Dear Senator Schumer,
You recently approached SEC head Mary Schapiro with some very valid concerns about Flash trading, and the potential for investor abuse by advance looks to select market participants ahead of the general order pool. Your crusade was subsequently enjoined by such equity market luminaries as Robert Greifeld, president and CEO of the Nasdaq Stock Market, who had this to say regarding not just Flash trades in particular, but numerous other components of market topology, whose sole purpose is to obfuscate natural order flow and to provide loopholes for dominant market players to extract inefficiencies (i.e., scalp regular investors) arising from established and SEC-endorsed mechanisms of efficient market circumvention:
Flash orders, which are a fundamental part of high-frequency trading, are but one symptom of the current evolving market structure. Nasdaq OMX is concerned that the securities industry appears willing to accept more and more ‘darkness’ and limits on the availability of order information. Instead, the policy goal should be clear: to eliminate any order types or market structure policies that do not contribute to public price formation and market transparency.
The industry has a unique opportunity at this time to take a hard look at dark order types and the underlying market structure issues that do not support public price information.
Senator Schumer, while Zero Hedge applauds your initiative, the truth is that the wrongdoing in the context of potential investor market abuse runs far deeper and is much more pervasive than you realize. And while one can highlight the merits of the Op-Ed published in the New York Times earlier by quant titan Paul Wilmott entitled "Hurrying Into The Next Panic" (a recommended read for you and your staff), which notes numerous frightening implications brought about by the domination of Hiqh Frequency Trading, let us stick within the context of advance looks, which is at the basis of your letter seeking the ban of Flash-like behavior.
Zero Hedge would like to highlight that while your letter to Mary Schapiro indicated your concern with such market actors as DirectEdge, BATS and Nasdaq, the truth is there are substantially larger and more dangerous "fish" on which you should focus your attention.
As a primary example, I would like to refer you to Goldman Sachs' (NYSE:GS) dark pool, SIGMA X.
While I recommend you read the full report and other related literature (especially if you wish to understand why VWAP or Volume-Weighted Average Price is such a critical concept in modern trading), I would like to bring your attention to page 6 of this report, and in particular the following sections:
The child orders generated by Goldman Sachs algorithms interact with SIGMA X liquidity.
When a client routes a marketable order through SIGMA, the smart router first exposes the order to SIGMA X liquidity.
This basically means that as a Goldman algo strategy splits an incoming block trade into smaller (child) components, these orders will first be advance-exposed to Goldman's own prop strategies which get a "first look" (no pun intended) at the order flow to dispose of as they desire. Additionally, due to the flashing advance window, Goldman implicitly knows in advance of a potential spike in order flow - in other words if there is a size buyer or seller of any given particular stock - an incalculable edge in today's market, allowing one to potentially take advantage (frontrun) of forced buyins and unwinds and major block trades.
This provides the firm with a material advantage over other market participants.
In order to get a sense of the size of this potential abuse, as Goldman itself discloses, SIGMA X traded over 123 million (matched-only, single counted) shares daily in May, over 600 million per week. This is a staggering amount of shares over a cumulative extended period of time, and could potentially provide the firm with a substantial unfair advantage over other participants.
Furthermore, Goldman is a dominant Program Trading market player on the New York Stock Exchange, by virtue of its participation in the NYSE's Supplemental Liquidity Provider program. As publicly disclosed, Goldman traded over 796 million principal shares (for its own benefit, not as an agent) in the prior week alone, almost double the next largest market participant Credit Suisse (NYSE:CS) which traded a total volume of just over 420 million shares.
Whether or not Goldman can implicitly take advantage of the advance looks Goldman receives compliments of its own dark pool, SIGMA X, and then subsequently reroutes this informational advantage to trades executed on the NYSE, and other exchanges and ECNs, is also a very pertinent question.
However, even if acting in a vaccum exclusively within the confines of SIGMA X, Goldman's modus operandi begs the question: if, as your letter discloses, you believe Flash-like behavior is a detriment to investors, we encourage your team to focus its attention on this matter. The potential abuse in the context of SIGMA X, is substantial, and much more so if it is not confined to the dark pool exclusively.
In conclusion, SIGMA X was conceived and brought to market via Spear, Leeds and Kellogg: I would like to present to you the form contract with Goldman that new customers have to sign when they agree to engage SLK for any client purposes. I bring your attention to the highlighted area (click to enlarge):
Zero Hedge is happy to answer any questions at your convenience. You may contact us at email@example.com
PS. In case readers are having trouble grabbing the original document, here is the link to the file saved internally.