High-Frequency Trading: A Regulatory Strategy

Abstract

High-frequency trading – a new form of lightning-fast computerized trading conducted without direct human intervention – has remade American stock markets in the past decade, increasing trading volume enormously while dramatically reducing the costs of buying and selling stock. Even so, high-frequency trading is controversial, raising the specter of market manipulation and unfair trading advantages. The most unique and serious risk is the risk of extreme spikes and crashes in stock prices. The most dramatic of these was the so-called “Flash Crash” of May 6, 2010, which brought wide public attention to so-called high-frequency trading for the first time. In the space of only fifteen minutes, the stock market plunged to the single biggest intraday point loss in its history and then, even more astonishingly, almost completely recovered. This unprecedented event brought fresh scrutiny to so-called high-frequency trading, which is widely believed to have played a crucial role in the debacle. Despite a welter of subsequent regulatory proposals, the legal literature has been nearly silent with regard to this new frontier of securities litigation. In response, this Article proposes the broad outlines for a strategy for regulation of the risks of high-frequency trading. For risks that are already well understood, I would rely on best practices regulation. For risks that are novel and not yet fully understood, I would rely on a combination of ex post liability and structural reforms – including a consolidated system for tracking market activity and improved circuit breakers for arresting extreme market movements. The proposed regulatory regime would reassure the public and prevent the most extreme dangers associated with high-frequency trading, while still preserving the benefits of high-frequency trading and the incentives for market participants to develop improved best practices.

Keywords

High-Frequency Trading, Algorithmic Trading, Securities Regulation, Flash Crash

Publication Date

2014

Document Type

Article

Publication Information

48 University of Richmond Law Review 523 (2014)

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COinS Charles R. Korsmo Faculty Bio