12 ms·

The definition is probably cited in a lot of places because it's literally just the definition of insider trading. Which frontrunning is a form of. A nice neut

by ABCLAW 7y ago

The definition is probably cited in a lot of places because it's literally just the definition of insider trading. Which frontrunning is a form of. A nice neutral primer on the HFT frontrunning debate can be found here, which contains a note regarding the HFT industry's attempt to advance the 'fiduciary' requirement. https://fas.org/sgp/crs/misc/R43608.pdf https://fas.org/sgp/crs/misc/R43608.pdf Matt Levine, for instance, is very firmly on the 'keep frontrunning to only mean brokers interceeding before client orders' side of the semantic battle. Charlie Munger, by contrast, had no issues calling out the entire HFT industry as 'evil' and 'legalized front-running'. All this to say, there's clearly a lot of fight over the semantics here. If you want to look at the official industry position, look at the communication between SIFMA and FINRA during the relevant time period wrt frontrunning regulations. You'll see SIFMA makes repeated reference to recognizing they have a duty in respect of customer orders, while the FINRA rules (5270, for instance) do not track this language. SIFMA attempted to conflate Rule 5270 (Front Running of Block Transactions) with Rule 5320 (Prohibition Against Trading Ahead of Customer Orders). I know a few people who have admitted in private that this strategy was not a mistake. Rule 5270 notably has no exclusionary requirement that the non-public knowledge is in respect of a client trade. Rule 5270 also contains a definition of Publicly Available Information, which requires that the trade be COMPLETED prior to it being public. To note how much of a gong show this situation was, note that in requests from SIFMA to delay the implementation of Rule 5270, FINRA said they'd grant the extension because firms needed time to train staff and retool systems - but FINRA explicitly noted that the activities prohibited under 5270 were almost all already illegal and covered by other FINRA rules. So insider trading on non-public information is illegal and that's not news. Unless everyone does it with computers for a while. The regulator would look like an idiot for charging practically the entire industry, so instead they tell people they have a few years to knock off all that silly business while giving them a stern finger wagging. But they only 'fixed' it for large orders, and then only in an official sense. The SEC hasn't done much in the way of enforcement on this point.

