Remarks By Attorney General Eric T. Schneiderman to the 2013 Bloomberg Markets 50 Summit
September 24, 2013
Thank you. And thank you for being here. I have to congratulate Bloomberg News – this year’s Bloomberg Markets 50 Summit is a remarkable array of speakers and panels, and I am honored to be here with you.
I want to speak very briefly about a specific matter that is on my mind and I want to get on everyone’s radar screen, and then I’m going to go to questions, which is always the most fun part of appearances in front of audiences as sophisticated as this.
The issue I want to speak briefly about is something that Matt Winkler, Bloomberg Editor-in-Chief, who is going to be joining me for a conversation shortly, is very familiar with. And I have to start out by saying, as the Attorney General of New York State and as the first Attorney General in modern history to have spent more of my career in the private sector – in private practice – than in government work, I feel very strongly the need to restore and preserve public confidence in our financial services sector.
I come to this as someone who has spent a lot of years representing the American stock exchange, Merrill Lynch – a blessed memory – commodities firms’ and traders. And I must say it was a matter of serious concern to me when I started campaigning around the state and realized the low esteem which the financial services was held then in 2010 by New Yorkers, and to this day, it has not recovered from that. So, one set of rules for everyone is an important point, not just for those of us in the government. I think that for public confidence, that there is a set of rules for all, is tremendously important to the integrity of our markets and to restoring public confidence.
The American way is to give everyone a shot at success – individuals, giant corporations – everyone has to be able to use their brains, their guts, their insights and efforts to succeed – that is what our markets are suppose to provide. We understand that it is also very much a part of our tradition to seek every possible legal way to beat the competition. That’s a good thing. But that drive has to be guided by clear, intelligent rules and we have to protect our markets to make sure that no one starts out with an unfair advantage, or able to do whatever you can do to get an edge. But there is something about having a starting line that everyone has confidence in that is important to me.
And for most of the past century we’ve had rules – not always crystal clear – prohibiting insider trading. The average American thinks of insider trading as something done by Gordon Gekko,gobbling up companies using information no one else has. And traditional insider trading involves the buying and selling of security while in possession of material, non-public information about that security. That’s something lawyers have been billing hours about ever since Albert Wiggin, the head of the Chase National Bank, shorted his own stock in 1929, and millions and millions of hours have been billed by generations of lawyer in working out the precise parameters of insider trading.
Today I think we need to revisit some issues relating to this much litigated and scrutinized territory because we’re seeing something far more insidious than traditional insider trading. Small but powerful groups within the market are able to use soon to be public information combined with high frequency trading in a way that distorts our markets far more than Albert Wiggin or Ivan Bosky or even Gordon Gekko could ever have imagined. And this combination of high frequency trading with access to non-public information with a tiny sliver of advanced notice is what we call Insider Trading 2.0 in my office.
A new generation of market manipulators has emerged. And to put it in terms of a road race, old fashioned insider trading involved maybe a few people sneaking out ahead of the starting line. The new road-rigging, market-manipulating Insider Trading 2.0, it almost involves – you have to imagine it – folks that can move the starting line closer to the finish. The other competitors feet are still in the blocks – they don’t know the starting line has been moved.
And believe it or not, back in the 1960s, people held their stocks for an average of five years, which allowed them to build value, and now the average holding period is estimated at less than five days. In a small majority of cases, some experts estimate that it is less than one minute. And ladies and gentlemen no one buys stock because of value. No one invests in stock for a few hours or a few days to build a company to develop a product. This is just inconsistent with the basic ideas of our markets. And it’s also something that I think is necessary for us to address if we are going to, as I say, restore public confidence.
When I was a kid, everyone wanted to be in the market. I mean, the sign of success was you own your home and you have a portfolio of stocks. Normal average Americans thought that they and their brokers, if they were prudent, had an opportunity to buy low and sell high as the big time Wall Street players did. And the new market manipulators – the new folks that do something that would be unimaginable a decade ago – they refer to those average Americans as the dumb money. And ladies and gentlemen, a lot of us here may very well be a part of that dumb money because if you don’t have access to a supercomputer capable of flipping tens of thousands of shares in milliseconds, and access to market moving information a little bit ahead of everyone else, you may be in the dumb money, even if you think you’re an insider who thinks they have an edge.
When blinding speed is coupled with early access to data, it gives people the power to suck value out of markets before it even hits the rest of the Street. So, the power to skew data, to give you a concrete example, was exactly the service that Matt’s old friends at Thomson Reuters provided to select customers using data from the University of Michigan Consumer Survey.
