High Frequency Trading Law

Recent Developments in High Frequency Trading Law

Last year the Federal Court of New York was stormed by investors alleging that exchanges, banks, and broker dealers created an unfair marketplace through high frequency trading (“HFT”). All suits were inspired by Michael Lewis allegations, author of the best-seller “Flash Boys: A Wall Street Revolt”, who argued that the stock market is rigged in favor of exchanges, big banks and high-frequency traders.

Case Dismissed

By dismissing a three class-action on April 30 – Lanier v. BATS Exchange Inc et al, Nos. 14-cv-03745, 14-cv-03865 (S.D.N.Y. 2015) – Judge Katherine Forest of the U.S. District Court for the Southern District of New York placed her imprint into the debate to know whether the Security Exchange Commission (“SEC”) is the only competent entity to receive a complaint involving exchanges.

Harold Lanier, the aggrieved investor who initiated the suit claimed that several major U.S. exchanges, including among others, NASDAQ, NYSE and BATS, scammed ordinary investors by selling faster access to market data to high-frequency traders and therefore broke their initial duty as market regulators. Furthermore, the claimant added that they violated the nondiscrimination and fairness provisions enclosed in the subscriber agreements issued by the exchange which details both parties’ commitments.

The plaintiff rightfully called into question the competence of the SEC as it formerly approved the practices of HFT. But according to the Federal Judge, the Exchange Act provides that any conflict should be brought before the SEC, as a two-tiered procedure is already in place in case of a violation of its rules by an exchange. In any case, if the aggrieved party seeks to go further, only Federal Court of Appeals can review the SEC order. The Judge contested anyway that the allegations of the agreement violation were sufficient to state a claim.

The market regulators “absolute immunity” question is nonetheless still unanswered as the case has not been followed up. Defendants argued that, as self-regulatory organizations, they should benefit an absolute immunity from civil lawsuits intended to get damages in connection with their regulatory responsibilities. Hence only the SEC should hear investors’ complaints.

Pension Funds Joined the Battle

The class action led by the City of Providence and Rhode Island – City of Providence, Rhode Island et al v. BATS Global Markets Inc et al, Nos. 14-cv-02811, 14-MD-2589 (S.D.N.Y. 2015) – is however still ongoing as the motions to dismiss laid recently were set aside by Federal Judge Jesse Furman. The State-Boston Retirement System and three other funds located in Stockholm, Alexandria and the Virgin Islands joined the battle. Here, in addition to public exchanges such as BATS, CHX, NASDAQ and NYSE, Barclays LX dark pool is also targeted by the plaintiffs.

As dark pools are private exchanges without either quotations or subscribers noticeable, only large investors can deal on these platforms. Alternative trading systems are more and more coveted by investors and their part of the market doubled in the last five years. Nowadays around a third of the trades are being conducted through dark pools in the United States.

Although individual investors should not have access to these venues, mutual or pension funds might. Therefore, individuals can be harmed indirectly in dark pools which are much more vulnerable to HFT predators than public exchanges. The plaintiffs will nonetheless have to demonstrate clear and specific damages to win their case, which in this complex and obscure market, will need a very high level of expertise.

Hazy Dark Pools

In July 2014, individual investor Barbara Strougo brought her grievances to the New York District Court – Strougo v. Barclays, No. 14-cv-05797 (S.D.N.Y. 2015) – against Barclays and its executives of covering up aggressive high frequency trading operations on their Barclays LX dark pool.  In addition to that, she claimed that Barclays gave crucial non-public information to hostile traders.

In essence, Rule 10b-5 of Securities Exchange Act of 1934 deems illegal any behavior aimed to deceive people involved in securities transactions in an exchange. Would this mean that investors should be entitled to know the presence of HFT when trading in the venue?  Indeed, if the exchange owner is aware about HFT predators, not to disclose it would be breaking the law. Knowing the potential risks of his or her investment is a fundamental right to any investor.

The rules that regulate dark pools depend whether they are registered as national securities exchanges or broker dealers and also about their activities and trading volume. If recognized as broker dealers, they perform under a different set of regulations than public exchanges and the Exchange Act is not applicable in the same way. As a result, the SEC review does not apply and complainants can head straight to district court.

