Companies that provide early access to potentially market-moving data – and traders who act on unfairly accessed information – are the targets of New York Attorney General Eric T. Schneiderman, who also patrols Wall Street.
He calls the practice “Insider Trading 2.0,” and defines it as small groups of privileged traders creating unfair advantages for themselves by combining early glimpses of critical data with high-frequency trading – superfast computers that flip tens of thousands of shares in the blink of an eye.
Schneiderman says this new generation of market manipulators has devised schemes that allow them to suck all the value out of market-moving information before it hits the rest of the market, which he says is causing a crisis of confidence in US capital markets.
The only solution to the problem, he says, is to have one set of rules for everyone that prohibits insiders from buying or selling securities while in possession of material, nonpublic information about the securities.
Ninety-year-old Martin Act to the rescue
To achieve that, the attorney general says his office is aggressively using its power under New York’s Martin Act, a 1921 law aimed at financial fraud. Enforced by the Investor Protection Bureau – part of the state’s Attorney General’s office – the Martin Act gives New York’s attorney general broad enforcement powers to investigate suspected fraud in the offer, sale or purchase of securities.
The law authorizes the attorney general to bring civil and criminal cases to protect investors. The law does not require proof that a company intended to defraud and allows investigators to obtain substantial information from businesses.
First action caused company to stop distributing data
In his first action as part of the crackdown, Schniederman persuaded Thomson Reuters to stop giving its subscribers access to information in the Thomson Reuters/University of Michigan’s Survey of Consumers two seconds before the rest of the public had access to it.
“Two seconds would have been nothing in the old days, when investors bought and held onto stocks for years to let them build value,” Schniederman says. “But two seconds is a lifetime in the world of Insider Trading 2.0.”
The information was so powerful that in July 2012, 200,000 shares of an S&P 500 fund were traded in the first 10 milliseconds of the two-second window before the survey was released. But in July 2013, after Thomson Reuters reached an interim agreement with Schneiderman’s office to suspend the two-second edge, trading on the same fund during that 10-millisecond period plunged to just 500 shares.
Lemuel Brewster, a spokesman for Thomson Reuters, said the company’s approach to releasing data first to fee-paying clients is a widely accepted practice.
“Thomson Reuters strongly believes that news and information companies can legally distribute non-governmental data and exclusive news through services provided to fee-paying subscribers,” he said. “It is widely understood that news and information companies compete for exclusive news and differentiated content to help their customers make better informed trading and investment decisions.”
Schneiderman says agreements like the one with Thomson Reuters are solid steps toward restoring confidence in the markets. But his concern goes further and is looking at whether other companies have similar practices.
Many may have early access to analysts’ assessments
“Analyst sentiment—like the University of Michigan survey —is market-moving information. A firm that sees analyst assessments before they are released can front-run the market and gain an unfair advantage over the competition,” he says. “And when a trader can systematically plug illicit early data into a trading program, it can mean an enormous windfall.”
Schniederman is not the first New York Attorney General to use the Martin Act to change capital market practices for investor protection. Former Attorney General Eliot Spitzer aggressively wielded the law to expose the hyping of Internet stocks. The effort yielded a global settlement involving 10 banks and $1.4 billion in fines.
Attorney General seeks Wall Street whistleblowers
Schneiderman wants help from Wall Street to stop capital markets manipulators.
“It is in the interest of the vast majority of market players who are responsible actors to stop the bad actors who put the markets at risk for personal gain. My office has set up a hotline for financial industry insiders to confidentially report improper or illegal conduct involving the dangerous combination of early access to information and high-frequency trading, and we ask anyone who knows of such wrongdoing to come forward,” he says.