope that the SEC, so focused on substantiating an increase in its "meager" budget, will follow up on such and many other cases, and maybe even preempt them, so that employees don't have to actually come forth first and disclose alleged illegal activities by their market making employers.
The full filing from the Supreme Court Of New York is presented below (and attached)
PS. Has anybody seen Millennium's monthly P&L? One would imagine it may make for a captivating read.