A question of intent.
The case, in which two Norwegian day traders were found guilty of market manipulation by working out how a broker's algorithm worked and trading against it, has exacerbated fears that the markets are no longer a level playing field, causing retail trade to withdraw from the market. The pair were sentenced to jail time and the return in full of their ill-gotten gains on 14 October 2010. At a time when volumes remain at low levels, this is a significant worry for many in the industry.
"Retail investors have taken a step back from the market," says Amos. "They don't believe that the surveillance, regulatory or not, has evolved to ensure the markets are transparent and fair. Technology is not the culprit. The issue is how we govern the technology."
Confidence in the markets has to be treated as a priority, according to Amos, and it's something that every regulator is looking at. The fact that market surveillance systems are in demand from market infrastructures and participants underlines the increased importance of scrutiny to continued confidence in the equity markets.
"Forward-thinking investment banks and high-frequency funds have increased their focus on governance, risk and compliance," he says. "It all comes down to three things -- transparency, data and standards. Each of which needs to be defined and addressed."
Manipulative trading practices such as layering and spoofing, where traders send orders priced closely to the best bid or offer with no intention of executing in an attempt to increase perceived liquidity in a stock, are already the target of market surveillance systems offered by technology firms. But the availability of solutions doesn't necessarily reassure the wavering investor that the market is safe.
Fortunately, regulators too are beginning to wake up to the rising dangers of market abuse. European regulator the Committee of European Securities Regulators is shortly to become the European Securities and Markets Authority -- a body with markedly increased powers to enforce a much more prescriptive regulatory standard. Amos views this as a positive step to restoring confidence in the markets.
Moreover, the European Commission recently published responses to its public consultation on the Market Abuse Directive (MAD), which is intended to harmonise the regulatory approach to market manipulation and insider dealing in Europe. The consultation received 90 responses from a cross-section of financial firms, exchanges and associations, including the British Bankers Association and the London Stock Exchange, which were broadly in favour of moves such as the extension of the directive to include attempted manipulation.
The change is not limited to Europe. Amos points to the comments made earlier this month by Richard Ketchum, chairman and chief executive at the US Financial Industry Regulatory Authority (FINRA). In Ketchum's opinion, a broker-dealer that did not have processes in place to deal with rogue algorithms constituted a regulatory problem. He also called for increased accountability, stating that FINRA would devote resources to the issue.
However, it remains important to distinguish what exactly constitutes market manipulation. Despite mistrust of trading strategies based on low-latency technology in some quarters, Amos asserts that the key to market abuse is not the use of technology, but the intention behind it.
"They (the Norwegians) outwitted the algorithm to affect stock prices in their favour, and then they profited," says Amos. "They were crafting the opportunity, rather than just trading. That's abusive."
Amos argues that a high-frequency trader engaged in 'quote stuffing' -- the practice of sending out masses of orders and then cancelling them to overload trading systems -- is essentially just as guilty as the Norwegian day traders, citing the case of Trillium Brokerage Services in the US, who were fined US$1 million for quote stuffing 46,000 times in two years.
In the case of the Norwegians, it wasn't that the traders convicted acted in a way that was detrimental to the victim that mattered to the judge, but rather that their behaviour, in influencing an algorithm to adjust its prices, was detrimental to the market itself. It is a warning sign that others would do well to heed.
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