At the beginning of last week, Thompson Reuters announced that it was suspending its practice of releasing data from a closely watched consumer confidence survey to a subset of subscribers before the rest of the market had access to the information. For a mere $6,000 a month, a number of high-frequency traders had a two-second jump on the market.
How big of an advantage was this? As James Stewart of The New York Times reported, it was “arresting.” In the first 10 milliseconds of the two-second window this past Friday — that is, the first time the report was issued without a head start — only 500 shares of a leading S&P 500 (INDEXSP:.INX) exchange-traded fund changed hands. In the same 10 milliseconds last year, a staggering 200,000 shares were traded.
The “news-feed” trade
Known as the “news-feed” trade, this has been one of Wall Street’s best-kept non-secrets over the past few years. A veritable cottage industry of data aggregators and providers has sprung up. According to The Wall Street Journal, “the delivery of machine-readable news will generate $75 million in revenue for financial-news providers this year, up almost 50% in five years.”
In addition to the Thompson Reuters/University of Michigan consumer sentiment survey, there’s the Chicago Business Barometer distributed by the German financial exchange Deutsche Borse, the monthly manufacturing index supplied by the Institute of Supply Management, data about monthly shipments of appliances by the Association of Home Appliance Manufacturers, the Bedding Barometer which gauges the monthly sales of mattresses, and on and on.
All told, there are dozens of such reports that paying customers can get access to before the rest of the market. But while it seems like this burgeoning trend must be bad for individual investors who don’t have the means to compete on a level playing field, the evidence doesn’t necessarily support that assumption.
An appearance of impropriety
It’s impossible to deny that this practice appears, at least on its face, to be both unfair and bad for the markets. “It sends a really bad message to people, that markets aren’t fair, transparent,” my colleague Ilan Moscovitz observed.
“The reason America’s markets are the best and strongest markets in the world, is that individuals always believed they could get a fair trade,” New York Attorney General Eric Schneiderman told the Times‘ Stewart last week. “If you did your research well, you weren’t at a disadvantage because of information you couldn’t possibly access. It wasn’t a rigged casino.”
The practice also seems to fly in the face of the securities laws that govern the dissemination of information from publically traded corporations. The rules against insider trading are obviously paramount here. But even beyond these, there’s Regulation Fair Disclosure, which mandates that all publically traded companies must disclose material information to investors at the same time.
To be clear, the sale of information like this isn’t illegal. “The activity is widespread and legal,” Michael Rothfeld of The Wall Street Journal noted. “Federal securities law doesn’t prevent investors from trading based on nonpublic information they have legally bought from other private entities.”
In addition, viewed from the perspective of economic theory, it might very well foster inefficiency. One of the fundamental predicates of a competitive market is that there is “perfect information,” which means that all consumers and producers are assumed to have the same (and thereby simultaneous) knowledge of things like price, quality, and production methods. Clearly, this isn’t the case when a subset of market participants gets access to critical data before others.
Thinking beyond the headlines
The idea that high-frequency traders exploit their preferential access to data in order to turn a quick and often generous profit makes for salacious and clickable headlines. But whether or not the practice is actually bad for individual investors is more nuanced. If you dig a bit further into it, in fact, there’s reason to believe that all of the hoopla is much ado about nothing.
Nobody would deny the fact that economic reports such as those discussed here are important. What fewer people appreciate, however, is that it’s expensive to collect and disseminate the underlying data. “People need financial incentives to dig up information, and the marketplace benefits,” former SEC Chairman Harvey Pitt told the Times.
Richard Curtin, the economist who runs the consumer confidence survey at the University of Michigan, agreed. “Hardly anyone would pay for it if they didn’t see a profit motive,” Curtin told the Journal‘s Brody Mullins at the beginning of last month. “This research is totally funded by private sources for the benefit of scientific analysis, to assess public policy, and to advance business interests. Without a source of revenue, the project would cease to exist and the benefits would disappear.”
Beyond that, if you take a step back, you can’t help but wonder: What’s the difference between the market surging or tanking at 9:57 a.m. versus 10:00 a.m.? None, quite frankly, or at least not from the perspective of a long-term investor. “Ordinary investors aren’t betting on consumer confidence numbers within two seconds of their release,” Moscovitz said in the same conversation.
