Flash Trading: Goldman Sachs Front Running Everyone Else

There is a curious article in the latest edition of Traders Magazine. It is curious mostly because it was allowed to be published, as it definitively peels off the cover of what truly happens at the pantheon of stock exchanges, that dominated by a private club of select high frequency traders, who obtain better and faster pricing than everyone else, and where the group of "select few" is seemingly legally allowed and even encouraged to front-run the "every-one else" (you, dear reader, are most likely in the latter camp). If you ever wondered why HFT generates profits of over $20 billion a year, please read this article.

As for Zero Hedge's intents, we would yet again request feedback from the proper authorities on whether one can derive more than superficial similarities between the method of operation of Direct Edge's Enhanced Liquidity Provider (ELP) program and NYSE's Supplemental Liquidity Provider program (aka, the Goldman (GS) kiss). Amusingly, it is none other than the NYSE's own Larry Leibowitz who raised the most ruckus about the potential abuse of the ELP program.

At an industry conference on market structure in May, a panel on market centers broached the subject of "flash" orders and almost ended in fisticuffs. In one corner was defending champion William O'Brien, CEO of Direct Edge. In the other was Larry Leibowitz, his hot-under-the-collar opponent from the Big Board...The head of U.S. execution and global technology at NYSE Euronext assailed Direct Edge's Enhanced Liquidity Provider or ELP program as the "enhanced look" program, comparing it to the advance look at orders that NYSE specialists used to get. That practice was seen as giving specialists unfair advantages over other market participants, and potentially disadvantaging order senders.

Wait, Flash orders, enhanced looks... What?

From the article:

Flash orders are also called "step up" or "pre-routing display" orders. The rationale for these order types is simple: Better me than you. They allow a venue to execute marketable orders in-house when that market is not at the national best bid or offer, instead of routing those orders to rival markets. They do this by briefly displaying information about the order to the venue's participants and soliciting NBBO-priced responses. [TD: frontrunning is not quite the right word here, but it fits so damn well] If there are no responses, the order can be canceled or routed to the market with the best price.

All four markets with flash orders treat these orders in a similar way. If they get a marketable buy order, for instance, that would otherwise be routed to a market quoting at the NBBO, they flash the order to some or all of their participants as a bid at the same price as the national best offer. Exactly who sees the flash, how that information is conveyed and the duration of the flash vary by market. The maximum allowable time for a flash is 500 milliseconds, or half a second, although most of the markets flash routable orders for under 30 milliseconds.

NYSE Euronext's anti-flash tirade didn't end with the SIFMA conference. The exchange operator, along with market-making firm GETCO and SIFMA, weighed in on the Nasdaq and BATS flash order types with formal letters to the Securities and Exchange Commission. NYSE and SIFMA urged the SEC to abrogate the Nasdaq rule filing and reject BATS's filing. All three pushed the SEC to study the potential impact of flash orders on the marketplace before deciding whether to give them free rein.

NYSE and GETCO charged that markets with flash orders were essentially running private markets of quotes for select participants that competed with the public quote stream. With Nasdaq and BATS rolling out new order types to combat Direct Edge, the upshot, in their view, was bad market structure and probably eventual harm to investors.

[read the following paragraph very closely as it is at the heart of the 4 month long tirade on Zero Hedge against the NYSE, against Program Trading, against the SLP and against Goldman Sachs]

These firms and SIFMA argued that flash order types call into question some of the basic tenets of the equities market structure. In various combinations, they claimed that the effort to keep flow in-house undermines the concept of a quotation, impairs the meaningfulness of the NBBO, jeopardizes liquidity provision by hurting liquidity providers quoting at the NBBO, and potentially upsets the pursuit of best execution.

So the NYSE is making a mega fuss about a potential market entrant that does what everyone else does - understandable, nobody likes competition, especially not the New York Stock Exchange which has been losing market presence and top line revenue by the boatload recently. Yet the question stands just how much of this "best kept secret" protocol does the NYSE employ currently to facilitate Supplementary Liquidity Providers, or rather, Provider (singular) - Goldman Sachs. When one firm dominates 50% of principal HFT trading on an exchange and, according to the above logic, can legally front run the other half, what does that mean for the rest of the world?