throwawaymath 7y ago
> So insider trading on non-public information is illegal and that's not news. This is a frustratingly common misconception, but it is still incorrect. If you ascertain material nonpublic information without breaking a confidentiality agreement or fiduciary duty, you are fully allowed to trade on that research. Price discovery is a core function of a financial market. Without information asymmetry, there exists no meaningful way to signal new prices to a market. In the abstract, the only way to achieve alpha is to have an informational advantage over the market consensus. This is why the SEC is generally very careful in its terminology; to wit, you will usually see the terms "insider trading" and "illegal insider trading" distinguished. The "illegal" prefix is significant. Insider trading also refers more generally to the mundane, non-criminal trading activity of any corporate insiders. Legally trading with material nonpublic data is not insider trading by definition, because you can't legally trade on that kind of information as an insider. Take a look at the SEC's spotlight of insider trading cases[1]. Note the commonalities - a confidentiality or agreement or fiduciary duty was broken directly (e.g. by an employee of the firm involved) or indirectly (e.g. by friends or family of the employee). Likewise, consider the SEC's definition of illegal insider trading[2]. As for what Munger has said about HFT - it frustrates me to hear that he's said those things, because of the coherent criticisms you can levy against the practice, frontrunning is not one of them. It's extraordinarily frustrating to me that you're characterizing this as something debatable - it isn't! "Frontrunning" has an established, precise definition which the SEC will happily and aggressively use for litigation - HFT or otherwise. Whatever Munger's problems with HFT are, his argument would be strictly better if he dropped the inaccurate jargon and simply criticized the practice directly. In fact, I can't find a single citation in which Munger actually provides an argument for why HFT is bad or frontrunning. There are legitimate reasons you can be concerned about HFT, but Munger doesn't seem to mention them. Instead, every source I can find has him claiming HFT is wasteful or unproductive because he doesn't like the idea of people competing on nanoseconds. His overall dislike for the practice is extremely underspecified. In contrast, Levine is actually far more neutral about the activity than you've given him credit for. He has written extensively about HFT, Flash Boys, IEX, the various players involved and the peripheral industries and incentives. He might not be as personally successful or wealthy as Munger, but his take on the subject is - objectively speaking - much more well-constructed and coherent. ___________________ 1. https://www.sec.gov/spotlight/insidertrading/cases.shtml https://www.sec.gov/spotlight/insidertrading/cases.shtml 2. https://www.sec.gov/fast-answers/answersinsiderhtm.html https://www.sec.gov/fast-answers/answersinsiderhtm.html
- ABCLAW 7y ago
  That paragraph was meant to be glib, sorry if it wasn't precise enough. Money Stuff #2 has cratered before it really got wings. That said, your response is half accurate. You're right that not all trading on non-public information is illegal, because price discovery is important (note, however, that in common parlance, 'insider trading' refers to illegal insider trading, not trading on non-public information). Anyways, regardless that's not the case here. First off, frontrunning does not help with price discovery. Second, trading ahead of a trade that's imminent and non-public is not legal. The opening subsection of rule 5270 is fairly straightforward: "(a) No member or person associated with a member shall cause to be executed an order to buy or sell a security or a related financial instrument when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in that security, a related financial instrument or a security underlying the related financial instrument prior to the time information concerning the block transaction has been made publicly available or has otherwise become stale or obsolete." Recall, FINRA went to lengths to point out that this was ALREADY illegal by the time this section was put into force after the flash crash. As for Munger, his views are fairly straightforward. https://www.cnbc.com/video/2013/05/03/why-charlie-munger-thinks-hft-is-basically-evil.html https://www.cnbc.com/video/2013/05/03/why-charlie-munger-thi... https://www.cnbc.com/video/2014/05/05/hft-equivalent-of-rats-in-a-granary-munger.html https://www.cnbc.com/video/2014/05/05/hft-equivalent-of-rats... "It does civilization no good at all. It's the equivalent of letting rats into a granary. I don't like it." I think your note regarding Levine shows a point you've missed. I'm not saying Levine is for or against HFT activity. I'm saying he prefers a narrow interpretation of the term front-running like you do. However, even he capitulated, because both usages are acceptable. Hence my original note at the start of this chain where I note there's a dispute regarding the use of the term. "In Money Stuff yesterday I said that "I seem to be losing the fight against semantic drift in the term 'front-running,'" which (I thought) used to mean a broker's breach of fiduciary duty by trading ahead of his customers, but which now seems to mean anyone's trading ahead of anyone else. Reader Bill Bremse pointed out by e-mail that some form of the second sense has been in respectable use for quite a long time, including by Larry Harris in the 1990s. I am not sure there is any higher authority on market-structure usage than Larry Harris, so I will cheerfully confess error on this one. "Front-running" can indeed mean something other than an illegal fiduciary violation, though at least Harris seems to have used it to mean trading ahead of exposed limit orders, not racing to trade on one exchange after seeing executions on the other. Though I don't know how much that was a thing in the 1990s." A bit of an explanatory note: Prof. Larry Harris literally wrote the book on exchanges. He was also the Chief Economist for the SEC in the early 2000s, and later the head of their economic analysis unit. Here's Order Exposure and Parasitic Traders, which he authored in 1997, well before HFT really took off. He refers to the activity we're discussing as front running, and explains systemic issues with the trading strategy before the HFT industry even existed: http://www-bcf.usc.edu/~lharris/ACROBAT/Exposure.pdf http://www-bcf.usc.edu/~lharris/ACROBAT/Exposure.pdf

