August 1, 2012

Bending Like Beck

Do you hate day traders?

Reading the 30-page Waiver and Consent letter from Peter Beck, who once ran now-defunct day-trading firm Swift Trade, it seems FINRA must.

Maybe you do too. But there’s a lesson in the story here, IR folks.

If you missed it, Beck’s woes got page-one billing from the keyboard of Scott Patterson at the Wall Street Journal yesterday. Beck ran a loose global day-trading federation last decade that at peak hosted some 4,000 traders outside the United States funneling orders through Beck’s execution broker Biremis Securities in Toronto.

The allegations are a compendium on failed oversight. We counted 35 instances of the words “appropriate,” “proper,” “improper” and “improperly” in the document signed by Beck and his legal counsel. It effectively bans Beck from US securities markets (although Beck operated outside the US so the ban seems hollow).

Behind bolded subheadings, the letter says primarily that Beck failed to supervise staff, didn’t keep good records and didn’t comply with standards. What gets attention in the Wall Street Journal is a practice called “layering,” in which traders place a bunch of orders at various price points, say, to buy shares in one place, and then simultaneously enter opposing orders elsewhere, and then cancel most orders as soon as other participants react. The aim is a quick profit at minimal risk.

But layering is a matter of interpretation. Everybody layers. Markets makers using algorithms to work orders for real investors engage in forms of layering. Otherwise, your most basic high-frequency-trading algorithm would immediately identify the order and front-run it. Frankly, layering is necessary to comply with the SEC’s Best Bid or Offer rules when breaking up large orders.

So really, what FINRA (and the SEC) contend is that it’s not what you do, but how. If you do it like Morgan Stanley, you’re cool as layer cake. If you bend it like Beck, you’re out.

By the way, Beck’s firms are long gone. Looking back at data for large Nasdaq-traded clients, order flow through Biremis peaked in 2007 and by late 2008 had disappeared. Behaviorally, volumes back then at Ameritrade, Citadel, Assent, Genesis, even National Financial Services, looked much like Biremis’s.

Beck was in fact mimicking big broker-dealers: Consolidating disparate orders into a liquidity stream for generating rebate payments from exchanges.

We’re not justifying Beck’s bent ways. We’re concerned that market regulation is focused on compliance instead of how markets work. Miscreants could be gaming markets so long as they file the proper forms.

After all, most questionable trade-execution methods could hardly exist if regulators didn’t mandate price spreads and the electronic interlinking of every market. As it is, it’s nearly impossible to distinguish the good from the evil lurking in well-followed rules.

We’d be safer scrapping the entire National Market System and starting over.

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