Continuing with the article:

NYSE Euronext, despite frowning on flash orders, may wind up joining the party. Joe Mecane, executive vice president for U.S. markets at the company, notes that if the SEC allows these flash order types to stand, NYSE Arca would probably convert an existing order type into a flash-type interaction, and would look to more broadly disseminate that information. [TD: Or already is via the SLP?] "If the SEC is implicitly allowing private access to information, we'll need to do it to be competitive," he said. NYSE Euronext may decide to offer flash orders on the NYSE as well, Mecane said. Nasdaq, for its part, is implementing a flash-type order this month on Nasdaq OMX BX, its Boston equities market.

Wait, the NYSE is waiting for the deliberations of the same SEC after it did not even care to hear back on whether or not the NYSE's SLP deserves a comment period, objections, and traditional response time, and which waited until the last day to file an extension automatically assuming it would be granted...(And granted of course it was, as the only beneficiary again was Goldman Sachs.)

The primary argument against flash orders is that they create private markets and are therefore a step back for market structure. "These programs are creating a private locked market for a small group of participants, and they are holding up the execution process for that marketable order," Mecane said. He added that the Big Board operator isn't against dark pools, competition or innovative business models. "Our issue is that this creates a tiered market," he said.

Market maker GETCO told the SEC that by creating a two-tiered market, flash orders give professionals receiving the flashes a leg up over other investors. Non-public quotes could also "negatively affect the broader market, including retail investors who rely on the NBBO to ensure that their orders obtain the best, reasonably available price," the firm said. GETCO argued that flash orders, like dark liquidity that executes at the NBBO, also leave limit orders that established the best price in the lurch.

One wonders what the response of the SEC will be to this allegation. One wonders less, once it becomes painfully clear that any condemnation of two-tiering and flash orders would potentially automatically preclude Goldman from trading 1 billion PT shares a week for its prop trading accounts.

Ironically, NASDAQ and BATS already may be in enough hot water to really raise the temperature on not only Direct Edge but the NYSE as well:

Direct Edge's O'Brien draws a distinction between how the information his market disseminates is seen and what Nasdaq and BATS are doing. His flashes, he said, are sent out on a different data feed than the ECN's depth-of-book feed, while Nasdaq's and BATS's flash orders are not. As a result, the latter exchanges' feeds look like they're locking the market. (Last month, both exchanges added a flag to flashed orders to identify them for subscribers.)

In Selway's view, this argument clouds the point. The point, he said, is that order messages are being broadcast at prices that, effectively, lock protected quotes. This creates an elite tier of traders with access to better-priced orders than those receiving public quotes through the securities information processors, giving flash recipients an information advantage, he said.

Ok, so where are the plethora of voices claiming that advanced exchange looks are completely innocuous and nobody suffers as a result of a select few profiting massively... We are waiting.

Direct Edge's O'Brien argues that critics of his market's ELP program are twisting a successful innovation into a regulatory concern for purely competitive reasons. He said the ELP program gives participants a choice about how they want their order flow handled, and enables customers to lower their market-impact and transaction costs. He also notes that critics of the ELP program, which includes dark pools among its participants, are anti-internalization. Internalization refers to the ability of brokers to match customer orders away from public markets. But the ECN's flash orders, on the contrary, O'Brien said, have "democratized access to dark liquidity sources by enabling retail customers to choose to interact with that liquidity to seek larger-size executions and potentially better prices."

Would one be shocked that the NYSE would be so vocally against Direct Edge when it has the SLP in its back pocket effectively dominating what could be the biggest flash trading market in history? Many more questions remain unanswered, but we hope readers now have a much better sense of the continuing fight against the ever more evident extensive informational advantage that Goldman Sachs may probably have thanks to its monopoly of the SLP program.

