Goldman (GS) at Risk from High-Speed Trading? - Analyst Blog

Adding to growing concerns related to high-speed trading, The Goldman Sachs Group, Inc. GS revealed in its latest quarterly filing that the company is facing investigations regarding the practice. The company stands among several other defendants including high-frequency trading firms, securities exchanges and broker-dealers in a putative class action filed on Apr 18, 2014 in the U.S. District Court for the Southern District of New York.

The Charge

The class action has been brought on behalf of public investors who traded in the U.S stock market on a registered public stock exchange or on a U.S. based alternative trading platform since Apr 18, 2009.

The class action alleges that the securities exchanges together with the brokerage firms and the high-frequency trading firms resorted to inappropriate methods while carrying out business transactions. Further, they are accused of sharing non-public information with certain market players who capitalized on such information, causing manipulation in stock prices. Precisely, the defendants are alleged to have violated the federal securities laws related to market manipulation and insider trading.

Such fraudulent activities amounted to market rigging. Consequently, the plaintiffs traded at artificial manipulative prices instead of true and actual prices.

The defendants include exchanges like NYSE and NASDAQ, while Barclays PLC BCS, Credit Suisse Group AG CS    and The Charles Schwab Corporation SCHW were among other alleged companies.

High Frequency Trading: What's the Buzz?

With the advent of technology, trading has become much faster and easier. As a result, electronic trading is currently dominating the market.
 
With speed and algorithms, the high speed traders buy and sell securities within fraction of seconds, some times measured in microseconds, or millionths of a second. The main objective is to gain profit from the smallest price changes. This trading are not meant for the general public, rather these are carried on by high-frequency trading firms that use supercomputers specially designed for similar transactions. These firms get direct access to exchanges through their brokers' accounts - referred to as “naked access”.

However, in 2010, high-frequency trading was held responsible for wiping out hundreds of billions of dollars of market value in a "flash crash."

Following the release of Flash Boys: A Wall Street Revolt by Michael Lewis, that focused on the role of high frequency trading firms rigging the US stock market, the U.S. Federal Bureau of Investigation (FBI) and the U.S Justice Department (DOJ) announced investigations into high frequency trades for possible violations of the law. Also New York Attorney General Eric Schneiderman and the SEC and are undertaking similar investigation.

Where Goldman Stands

The class action mentioned that Goldman's brokerage division traded on behalf of the plaintiffs during the aforementioned period on stock exchanges and alternate trading venues. It also hinted at Goldman's own trading operations engaged in high frequency trading that once garnered about 10% of the company's total revenue.

Further, the class action mentioned that during the said period Goldman realized profits from defendants like NASDAQ and NYSE owing to transactions through its own trading venues including Sigma X.  Sigma X at present stands as one of the largest dark pools in the market.

Dark pools are private platforms wherein the secrecy of investors is guarded well in comparison to public exchanges. Notably, many dark pools offer access to their trade data to outsiders including high frequency trading firms. With increasing competition in the dark pool industry, the technical faults and issues have heightened the associated risks and raised concerns over the relationship that the high frequency firms and the dark pools share.

According to a report in The Wall Street Journal last month, Goldman was contemplating the closure of Sigma X. However, there has been no official revelation to date.

Bottom Line

Undoubtedly, any negative outcome of the investigations will force Goldman to stop such trading practices, which may result in lower trading revenues. In fact, it could be high enough to mar the total revenue. However, nothing can be certainly said until the extent of Goldman's involvement in high-frequency trading is known.