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001sky
FBI Investigating High-Speed Trading

Examination Centers on Possible Trading on Nonpublic Information

By

Scott Patterson and Michael Rothfeld

Updated March 31, 2014 9:59 p.m. ET

The Federal Bureau of Investigation is probing whether high-speed trading
firms are engaging in insider trading by taking advantage of fast-moving
market information unavailable to other investors.

The investigation, launched about a year ago, involves a range of trading
activities and is still in its early stages, according to a senior FBI
official and an agency spokesman. Among the activities being probed is whether
high-speed firms are trading ahead of other investors based on information
that other market participants can't see.

Among the types of trading under scrutiny is the practice of placing a group
of trades and then canceling them to create the false appearance of market
activity. Such activity could be considered potential market manipulation by
encouraging others to trade based on false orders.

Another form of activity under scrutiny involves using high-speed trading to
place orders to conceal that the transactions are based on an illegal tip.

"There are many people in government who are very focused on this and who are
concerned about it and who think it breaks the law," an FBI spokesman said.
"There is a big concern that high-frequency traders are getting material
nonpublic information ahead of others and trading on it."

Ultimately, federal prosecutors would have to decide whether the facts of a
specific case warrant bringing charges, the FBI official said.

The probe, which has picked up steam in recent months, comes amid heightened
scrutiny of computerized trading. New York Attorney General Eric Schneiderman
is investigating whether high-speed trading firms have gained advantages that
aren't available to regular investors, such as access to superfast data feeds.

The Commodity Futures Trading Commission and the Securities and Exchange
Commission are looking into ties between high-speed traders and major
exchanges, examining whether the firms are getting preferential treatment that
puts other investors at a disadvantage, said people familiar with the probes.

Since the beginning of the investigation, the FBI, working with the SEC, has
developed fact patterns of potentially illegal trading and run them by
prosecutors to determine if they could be used in a criminal case.

For the FBI, the investigation marks a new and unusual phase of its focus on
insider trading. Because high-speed trades are executed by computer programs,
it is often more difficult to detect nefarious activity and to prove that it
was executed intentionally.

FBI officials said they are looking for patterns in the market that can reveal
whether any trading activities in question violate the law. They would then
have to be able to prove that those trades were made with fraudulent intent.

The FBI said it has dedicated a large number of agents to the investigation.
FBI officials are looking into whether some brokers trade on information about
client orders before executing them, and whether brokers use information about
after-hours trading to beat the market when it opens the next morning.

Among those being probed are proprietary-trading outfits, which trade strictly
for their own account, as well as fast-moving broker operations that buy and
sell orders on behalf of clients, such as mutual funds and pension plans.

The push comes after a long-running focus on more traditional insider trading
by federal prosecutors and the FBI in New York.

Speed in the Spotlight

Scrutiny has been growing on fraction-of-a-second differences in access to
information. Recent highlights:

The U.S. attorney's office in Manhattan has charged 90 people with insider
trading using confidential information about earnings reports, mergers and
other market-moving news since October 2009. So far, 79 of those people have
pleaded guilty or been convicted at trial and none have been acquitted.

The Justice Department said it is working with other regulators on the probe,
including the SEC, CFTC and Financial Industry Regulatory Authority, which
oversees broker-dealers. The investigation, which the FBI calls the High-Speed
Trading Initiative, is also focusing on whether the waves of orders that flood
the market from high-frequency firms are being used to manipulate prices to
their benefit.

Investigators are also seeking leads from traders or others who may have
participated in illegal activity. "People will benefit to varying degrees by
calling us at an early stage," he said.

Market regulators have been investigating whether high-frequency traders have
unfair advantages over other investors for several years. SEC enforcement
officials continue to probe whether high-speed firms were using so-called
order types—directions traders use to tell an exchange how to handle their
orders—to jump ahead of less savvy investors. In a page-one article in
September 2012, The Wall Street Journal reported that a former high-frequency
trader, Haim Bodek, blew the whistle to the SEC on how certain order types
could hurt other investors.

CFTC investigators are probing whether high-frequency firms are routinely
distorting futures markets by acting as buyer and seller in the same
transactions, illegal trading activity known as wash trades. Such trades are
banned by U.S. law because they can feed false information into the market and
manipulate prices.