Barclays’ dismissal bids were turned down by the Federal Judge as questions about the integrity of its alternative trading system are still unanswered. The Judge expressed her concern about specific misstatements – i.e., touting the safety of the LX platform while, on the other hand, allowing aggressive behavior.

Barclays maintains that it would deny access to any trader who operates aggressively on its platform but the plaintiff assure that the platform was infested by high speed traders who used their technology to make profit at the expense of common investors.

David Against Goliath

While big financial companies struggle against investors to defend themselves and try to minimize the impact of HFT on the market, Goldman Sachs is determined not to let go off anything against one of its former computer programmer. Serge Aleynikov left his employer to join startup Teza Technologies, bringing with him the trading algorithm he had set up while working there. The stolen code in question was initially an open source code barely modified under the pressure of the bank to reach quick results.

Notwithstanding that Mr. Aleynikov had been cleared of all federal charges after having spent one year behind bars, Manhattan District Attorney Cyrus R. Vance Jr. took over the case and filed and a new suit against the programmer – New York v. Sergey Aleynikov, No. 004447/2012 (N.Y.C. Crim. Ct.).

Here again, on the first step of the judicial procedure, Mr. Aleynikov was found somewhat guilty of stealing the codes –i.e., the jury, confused faced of the complexity of the matter, reached a mitigate decision founding him not guilty of unlawful duplication of computer-related material, guilty of unlawful use of secret scientific material and deadlocked on another unlawful use charge. Even though the conviction stands, he is unlikely to serve any more time in prison.

Although outlandish, the Aleynikov case is not isolated in the High Frequency Trading history. Other programmers were arrested by Mr. Vance to whom intellectual property theft should be seen as physical property theft.

The District Attorney to say: “When an employee takes software to create his own company, anybody would classify that as “stealing” or “theft”; under existing state law, however, stealing valuable printer toner out of an office supply closet is a more serious offense than stealing valuable computer source code.”

Jason Vuu, Glen Cressman and Simon Lu, all in their mid-twenties, were arrested and prosecuted on similar counts – People v. Simon Lu et al., No. 03869/2013 (N.Y.C. Crim. Ct.). Vuu and Cressman were former employees of the Dutch trading house Flow Traders. All three ducked prison for pleading guilty and were fined and put under probation.

Kang Gao, former analyst for hedge fund Two Sigma Investments was however sentenced ten months in jail – New York. v. Kang Gao, No. 00640/2014 (N.Y.C. Crim. Ct.) –, a time that he had already served waiting for his judgement.














FINRA Arbitration Not Always Mandatory

For the Moment, FINRA Arbitration with Customers is Not Mandatory, So Say Two Federal Appeals Courts

In August 2014, the Court of Appeals in the 2nd Circuit (i.e., NY and CT) joined its brethren in the 9th Circuit (i.e., CA, NV, OR, WA, MT, ID, AK and HA) in holding that a FINRA member firm and its customer may agree to settle disputes in court and not in FINRA arbitration.  Meanwhile, the Court of Appeals in the 4th Circuit (i.e., MD, WV, VA, NC and SC) ruled the opposite in 2013 under similar facts.  Resolution of this circuit split would have to come from the U.S. Supreme Court – not a certainty.


FINRA Rule 12200 provides as follows:

Parties must arbitrate a dispute under the Code if:

  • Arbitration under the Code is either:

    (1) Required by a written agreement, or
    (2) Requested by the customer;

  • The dispute is between a customer and a member or associated person of a member; and
  • The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

[Emphases added.]

In 2013, the 4th Circuit rejected efforts by units of Citigroup and UBS (FINRA member firms) to block arbitration of auction-rate bond-related claims brought by Virginia-based Carilion Clinic. UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319 (4th Cir.2013).  Carilion had hired UBS and Citigroup to underwrite and broker its auction-rate bond offerings starting in 2005.  Carilion alleged that UBS and Citigroup misled Carilion by neglecting to mention that they had a practice of placing supporting bids in such auction, so as to prevent the failure of such auctions.  When such auction markets collapsed in 2008 and the brokers withdrew their supporting bids, Carilion lost millions of dollars when it was forced to refinance its debt at much higher rates.  Carilion filed statements of claim against UBS and Citigroup in FINRA arbitration in 2012, and UBS and Citigroup quickly filed in federal court to block same.

