An individual investor calls his broker and requests $100,000 of a certain stock for his portfolio. The broker sees that shares of that stock are currently being offered at $10 a share, and that there are 4,000 shares available on the New York Stock Exchange (NYSE), 3,000 on NASDAQ, and 3,000 on the BATS Global Exchange, for a total of 10,000 shares. Satisfied with his ability to fulfill his client’s request, the broker hits “submit”— only to find that these offerings have disappeared and that the cheapest offering price of the stock is now above $10 a share, resulting in a purchase of fewer than the expected 10,000 shares for his client.
This rapid, blink-of-an-eye increase in price is but one side effect of high-frequency trading (HFT), the newest technology to affect the stock market. Because the broker in our story was located at different physical distances from the NYSE, NASDAQ, and BATS servers, the various pieces of his order reached each exchange at different times. Due to faster fiber-optic cables and closer proximity to the exchanges’ servers, high-frequency traders saw the first portion of the broker’s order on one exchange, registered that he was interested in purchasing that security, bought it themselves on the second exchange, and offered it back to the broker at a higher price when his request reached the second exchange—and so on, until his order was filled. As a result, after the broker completed the order, his client ended up with fewer than the anticipated 10,000 shares due to the increased share price—all because high-frequency traders saw the order coming.
HFT has been gaining traction in the marketplace since the late 2000s and will likely continue to increase its share over time as investors seek access to higher speeds and faster trades. Along with the advantages of increased speed, however, come many negative effects for investors still utilizing slower, moreconventional electronic trading strategies. Such investors, stung by lost profits and increased prices, have begun to seek protection and relief through the federal securities laws—but how likely are their claims to succeed? And, in the event that HFT becomes a standard practice among investors, how should litigants in securities class actions react to this new technology?