Trading on a Not-So-Level Playing Field

Oct 30, 2014 at 8:11 AM
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Is there no end to SEC bias? If it's not the new NCAA playoff, it's the advantages conferred to a few favored "traders."

Hedge funds and other rapid-fire investors can get access to market-moving documents ahead of other users of the Securities and Exchange Commission's system for distributing company filings, giving them a potential edge on the rest of the market.

Two separate groups of academic researchers have documented a lag time between the moment paying subscribers, including trading firms, newswires and others, receive the filings via a direct feed from an SEC contractor and when the documents are publicly available on the agency's website.

The studies found a wide variation in the lag time, from no delay to one lasting more than a minute -- a considerable advantage for computer-driven traders.

Let me get this straight: Algos can execute orders far faster than humans for a variety of reasons. So, they can react to news before you can anyway, even if they get the news at the same time. That's not enough of an edge, though. They now can literally see the news before you can. A second early might as well be an hour. A minute early is like a year.

Look, there should be some earned advantage to those with the brainpower and capital to create and invest in technology that can read and react to news events. I traded for years on a floor. I understand how the system works, in the sense that entities pay up to see information quicker. Back before it went all "algo," it was in the form of "soft dollars." Maybe you help a broker with a less desirable order so as to get an earlier look at a more desirable one.

Essentially combining these two edges is beyond the pale. And we're not talking about a broker looking to make a living. This is the Securities and Exchange Commission (SEC). Its job (in theory, of course) is to protect the interests of all investors.

How do they get this advantage?

The studies focus on the SEC's Electronic Data Gathering, Analysis and Retrieval system, or Edgar, which was launched in the 1990s to disseminate earnings reports and other documents filed to the agency. Investors know Edgar as the name on the website they visit to retrieve public filings.

Less widely known is the fact that filings also are transmitted to a group of roughly 40 paying subscribers, including newswire services such as the one owned by Dow Jones, publisher of The Wall Street Journal, according to people familiar with the matter. Subscribers currently pay about $1,500 a month to an SEC contractor -- hired to run the Edgar system -- in order to receive all Edgar filings, according to one subscriber and public documents.

When a company submits a document, the contractor forwards it to the Edgar subscribers and to the SEC website "at the same time," according to the SEC. But, the studies suggest that the SEC website can take anywhere from 10 seconds to more than a minute to post the documents, giving an advantage to the Edgar subscribers or their customers, who are often professional investors. Mom and pop investors can download the documents from the SEC website, but the information may already be known to others in the market, the studies indicate.

It's good to know that news organizations knew this was going on, seeing as they got this information early as well. No one ever said we have a level playing field, but this just all goes too far.

Again, people will fork over dollars to get early looks at everything. It's the fact that the SEC makes this all possible that causes this particular allegation to stand out, in my opinion.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.



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