Tuesday, September 14, 2010

FINRA vs Trillium

I've been trying to understand this week's FINRA ruling regarding Trillium.

I've seen a number of varying reports trying to explain the ruling to lay-people like me. The first one I saw claimed that this was a clear finding against "quote-stuffing", and was the beginnings of a crackdown on high frequency trading. Another, from today's New York Times, said that the decision was related to HFT, and used some pretty strong language:

he Financial Industry Regulatory Authority said it had fined Trillium, a brokerage firm based in New York, $1 million for carrying out an illegal high-frequency trading strategy, while also fining and suspending the firm’s heads of compliance and trading, and nine traders under their supervision.

But the FINRA press release does not use the word "illegal"; rather, they use the words "illicit", "improper", and "illegitimate", which are not quite the same. The press release does carry this quote from Thomas R. Gira, Executive Vice President, FINRA Market Regulation:

FINRA will continue to aggressively pursue disciplinary action for illegal conduct, including abusive momentum ignition strategies and high frequency trading activity that inappropriately undermines legitimate trading activity, in addition to related supervisory failures.

However, it's not clear whether this quote specifically refers to the Trillium finding, or rather just describes FINRA's intent to more actively police the modern electronic markets.

I tried reading through the detailed FINRA finding paper for more details. It says that the Trillium staff

engaged in a repeated pattern of layering conduct to take advantage of trading, including algorithmic trading by other firms


and obtained a full or partial execution for that order through the entry of numerous layered, non-bona fide, market moving orders on the side of the market opposite the limit order

Note that the finding doesn't say that Trillium themselves were doing the HFT, but rather that they were taking actions that were designed to interact with the HFT algorithms of other market participants.

The finding explains the activity in greater detail later:

Within seconds after the Trillium Trader received the execution or partial execution of the buy (sell) limit order, he intentionally and knowingly canceled the non-bona fide orders that he had placed into Single Book.

Felix Salmon has a post up at Seeking Alpha where he explains the notion of "layering" in more detail, and clarifies the difference between layering and quote-stuffing:

The distinction is an important one. Quote-stuffing, if it exists, is a destructive attack on an entire stock market. Layering, by contrast, is relatively benign, and the only people who get damaged by it are high-frequency traders who are looking to sniff out where the market is going and place trades attempting to front-run that move.

Salmon also makes the point that this isn't really a finding that has to do with HFT and whether HFT needs to be altered:

it’s a bit of a stretch to paint this as the first battle in the war against high-frequency traders — not least because there isn’t actually anything particularly high-frequency about what Trillium was doing.

I think that a number of people jumped the gun because there's been a lot of press recently hinting that the SEC was getting ready to do something about the dangers of High Frequency Trading and quote stuffing, for example see this article in USA Today.

But it's important not to get confused. Salmon's essay seems to be clear and detailed, and I'm pretty confident that he's laying out these actions accurately. If you're interested in these issues, and trying to figure out where all this technology and legal policy is going, gave Salmon's post a good read.

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