09-12-14

Exchanges Face HFT Lawsuits

A class action lawsuit has been filed in the Southern District of New York, challenging stock exchanges' established immunity from damages. The lawsuit, which includes such plaintiffs as the City of Providence, Rhode Island and the State-Boston Retirement System, alleges that the exchanges provided high frequency trading (HFT) firms "enhanced trading information at faster speeds" and developed "complex order types" which were designed to benefit HFT firms.

While exchanges are self-regulating, they are given the same level of protection as government regulators from liability or damages that clients might suffer as a result of their actions. This case seeks to challenge that model, which was already called into question last year when SEC Chair Mary Jo White publicly stated:

"...the current nature of exchange competition and the self-regulatory model should be fully evaluated in light of the evolving market structure and trading practices. This evaluation should include whether the current exchange regulatory structure continues to meet the needs of investors and public companies."

The complaint names BATS, NASDAQ, and the NYSE as well as other exchanges.  Interestingly, they also name Barclays (as the operator of a private dark pool used regularly by HFTs), so this case will contain elements relevant to public exchanges with listed prices, as well as private pools with less price information. Even more interestingly, no HFT firms themselves are actually named; this lawsuit seems to be about activity that enabled HFTs to engage in various profitable strategies, rather than about the entities executing those strategies in the market. For more information on HFTs, and their role in the market, please see our White Paper on the subject here.

Beyond challenging the presumed immunity of the exchanges, this case will also face a difficult task in establishing damages. It will be difficult for plaintiffs to demonstrate clear and specific damages, given that markets are moving extraordinarily high volumes extremely quickly (not to mention the challenges in establishing damages related to the dark pool). If plaintiffs are able to establish an accepted theory of damages, that could well pave the way for additional lawsuits. 

The next step in this case is likely a request for dismissal from the named exchanges, relying on their historical immunity.

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