The Law and Ethics of High-Frequency Trading

Michael Lewis's recent book FLASH BOYS has resurrected the controversy concerning “high-frequency trading” (HFT) in the stock markets. While HFT has been important in the stock markets for about a decade, and may have already peaked in terms of its economic significance, it touched a nerve with a public suspicious of financial institutions in the wake of the financial crisis of 2008-2009. In reality, HFT is not one thing, but a wide array of practices conducted by technologically adept electronic traders. Some of these practices are benign, and some even bring benefits such as liquidity and improved price discovery to financial markets. On the other hand, there are legitimate grounds for the commonly heard complaint that “HFT is not fair.” Certain HFT practices such as co-location, flash orders, and enriched data feeds create a two-tiered financial marketplace, while other practices such as momentum ignition, spoofing, and layering are merely high-tech versions of traditional market manipulation. Finally, the creation of special order types such as “Hide Not Slide” shows the exchanges allowing their HFT clients to jump the queue of price-time priority embedded in Regulation NMS and stock market practice. While the commonly-used technique of a cost-benefit analysis leads to equivocal or indeterminate results when applied to HFT trading activity in complex and often opaque markets, a more basic ethic of fairness grounded in commonly accepted rules of financial market behavior illustrates that certain HFT practices are indeed unfair. This Article draws on the legal, finance, and business ethics literature to illustrate exactly how certain forms of HFT are unfair, and proposes four core principles to guide HFT activity and its regulation