U.S. regulators have grown so concerned that traders are using high-speed computers to manipulate markets that they’re planning a new tactic to clamp down on the practice -- rating brokers on how much spoofing they allow to flow through their order books.

The Financial Industry Regulatory Authority said it plans to issue report cards this year that will grade firms on how many phony bids to buy or sell stock they might have a role in facilitating. Finra, a market cop funded by Wall Street, expects brokers to use the assessments to root out any misconduct, the regulator said Tuesday in its annual letter on exam priorities.

To make money, spoofers flood the market with a series of fake orders to entice other traders and then cancel the orders once prices move in the direction they desire. Finra’s plan to write up report cards shows how deeply regulators fear the electronic bait-and-switch has infected trading following high-profile cases such as that of London’s Navinder Sarao, who was arrested in April after authorities accused him of spoofing that contributed to the 2010 flash crash for U.S. stocks.

The report cards will highlight instances in which potentially manipulative orders flow through a single broker and situations in which orders flow through multiple firms, Finra said. The assessments will focus on spoofing and another abusive practice known as layering, which also involves traders submitting orders that they have no intention of following through on.

Rigged Markets?

Efforts to reduce spoofing have gone global with both Chinese securities regulators and U.S. presidential hopeful Hillary Clinton proposing that traders pay a fee for habitual order cancellations. For every 27 orders placed on U.S. stock exchanges, about one is filled, according data from the U.S. Securities and Exchange Commission. In other words, approximately 96 percent of all orders sent to U.S. equity markets are never executed.

Critics of high-frequency trading have cited the industry’s reliance on canceled orders as evidence that markets are unfair, or worse, rigged.

David Fuller's view

The law of the jungle has always applied to financial markets, although that description is not fair to the many varied and remarkable creatures which populate a rainforest.  They do not have high-frequency trading software which stacks the deck against everyone else.  This allows front-running and spoofing which should be illegal and punishable, because it is stealing from other investors in very small individual quantities per trade but which reoccur many thousands if not millions of times per day. 

I have written about the plague of high-frequency trading for years, as veteran subscribers may recall, including the efforts of people like Brad Katsuyama, who featured in Michael Lewis’ excellent book, Flash Boys.

Bloomberg columnist Barry Ritholtz has also proposed sensible changes which would curb the worst excesses of high-frequency trading, including a one-second time delay on transactions and a fee of 0.01 cent on any orders, filled or not.  Here is Barry Ritholtz’s excellent column: Money Managers Go on Offense Against Speed Traders, which I posted on 30 October 2015. 

(See also: How regulators have cracked down on high frequency traders, from The Telegraph, although in my opinion this headline overstates what has actually happened)