High-Frequency Traders Under U.S. Investigation For 'Wash Trading'

U.S. regulators are reportedly probing whether high-frequency trading firms have been conducting transactions with themselves in a potentially illegal practice known as "wash trading" that may distort market prices.

The Securities and Exchange Commission and the Commodity Futures Trading Commission are looking into whether high-frequency traders have been buying and selling contracts to themselves, according to Bloomberg, which cited two people with knowledge of the matter. Wash trading is a particular risk for high-frequency traders, which use computer algorithms to quickly trade stocks, bonds and derivatives contracts, because these firms often have multiple trading algorithms working at once, Bloomberg noted.

Spokespeople for both regulators declined to comment.

Mark Gorton, founder of high frequency trading firm Tower Research Capital, said wash trading is "not a huge deal."

"It happens in certain cases, but it does no harm, so unless regulators want to get all worked up over something pretty minor (not that this doesn't happen), I don't expect it to be a big deal," Gorton told The Huffington Post in an email.

High-speed exchange operators Bats Global Markets and Direct Edge Holdings have recently launched services designed to help high-speed traders avoid “undesirable executions against themselves,” as Bats put it to Bloomberg. Wash trades are illegal if intentionally done to manipulate the price of a stock or other security.

The reported inquiry comes two days after the Commodity Futures Trading Commission held an open meeting to lay groundwork for broader Commodity Futures Trading Commission oversight of high-frequency trading by officially defining it.

An advisory panel settled on a draft, describing high-frequency trading as "a form of automated trading that employs algorithms for decision making ... without human direction" and uses "low-latency technology that is designed to minimize response times," "high-speed connections" and "high message rates -- orders, quotes or cancellations."

The Securities and Exchange Commission and the Commodity Futures Trading Commission have scrutinized high-frequency trading in the past, particularly after the so-called "flash crash," in 2010 in which the Dow Jones Industrial Average plummeted 1,000 points in a matter of minutes. The regulators said high-frequency traders contributed to the plunge.

The latest probe would center on activity intended to manipulate prices, which is illegal, Bloomberg reported. There was no suggestion of illegal activity related to the flash crash.

Penalties for wash trading have been rather soft. In early June, JPMorgan Chase was found guilty of executing 10 wash trades on crude oil and gasoline futures in 2010, according to Reuters. Those trades earned the bank a reported $30,000 fine from CME Group, the organization that owns the New York Mercantile Exchange. As Reuters pointed out, $30,000 is just over one-millionth of JPMorgan's total compensation outlay of $29 billion in 2011.