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The New Insider Trading

by Michael W. Stocker
Eyes On Wall Street |

Wall Street has a long history of investors profiting on their access to non-public information about the business prospects of publicly traded companies. However, new kinds of "insider" trading, kinds that are still legal, are the subject of increasing regulatory concern.

These technological advantages take several forms. As recently explained by Eyes, in flash trading, select investors pay for access to information about stock purchases and sales fractions of a second before the information becomes public.

Naked access occurs when brokerage firms pay sponsors-- firms approved to trade on particular exchanges-- to execute orders anonymously through the sponsors' computers, getting tiny but profitable time advantages over the rest of investors. Accounting for more than half of the daily trading volume, "naked" access is currently solely regulated by rules imposed by participating exchanges and brokers. The SEC has threatened to implement rules that would undercut the speed advantage gained through such access.

A "dark pool" is a private exchange over which sophisticated traders can electronically buy and sell large amounts of stock, taking advantage of technology that lets them complete transactions faster than could be achieved in the NYSE. As recently reported in a New York Times article about "dark pools," these exchanges have caused the daily trading volume of the NYSE to decrease by approximately 39% over a four-year period.

While all of these practices pose complicated problems for regulators, they may also highlight a disturbing trend: that technological advantages may be overtaking investor acumen as the key to profiting on the markets.

Update on Dark Pools Regulation

Concerned about problems posed by "dark pool" markets, on October 21, 2009, the SEC voted to propose new rules that would require more stock quotes in the "dark pool" systems to be publicly displayed. The rule changes may be adopted after a 90-day public comment period. The SEC Chairman, Mary L. Schapiro, discussed the issue in a speech titled " Statement on Dark Pool Regulation Before the Commission Open Meeting."

For more details on the proposed regulations, please see the October 28, 2009 Eyes post.