Comments

[Mad Hedge F...:]

This is worse. It looks like Goldman Sacs is going to leg over the Treasury once again. It is buying back the warrants it issued the Feds as part of its TARP dole out for a mere $1.1 billion, giving a 23% annualized return on the investment. Why is the government selling? Do you think GS knows something about its future earnings the government doesn’t? Could this be the greatest example of insider trading of all time? Has anyone at the Treasury considered keeping free calls on GS to maturity, as Warren Buffet is with his paper? Then they might be worth $10 billion, or even $100 billion. I know that if hedge funds could get these warrants at the same terms as the Treasury, they’d be loading the boat. Safe to say that when GS shakes your hand, you want to count all of your fingers afterward.

Jul 22 01:48 PM

[Ferdinand E...:]

I'd better make an appointment with a talkative psychiatrist, because I simply can't understand all of the bad feeling toward GS. Maybe he or she could explain my failure to agree with the self-appointed cognoscenti. I remember how in my lectures I liked to ridicule one of GS's share market experts, but outside of that I enjoyed identifying that organization as a shining example of what an investment bank should be - and I still feel that way.

Jul 22 02:01 PM

[BullnBear:]

Great article and great posts around this data, I’m glad that we have an avenue within Seeking Alpha to drag this type of activity into the proverbial light.

Jul 22 02:15 PM

[WhoisJohnGalt:]

Why does GS have to cheat when they're bed buddies with Uncle Sam?

Jul 22 05:03 PM

[HedgieTheWhale:]

Another point of interest, Joe Mecane use to work for Larry Leibowitz at UBS and both were responsible for building out UBS' trading platform, including dark pools. It seems now that they are on the other side and loosing market share they don't like a little competition. Regarding GS they have no additional upperhand then the other big IB brokerdealers except for maybe smarter programmers. This GS conspiracy is starting to ring hollow.

Jul 22 07:35 PM

[untrusting ...:]

Because it's all about big money. The more you cheat, the more you make. How do you think GS pays themselves billions of dollars in bonus compenstation every year? The other side of the coin is somebody else loses the amount that GS pilfers from the system, but no crook ever cared about that. The politicans and the regulators are so corrupted via lobbying, patronage jobs, etc. that don't expect anything to ever be done about it by them. Realistically there are only two hopes: 1) RICO prosecutions by an independent special prosecutor - as RICO was designed for drug-pushers and the mafia - it would be highly appropriate to have RICO investigations and prosecutions of Wall Street. The greatest appeal of RICO prosecutions is they permit serious jail time and 100% consfication of assets (something Wall Street would tremble with fear about). Alternatively, 2) large class action lawsuit firms - there are probably several very large class action law firms that have the resources, expertise, and staying power to spend the hundreds of millions of dollars and years it would take to go after GS and other Wall Street fraudsters. Because it would be a titanic fight just like the tobacco litigation they eventually won. The stakes are probably high enough, in the trillions, for one of them to take it on but it would take a large private investor like Calpers to start it off or be the lead plantiff.


On Jul 22 05:03 PM WhoisJohnGalt wrote:

> Why does GS have to cheat when they're bed buddies with Uncle Sam?

Jul 22 08:23 PM

[perceptions...:]

I like it!


On Jul 22 08:46 AM doubleguns wrote:

> A mugger on the street is performing nothing more than redistribution
> of wealth. In this case the mugger is GS.

Jul 26 02:43 AM

[Avooch:]

Front Running ?

Old News

The good news is that the crooks that front run don't need to harm those investors who use fundamentals to pick stocks.

If one analyzes fundamentals - establishes a reasonable price - and waits to strike - even retail investors can do quite well.

Don't Get Massacred !

gudovac1941.blogspot.com/

Jul 26 07:10 PM

[ray b:]

Is it front running if it takes only 3/100ths of a second to get in front of a trade? I think GS would say no. 3/100ths of a second in F1 is a precious commodity. It is here too.

Why doesnt Tyler Durden do an impression of River Tan and kick some butt? Or is blogging the closest thing to it?

In an age where investing is getting more complicated every day, its hard to believe that you could explain these issues to the masses and their congressional representatives in a manner that can help them understand.

Especially when those in the know revel in being obtuse.

Jul 26 07:16 PM

[PaperGains:]

The retail investor will eventually leave all together if regulators and law makers do nothing.

I remember when-you did your research, put together a sound plan, and over time the fundamentals determined whether you won or lost. Now firms like Goldman and large hedge funds determine whether you win or lose.

