Friday, September 21, 2012Last Update: 5:32 PM PT

SEC's Competence Called Into Question

MILWAUKEE (CN) - A Wisconsin company claims in court that the SEC is withholding evidence of "a large securities trading fraud ... in the 'high-frequency' trading industry," and may be doing so to disguise its own incompetence. In a federal FOIA complaint, EMM Holdings claims the SEC denied its request for "records of consumer complaints, no-action letters, interpretive letters, records compiled in any and all investigations, consumer complaints, and staff comment letters in relation to Quantlab Securities." It claims the documents will shed light on whether the SEC actually "understands and is competently pursuing malfeasance in the HFT [high-frequency trading] industry." EMM Holdings is a nonbank holding company, according to its complaint. The complaint states: "Through other litigation, plaintiff believes it has uncovered a large securities trading fraud scheme and/or a systematic use of unfair advantages (herein 'malfeasance') by those engaged in the 'high frequency trading' (HFT) industry. Plaintiff believes the global securities markets would be well-served by exposing malfeasance by market participants." EMM states: "Quantlab Securities is a large HFT enterprise, having reported revenues of over $165 million in 2010 alone. There is reason to believe they have or are engaged in some malfeasance. First, of course, are defendant's acknowledgements that there is an ongoing investigation or proceeding relating to Quantlab Securities. Second, Quantlab Securities and its related companies have been repeatedly fined for submitting faulty Order Audit Trail (OATs) records to the Financial Industry Regulatory Authority (FINRA). These records are exactly what their name describes: a paper trail that allows regulators to re-create a market participant's past actions. By repeatedly submitting faulty reports, it is plausible that Quantlab Securities was engaging in a systematic cover-up of their securities trading patterns to escape regulatory attention. The information sought by plaintiff would corroborate the belief that Quantlab Securities engaged in market malfeasance to make enormous profits. Discovering and exposing such malfeasance is crucial to ensure confidence in the global markets. Further, the sought records will shed light on whether defendant understands and is competently pursuing malfeasance in the HFT industry." High-frequency trading is "an extremely complex securities trading method that uses powerful computers to transact a large number of trade orders at very fast speeds," the complaint states." HFT participants use advanced and continually changing algorithms to analyze multiple market factors and execute trade orders based on these factors." EMM adds: "The combination of huge profits with highly-complex methods and technology has created a perfect storm for malfeasance: the defendant and other regulators cannot possibly understand the HFT industry they are charged with regulating. Therefore, if there exists any evidence of malfeasance by HFT participants, this information must promptly come to light. More attention to the HFT industry will allow the entire public, including others in the financial industry, to share their knowledge, expertise, and perspective as to wrongful or questionable tactics used by HFT participants. Moreover, if the sought records uncover regulatory inaction then public scrutiny and pressure should come to bear on defendant." According to EMM: "The HFT industry has become a major force in the global financial markets while remaining impenetrable to public understanding and regulatory supervision. HFT activity constitutes somewhere between 50 percent and 75 percent of all securities trades made on the public exchanges. A handful of large HFTs are alleged to account for more than 10 percent of any given day's trading volume. Importantly, the massive profits obtained by HFTs come at the expense of long-term 'mom and pop' investors, pension funds, and mutual funds." In its denial letter, the SEC said it was withholding the information under Exemption 5 U.S.C. § 552(b)(7)(A) and 17 CFR § 200.80(b)(7)(i). "This exemption protects from disclosure records compiled for law enforcement purposes, the release of which could reasonably be expected to interfere with enforcement activities," the SEC wrote. EMM doesn't believe it. It wonder whether the SEC is really investigating Quantlab. "Given defendant's near complete abdication of its prosecutorial duties during the 2008 financial crisis, inaction and delay may unfortunately have become defendant's modus operandi for dealing with complex financial malfeasance. Discovering whether there has been a capitulation by regulators in their supervision of the HFT industry is a primary goal of plaintiff in this matter." EMM wants to see the records it requested. It is represented by Daniel Morgan Adams of Milwaukee.