Regulators Consider High-Frequency Trading as Potentially Wash Sale Transactions

The Wall Street Journal reported on March 18, 2013 that U.S. Regulators, including the Commodity Futures Trading Commission (CFTC) and the Financial Industry Regulatory Authority (FINRA) are reviewing trading of high-frequency firms to determine if they are engaging in prohibited transactions, such as “wash” trades. The Article stated that the Regulators are reviewing records of primarily two exchanges, the CME Group, where the majority of wash trades have occurred, and the InterncontinentalExchange, Inc.

The Article identified that regulators are concerned that the exchanges do not have appropriate systems in place to identify or stop wash trades, especially in light of recent technical glitches leading to pronounced losses, including the Knight Capital Group and Facebook debacles in 2012.

Wash trades are when the same party places bids and asks for the same security, which causes there to appear increased activity in the security, which may affect its value, causing gains or losses to other investors who may be legitimately interested. In this way, a market participant manipulates the price of the security, prompting other participants to enter the market.

The Article identified that securities laws generally require a finding that the prohibited trading was intentional, although changes brought about by the Dodd-Frank Wall Street Reform and Consumer Protection Act allow the CFTC to prosecute firms that disrupt the market, even when not intentional. The Article also mentioned that FINRA officials are proposing to a legal standard to wash trades that would remove the requirement of “scienter,” or a knowledge or wrongness. Such a change in the law may make it easier for regulators to enforce the laws, but may have a deterrent effect to legitimate trading strategies by firms who happen to place bets on both sides of the market, but for different reasons. In such an instance, the firm could claim that it did not intentionally enter into what could be considered a wash trade.

Regulators such as the Securities and Exchange Commission (SEC) have regularly brought investigations and enforcement proceedings against market participants for alleged wash trades or sales, as well as for other forms of perceived market manipulation.

The attorneys at Malecki Law represent individuals in regulatory investigations and enforcement actions, including those involving alleged wash trades in forums such as FINRA and before the SEC. If you believe you have become a potential witness or subject to a subpoena requesting information from a U.S. Regulator, please contact an attorney at Malecki Law to determine the most appropriate course of action to follow.

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