“We have to capture every trade now,” O’Brien said. “In today’s markets it’s all about analyzing patterns and contexts.”
Yet given how rapidly fraudsters can change their methods to hoodwink human beings, outwitting surveillance software could be even easier. Algorithms are sophisticated but they’re incapable of determining whether a flurry of buy and sell orders are legitimate or unlawful.
“The surveillance tools are merely the first line of defense,” said Haim Bodek, founder of Decimus Capital Markets, a New York-based algorithmic investing firm. “These tools can help bring suspicious activity to the attention of regulators, trading venues and brokers, but they’re a poor substitute for a compliance program that monitors activity across affiliated accounts and groups of traders.”
Even when the technology does uncover possible skulduggery, it takes years to adjudicate cases because prosecutors need to prove the intent of traders. In December 2010, surveillance analysts in the London office of Bats Global Markets Inc. used Smarts to figure out how a trio of traders in Hungary were spoofing the shares of a small Australian mining firm. The spoofers drove down the stock price with phantom sell orders, scooped up the shares, and then goosed the price with phony bids, according to a civil suit brought against them by U.K. regulators.
Five Years
“They were trying to suck people into the marketplace,” said Michael Aitken, a professor of information and communications technology at Macquarie University in Sydney who founded Smarts in 1994.
It took five years to wrap up the case. On Aug. 12, a British judge ruled the traders had violated market-abuse laws and fined them 6.1 million pounds ($9.1 million).
However long these cases take, the cat-and-mouse game between watchdogs and spoofers is poised to intensify next year. Cinnober and Scila AB, another Stockholm-based player, are installing a trading-surveillance system at the New York Stock Exchange that will replace many of the monitoring functions performed by the Financial Industry Regulatory Authority.
Aiken said it’s only a matter of time before spoofers begin manipulating the prices of securities and derivatives contracts in multiple markets at the same time, including dark pools.
“If you can influence prices in one market and trade somewhere else, then let’s see who catches you,” Aitken said.