First, UBS and Citigroup effectively argued that Carilion was too sophisticated to be a “customer” under FINRA rules.  The 4th Circuit disagreed, finding Carilion to be a “customer” under FINRA rules.

Next, UBS and Citigroup argued that the forum selection clauses in the agreements with Carilion clearly said that district court in New York City would be the forum for disputes under the agreement.  The 4th Circuit held that FINRA arbitration rules mandating FINRA as the forum for disputes with customers trumped such forum selection clauses, especially since there was no specific waiver by Carilion of its right to arbitration.

In March 2014, the 9th Circuit essentially disagreed with the 4th Circuit’s holding in Carilion.  In an auction-rate security case, the court held that “the forum selection clauses superseded Goldman’s default obligation to arbitrate under the FINRA Rules and that, by agreeing to these clauses, Reno disclaimed any right it might otherwise have had to the FINRA arbitration forum.”  Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733 (9th Cir.2014).

In August 2014, the 2nd Circuit followed suit in yet two more auction-rate security-related cases, and took the unusual step of stating “We thus disagree with the contrary conclusion reached by the Fourth Circuit in Carilion Clinic.”   Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, No. 13-797-cv and Citigroup Global Markets Inc. v. North Carolina Eastern Municipal Power Agency, No. 13-2247-cv (August 21, 2014).  The 2nd Circuit held that, “Under our precedent, the forum selection clause at issue in these cases is plainly sufficient to supersede FINRA Rule 12200.”


These circuit splits mean that mandatory FINRA arbitration is alive and well in some parts of the country, but not others (including, as of August 2014, the important jurisdiction of New York).  These decisions remind both firms and their clients not to gloss over the standardized template language at the end of their agreements, especially forum selection clauses and integration clauses.

What the courts do not mention (nor need to, for their purposes) is FINRA IM-12000, which essentially gives FINRA enforcement power to pursue any member firms that “fail to submit a dispute for arbitration under the Code as required by the Code.” FINRA IM-12000(a).  It remains unknown as of this writing whether FINRA is investigating the above member firms for violations of FINRA Rule 12200, or will do so.  Firms like the ones above that fight FINRA arbitration as a forum for disputes with customers, do so at their own peril.

Motion to Strike Successful

Pastore & Dailey recently brought a successful motion to strike in Connecticut Superior Court against a former employee of a client (a major world-wide insurance company).  The Court’s decision included a finding that the former employee failed to articulate facts sufficient to support a claim of a fiduciary duty by an employer to an employee for a long-term incentive plan (“LTIP”).

PROCEDURE – The former employee sued the client over a year ago for further payments pursuant to the LTIP (the employee had already received several years of payments under the LTIP).  Pastore & Dailey first sent the former employee’s counsel a Request to Revise the Complaint, as we perceived the pleadings to be legally insufficient as written.  Opposing counsel for the former employee objected to the Request to Revise, but the Court overruled all of same, agreeing with Pastore & Dailey that the former employee needed to revise the Complaint per Pastore & Dailey’s Request to Revise.

The former employee’s counsel then revised the Complaint, but Pastore & Dailey filed a Motion to Strike with the court, again alleging that the pleadings in the Complaint were legally insufficient, as revised.  The parties had oral argument with the court a few months ago.

RESULT – Just recently, the court issued its decision, striking one of the counts per Pastore & Dailey’s motion, and indicating that another count is likely to fail, if Connecticut state law is found to apply.

In the count that was stricken, the Court stated that a mere “conclusory allegation” that the employer owed the employee a fiduciary duty under the LTIP was insufficient to overcome the Motion to Strike that count in the Complaint.

Regarding the count for an allegation of breach by the employer of an implied covenant of good faith and fair dealing, the Court stated such claim would also fail, should the Court ultimately determine that Connecticut law is the applicable law in this case.  (The Court stated that the choice of law question was not yet “ripe” at this stage of the proceedings.  But both the client and the employee are domiciled in Connecticut.)

Only a breach of contract claim otherwise remains in the Complaint.