October 17, 2014
In an effort to cultivate an orderly daily closing, ten minutes before the close at 3:50:00 p.m., NASDAQ releases a Net Order Imbalance Indicator, which is updated every five seconds until the last message at 3:59:55 p.m. It sounds good. It seems a laudable goal to ensure an orderly close. On the other hand, recent developments suggest that an orderly close may be more of a goal than a reality.
Historic HFT Manipulation Case
In what the Securities and Exchange Commission ("SEC") has characterized as its first ever high frequency trading ("HFT") manipulation case, on Oct. 16, 2014, the SEC filed an Order Instituting Proceedings
("OIP") alleging that Athena Capital Research, LLC., a New York City-based HFT firm, violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. In anticipation of the OIP, without admitting or denying the
findings, Respondent Athena Capital Research, LLC submitted an Offer of Settlement
, which the SEC
accepted, and, accordingly, the federal regulator imposed upon the firm a $1 million civil monetary penalty and a Cease-And-Desist
. In the Matter of Athena Capital Research, LLC, Respondent
(OIP, '34 Act Release No. 73369; Investment Advisers Act of 1940 Release No.
3950; Admin. Proc. File No. 3-16199 / October 16, 2014).
The SEC sanctioned a Athena Capital Research for placing a large number of aggressive, rapid-fire trades in the final two seconds of almost every trading day during a six-month period to manipulate the closing prices of thousands of NASDAQ-listed stocks.
As set forth in the OIP:
2. Between at least June through December 2009 (the "Relevant Period"), Athena made large purchases or sales of the stocks in the last two seconds before NASDAQ's 4:00 p.m. close in order to drive the stocks' closing prices slightly higher or lower. The manipulated closing prices allowed Athena to reap more reliable profits from its otherwise risky strategies. Internally, Athena called the algorithms that traded in the last few seconds "Gravy."
Given the significant volumes of Athena's trades entered at the last-second of the trading day, that firm was able to overwhelm the market's ability to absorb liquidity and was effectively able to move the closing prices in the firm's favor. The OIP explains that:
32. On average during the Relevant Period, Athena waited until the two seconds before
the close to fill nearly 56% of its accumulation - meaning it accumulated, on average, almost 5600 of every 10,000 shares it accumulated in the two seconds before the close.
33. During the Relevant Period, Athena's trading in the last two seconds accounted for
73% of the entire NASDAQ market volume, on average, for the stocks it traded during those two seconds. These massive volumes, relative to other market participants in the last two seconds,allowed Athena to overwhelm the market's available liquidity and push the market price - and therefore the closing price -in Athena's direction.
Let's Brag About It . . . In Writing
In what must now be deemed an epic case of hubris, Athena apparently transmitted internal emails in which the firm claimed to "owning the game," as a result of its Gravy transactions:
30. As a result of these steps, during the Relevant Period, Athena's Imbalance-Only
Orders were filled at least partially over 98% of the time and the firm traded on the entire
imbalance of almost every imbalance it wanted. Athena referred to this in internal emails as
"dominating the auction" and "owning the game." (emphasis added).
Working The Imbalances
As the markets begin to wind down each day, certain securities evidence "imbalances" in which buy and sell orders at the close do not pair off in a fashion that would promote a clean netting in the closing bell. The OIP alleges that Athena managed to put its orders in the position of being at least partially filled over 98% of the time - a statistical anomaly that effectively allowed Athena to be confident that its imbalance orders during the closing auction were filled at artificially favorable prices for tens of thousands of stocks right before the close of trading. Athena placed orders to fill imbalances in securities at the close of trading, and then traded or "accumulated" shares on the continuous market on the opposite side of its order. By way of example, the OIP offers this:
21. Athena's early trading on Imbalance Messages was fairly simple. For example, if
the Imbalance Message showed a buy imbalance of 10,000 shares in a particular stock, Athena placed a sell Imbalance-Only Order for 10,000 shares and then tried to accumulate those 10,000 during the next ten minutes before the close. If the Imbalance Message showed a sell imbalance of 10,000 shares, Athena placed a buy Imbalance-Only Order for 10,000 shares and then tried to accumulate a short position of 10,000 shares over the next ten minutes. Athena would exit its position by its on-close order, which, due to the on-close imbalance, was expected to be filled at a better price than the average price at which it accumulated shares.
As with so many schemes and dreams on Wall Street, at some point it became apparent that scrutiny was building. In language that may well be cited in years to come, we learn of how the dropping of the curtain was sensed:
53. Athena was also concerned about regulatory scrutiny of its last-second trades. On this and other index rebalance or options expiration dates, NASDAQ issued an automated regulatory alert for "Scrutiny on Expiration and Rebalance Days." It alerted market participants that "[s]uspicious orders or quotes that are potentially intended to manipulate the opening or closing price will be reported immediately to FINRA."
54. In September 2008, the CTO received the alert by email and forwarded it to
Manager 1 and Manager 2. He wrote: "Let's make sure we don't kill the golden goose."
Bill Singer's Comment: A start . . . a really good start in ferreting out some of the troubling practices of HFT. On the other hand, permit me to open the faucet and shower a bit of cold water upon this victory lap. Y'all are aware that the misconduct being "settled" in 2014 largely occurred in 2008, as in some 6 years ago, as in a long, long time ago according to the clocks of Wall Street and eons ago for the timepieces at HFT shops. So, you know, let's try to keep things in perspective here. At best, this is regulation via the rearview mirror. That doesn't detract from the misconduct at issue or from the impressive investigative work by the SEC staff; it does, however, send a frightening message that the human cops of Wall Street are not exactly keeping up with their robotic bad-guy counterparts.
Are Human Beings Obsolete On Wall Street? Is there still room on the floors, in the pits, and at the trading screens for human beings? Should we fear the inroads of high frequency trading and algorithms, or embrace those paths as modern Wall Street on- and off-ramps? Watch Side Bar With Bill Singer as Bill Singer and Shah Gilani explore HFT and debate its pros and cons. It's two old warhorses, Wall Street veterans, grousing and crossing swords. WATCH THE VIDEO