(Bloomberg) -- U.S. regulators have grown so concerned that traders are using high-speed computers to manipulate markets that they’re planning a new tactic to clamp down on the practice -- rating brokers on how much spoofing they allow to flow through their order books.
The Financial Industry Regulatory Authority said it plans to issue report cards this year that will grade firms on how many phony bids to buy or sell stock they might have a role in facilitating. Finra, a market cop funded by Wall Street, expects brokers to use the assessments to root out any misconduct, the regulator said Tuesday in its annual letter on exam priorities.
To make money, spoofers flood the market with a series of fake orders to entice other traders and then cancel the orders once prices move in the direction they desire. Finra’s plan to write up report cards shows how deeply regulators fear the electronic bait-and-switch has infected trading following high- profile cases such as that of London’s Navinder Sarao, who was arrested in April after authorities accused him of spoofing that contributed to the 2010 flash crash for U.S. stocks.
The report cards will highlight instances in which potentially manipulative orders flow through a single broker and situations in which orders flow through multiple firms, Finra said. The assessments will focus on spoofing and another abusive practice known as layering, which also involves traders submitting orders that they have no intention of following through on.
Efforts to reduce spoofing have gone global with both Chinese securities regulators and U.S. presidential hopeful Hillary Clinton proposing that traders pay a fee for habitual order cancellations. For every 27 orders placed on U.S. stock exchanges, about one is filled, according data from the U.S. Securities and Exchange Commission. In other words, approximately 96 percent of all orders sent to U.S. equity markets are never executed.
Critics of high-frequency trading have cited the industry’s reliance on canceled orders as evidence that markets are unfair, or worse, rigged.
But some academics and financial firms have argued that spoofing can actually be used as a defense against manipulation and that the only market participants hurt by it are other traders who rely on super-fast computers. Because spoofing usually happens in milliseconds, traders with long time horizons don’t react to the rapid-fire price quotes.
Some high-frequency traders have also said that restricting order cancellations might unfairly punish firms that are innocently using computer formulas to update the prices at which they offer to buy and sell securities. The firms argue that they have to withdraw orders because the speed at which stock markets now move makes many quotes irrelevant almost immediately.
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