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Lawsuit: Incompetent SEC Struggles To Rein In High-Speed Trading Fraud

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Having the Securities and Exchange Commission police high-speed trading is like pitting Barney Fife against Michael Corleone: The odds are not in its favor.

You might think it unfair to compare the SEC to the bumbling deputy sheriff of Mayberry, who couldn't be trusted to carry a loaded gun. But the Andy Griffith Show wiki reminds us that Fife was not totally useless: There were occasions, like that time he stood up to those farmers, when he showed backbone. Same thing with the SEC, which has managed to tear itself away from the pornography long enough extract some big fines from Wall Street after the financial crisis.

But the agency is clearly outgunned when it comes to dealing with high-frequency trading, many experts agree. And a new lawsuit goes so far as to accuse the SEC of covering up high-speed fraud so nobody will know just how incompetent it really is, Courthouse News reports.

In the suit, a Wisconsin company called EMM Holdings accuses the SEC of not investigating a Houston high-speed trading firm called Quantlab Financial. According to EMM, Quantlab is perpetrating fraud amid all the high-speed churning and burning it does in the stock market. EMM notes that Quantlab has been flagged six times in the past eight years by the Financial Industry Regulatory Authority, the brokerage industry's self-regulatory body, for not properly documenting its trades. EMM thinks this is evidence that Quantlab is trying to cover up some fraud, and it has asked the SEC for any documents showing an investigation of Quantlab. The SEC has refused, on the grounds that doing so might interfere with law-enforcement activities. EMM has sued the SEC to force it to give up whatever goods it has on Quantlab.

Trouble is, it's not entirely clear if the SEC is actually investigating Quantlab at all. EMM argues in its complaint that the only way the SEC could deny its record request is "if there is an on-going and active investigation." And EMM accuses the SEC of letting this investigation fester, hoping the statute of limitations will run out.

"Given [the SEC's] near complete abdication of its prosecutorial duties during the 2008 financial crisis, inaction and delay may unfortunately have become [the SEC's] modus operandi for dealing with complex financial malfeasance," EMM said in its complaint.

The SEC says it conducts all of its investigations privately and would not comment when asked whether its denial of EMM's request for documents amounted to an admission that it really is investigating Quantlab.

Quantlab did not immediately return a request for comment, but it has previously denied allegations of fraud.

It is worth noting that this appears to be the latest in a long drama involving Quantlab and Emmanuel Mamalakis, the principal of EMM Holdings. About five years ago, Mamalakis formed his own high-speed trading firm, called SXP Analytics, with a couple of former Quantlab employees. Quantlab accused them of stealing its secret high-speed trading recipe. The two parties have been brawling in court ever since.

But even if Mamalakis has an ax to grind, he's probably on to something when it comes to the SEC's ability to keep an eye on high-speed trading. And that's a huge problem, given the outsized influence high-speed traders have on our financial markets.

A new Chicago Fed study last week detailed how flash-trading robots have triumphed over financial markets, making up the majority of global trades in stocks and stock futures and huge chunks of the global foreign-exchange and bond markets.

The Chicago Fed study pointed out that high-speed-trading firms can barely control their own robots, a fact noted by Robert Oak of the Economic Populist blog:

Chicago Fed staff also found that out-of-control algorithms were more common than anticipated prior to the study and that there were no clear patterns as to their cause. Two of the four clearing BDs/FCMs, two-thirds of proprietary trading firms, and every exchange interviewed had experienced one or more errant algorithms.


If the market's robot masters can't handle their own algorithms, then surely the regulators, who are paid less and have worse technology, probably can't do it, either.

That makes it all too likely that we will get more Flash Crashes and Facebook IPO flops in the future, further eroding investor confidence. And it means plenty of opportunity for fraud, as high-speed traders blow through millions of trades in seconds -- long before Barney Fife can even get his single bullet into his gun.

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