by ABCLAW 7y ago

throwawaymath 7y ago

> So insider trading on non-public information is illegal and that's not news. This is a frustratingly common misconception, but it is still incorrect. If you ascertain material nonpublic information without breaking a confidentiality agreement or fiduciary duty, you are fully allowed to trade on that research. Price discovery is a core function of a financial market. Without information asymmetry, there exists no meaningful way to signal new prices to a market. In the abstract, the only way to achieve alpha is to have an informational advantage over the market consensus. This is why the SEC is generally very careful in its terminology; to wit, you will usually see the terms "insider trading" and "illegal insider trading" distinguished. The "illegal" prefix is significant. Insider trading also refers more generally to the mundane, non-criminal trading activity of any corporate insiders. Legally trading with material nonpublic data is not insider trading by definition, because you can't legally trade on that kind of information as an insider. Take a look at the SEC's spotlight of insider trading cases[1]. Note the commonalities - a confidentiality or agreement or fiduciary duty was broken directly (e.g. by an employee of the firm involved) or indirectly (e.g. by friends or family of the employee). Likewise, consider the SEC's definition of illegal insider trading[2]. As for what Munger has said about HFT - it frustrates me to hear that he's said those things, because of the coherent criticisms you can levy against the practice, frontrunning is not one of them. It's extraordinarily frustrating to me that you're characterizing this as something debatable - it isn't! "Frontrunning" has an established, precise definition which the SEC will happily and aggressively use for litigation - HFT or otherwise. Whatever Munger's problems with HFT are, his argument would be strictly better if he dropped the inaccurate jargon and simply criticized the practice directly. In fact, I can't find a single citation in which Munger actually provides an argument for why HFT is bad or frontrunning. There are legitimate reasons you can be concerned about HFT, but Munger doesn't seem to mention them. Instead, every source I can find has him claiming HFT is wasteful or unproductive because he doesn't like the idea of people competing on nanoseconds. His overall dislike for the practice is extremely underspecified. In contrast, Levine is actually far more neutral about the activity than you've given him credit for. He has written extensively about HFT, Flash Boys, IEX, the various players involved and the peripheral industries and incentives. He might not be as personally successful or wealthy as Munger, but his take on the subject is - objectively speaking - much more well-constructed and coherent. ___________________ 1. https://www.sec.gov/spotlight/insidertrading/cases.shtml https://www.sec.gov/spotlight/insidertrading/cases.shtml 2. https://www.sec.gov/fast-answers/answersinsiderhtm.html https://www.sec.gov/fast-answers/answersinsiderhtm.html

ABCLAW 7y ago
That paragraph was meant to be glib, sorry if it wasn't precise enough. Money Stuff #2 has cratered before it really got wings. That said, your response is half accurate. You're right that not all trading on non-public information is illegal, because price discovery is important (note, however, that in common parlance, 'insider trading' refers to illegal insider trading, not trading on non-public information). Anyways, regardless that's not the case here. First off, frontrunning does not help with price discovery. Second, trading ahead of a trade that's imminent and non-public is not legal. The opening subsection of rule 5270 is fairly straightforward: "(a) No member or person associated with a member shall cause to be executed an order to buy or sell a security or a related financial instrument when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in that security, a related financial instrument or a security underlying the related financial instrument prior to the time information concerning the block transaction has been made publicly available or has otherwise become stale or obsolete." Recall, FINRA went to lengths to point out that this was ALREADY illegal by the time this section was put into force after the flash crash. As for Munger, his views are fairly straightforward. https://www.cnbc.com/video/2013/05/03/why-charlie-munger-thinks-hft-is-basically-evil.html https://www.cnbc.com/video/2013/05/03/why-charlie-munger-thi... https://www.cnbc.com/video/2014/05/05/hft-equivalent-of-rats-in-a-granary-munger.html https://www.cnbc.com/video/2014/05/05/hft-equivalent-of-rats... "It does civilization no good at all. It's the equivalent of letting rats into a granary. I don't like it." I think your note regarding Levine shows a point you've missed. I'm not saying Levine is for or against HFT activity. I'm saying he prefers a narrow interpretation of the term front-running like you do. However, even he capitulated, because both usages are acceptable. Hence my original note at the start of this chain where I note there's a dispute regarding the use of the term. "In Money Stuff yesterday I said that "I seem to be losing the fight against semantic drift in the term 'front-running,'" which (I thought) used to mean a broker's breach of fiduciary duty by trading ahead of his customers, but which now seems to mean anyone's trading ahead of anyone else. Reader Bill Bremse pointed out by e-mail that some form of the second sense has been in respectable use for quite a long time, including by Larry Harris in the 1990s. I am not sure there is any higher authority on market-structure usage than Larry Harris, so I will cheerfully confess error on this one. "Front-running" can indeed mean something other than an illegal fiduciary violation, though at least Harris seems to have used it to mean trading ahead of exposed limit orders, not racing to trade on one exchange after seeing executions on the other. Though I don't know how much that was a thing in the 1990s." A bit of an explanatory note: Prof. Larry Harris literally wrote the book on exchanges. He was also the Chief Economist for the SEC in the early 2000s, and later the head of their economic analysis unit. Here's Order Exposure and Parasitic Traders, which he authored in 1997, well before HFT really took off. He refers to the activity we're discussing as front running, and explains systemic issues with the trading strategy before the HFT industry even existed: http://www-bcf.usc.edu/~lharris/ACROBAT/Exposure.pdf http://www-bcf.usc.edu/~lharris/ACROBAT/Exposure.pdf