I've seen more obvious manipulation in the past year in individual stocks that it makes me sick.

Regulators do away with rules that make it more difficult to write programs. Think of it this way, when there are no rules, anyone in the business can write a program. When there are many rules to consider, it becomes very difficult and almost impossible to write a program that might wreak havoc.

Jul 26 08:39 PM

[Avooch:]

Paper - key word "over time"


Let GS and other crooks speculate in a rigged system.

We can invest in Fundamentals


On Jul 26 08:39 PM PaperGains wrote:

> The retail investor will eventually leave all together if regulators
> and law makers do nothing.
>
> I remember when-you did your research, put together a sound plan,
> and over time the fundamentals determined whether you won or lost.
> Now firms like Goldman and large hedge funds determine whether you
> win or lose.
>
> I've seen more obvious manipulation in the past year in individual
> stocks that it makes me sick.
>
> Regulators do away with rules that make it more difficult to write
> programs. Think of it this way, when there are no rules, anyone in
> the business can write a program. When there are many rules to consider,
> it becomes very difficult and almost impossible to write a program
> that might wreak havoc.

Jul 26 09:58 PM

[E.D. Hart:]

Free market capitalism is neither free, nor is it a uniform monolithic market---but a rigged system where how the rules are written and enforced are in many ways under the control, or influence of those for whom the rules are designed to regulate. If this isn't Crony Capitalism I dont know what is. in other countries they call it corruption.

Yes, we are a socialistic nation--but the government is bailing out Big Business so they can become recapitalize, and cut costs, and move jobs overseas, and cut jobs, pay down debt, pay bonuses, etc. Socialism for the rich works in America because we still believe in trickle down economic ideology. Somehow this helps the working stiff on the street the theory goes...

Jul 27 01:54 AM

[baw:]

Well.well well,I thought the GM roll was a license to steal! Screen trading a level playing field "Dream on" There is NO way to police any of the black box games that go on EVERY day.I just hope that you Quants and hedgies spend millions and millions of dollars and gobble each other up and then the SEC/CFTC restricks you. Only then, will we have a fair game and open markets like it was meant to be!!!!!!!!!!!

Jul 30 06:11 PM

[zorrow:]

I hope Eliot Spitzer is writing a blockbuster muckraker book that will illuminate Goldman Sachs business practices for the general public and will be published right before the mid term elections.

Jul 31 11:54 AM

[sdrey:]

These guys get paid millions in bonuses, and yet they have to CHEAT to make any performance....a real bunch of geniuses..

We need to build more jails....

Aug 07 01:43 PM

[justanobody:]

This is not capitalism, my friend.


On Jul 22 09:16 AM JWhitling wrote:

> It seems "capitalism" has come to mean the legalization of theft
> almost anywhere you can find a path to the money. Any way you can
> find a chink to make way to "skim" seems to be allowed for insiders,
> even encouraged, with a wink. Who does GS bribe to get these rights?
>
>
> What's the future of capitalism? Can capitalism get any worse than
> this? After a century of systematic blurring of the lines there are
> no lines.
>
> I was going to apologize for the rant but after letting this sit
> on my screen for 10 minutes I realize that I better get on the ball
> and figure out how to seal "mine", lest I be left behind.

Sep 08 09:58 PM

[justanobody:]

I don't understand how government involvement by virtue of bailout, regulation, lobbying, etc. is capitalism. For those who want more regulation: Who do you think will be regulated? The ones doing the lobbying? Who will do the regulating? Is it the same legislators who are in the pockets of companies paying massive cash to lobby said legislators? And Michael Moore calls this capitalism? It is our system, true, but capitalism? Hardly.

Sep 08 10:04 PM

[meeke:]

Please check out a simple definition of flash/hft trading below:

www.ehow.com/how_52649...

Sep 19 04:47 PM

[meeke:]

Please check out a simple definition of flash/hft trading below:

www.ehow.com/how_52649...

Sep 19 04:47 PM

[Gold Bug:]

How Goldman Sachs made 3 Billions in 3 Months ???
watch expert explaining how the magic worked for Goldman Sachs :
economycollapse.blogsp...

Oct 18 06:06 PM