The reason my office began an investigation into this was our emerging awareness of the problems of Insider Trading 2.0, and I am sure some of you have heard about that investigation. Thomson Reuters was selling investors access to the University of Michigan’s surveys, market-moving information, five minutes before it was released to the general public. But Thomson Reuters was also selling to an even more elite group of clients an earlier glimpse and, for an substantial extra fee, these elite market movers were allowed to see the data two seconds before the customers who thought they were first in line who got it five minutes before the general public.
Two seconds is a lifetime in the world of Insider Trading 2.0.
Here’s an example of what happened before and after we reached an agreement with Thomson Reuters, which I’m very pleased we have done pending the outcome of our investigation to stop giving that two second edge. In July of 2012, when this practice was still going on, tens of thousands of shares of an S&P 500 ETF were traded in the magic two-second window before the University of Michigan Survey was released. That’s July 2012. One year later, after our agreement, the trading virtually stopped. Tens of thousands of shares came to down to less than two thousand shares traded during that two second window.
Again, it isn’t just the investors who get shut out of the trades who are hurt by this. I believe this hurts the markets as a whole. And again I have many, many friends, family, former clients on the Street. I talk to them all the time, and I feel that they sometimes live a little bit of a life inside of a bubble. No one is going to invest if they think the markets are rigged. Average Americans are not going to support intelligent, sensible regulations – non punitive regulations that are done intelligently – to allow for liquidity and allow markets to succeed if they believe this is just a rigged casino. We have to address the issue and that’s why my office intervened here. We’re pleased that Thomson Reuters agreed to hold up on the two second trading advantage pending the outcome of our negotiations and investigations.
But obviously our concern does not end with that firm. We are aware of the fact that others may be engaged in similar practices we are looking into that as well. One related problem that we are concerned about and are investigating has to do with early access to analyst assessments – analyst assessments about the companies they cover – because, like the University of Michigan survey of consumers, analyst sentiment is market-moving information. A firm with access to analyst assessments before they’re officially released, or before they are even released to a select group of customers, can front run the market and gain an unfair advantage over the competition. And when a firm can accomplish that systematically and plug early data into a high-frequency trading program, the unfair advantage can provide an enormous windfall and do enormous damage to the market.
Let me also note that, even in the absence of market manipulation, high-frequency trading posses secret challenges in our current regulatory scheme. Securities and Exchange Commissioner Mary Jo White, who is with us today, deserves credit for getting major stock exchanges to agree to a circuit breaker that would halt high-speed trades during emergencies. But that agreement, which includes NASDAQ and the New York Stock Exchange was reached just two weeks ago.
And everyone in this room, I hope, understands how disruptive these activities can be. In May 2010, and I remember this very distinctly, a single large cell program in an unusually turbulent trading day resulted in a frenzy of trading that sent the market spiraling out of control and the term “flash crash” entered our national lexicon.
This past April, to take things even a step further and underline the point, the things that are not even thought of as traditional insider information can be very dangerous when combined with high-frequency trading. There was a hacked Twitter report, reporting to call attention to a political event, which were explosions at the White House. This set off a wave of panic trading. And the report was immediately discredited, but not before the Dow lost 143 points in less than a minute.
This August, a technical glitch halted all trading on the NASDAQ for three solid hours, and I still don’t believe if we have gotten an explanation for that mysterious interruption. That was one of the things that gave impetus to the idea of a circuit breaker, which I think was a very critical first step. But it is not enough.
I am aware, and you are all aware that Washington is a hard place to do business these days. I urge everyone to, if you are represented by someone who is a non-Tea Party congressman of either party, please give them a hug whenever they return from Washington. I’ve never quite seen- And I’m not some political neophyte. I did some hard time in the New York State Senate. I have never seen anything like Washington right now.
But we have to do the best we can in all these circumstances. There are a lot of regulators and prosecutors who are trying to address these new emerging issues in spite of gridlock. But at some point, a more comprehensive solution is required. Fortunately, here in New York – and we’ll talk about this more in the Q & A – the Martin Act empowers my office to do things that our federal counterparts can’t do. And that’s really why we were able to break through the gridlock and strike a deal with Thomson Reuters. And that's why we are investigating others in this area of Insider Trading 2.0. And we can bring a lot of weight of the law to bear. We do want broader participation by our federal and state counterparts.
Agreements like the one we struck with Thomson Reuters are solid steps toward restoring confidence in the markets. We also, frankly, need more leadership from the business community. In every sector- This is one of the lessons I learned very quickly as attorney general. In every sector, the good actors are our best source of information about the bad actors. Whether you’re in the construction industry, or the hospitality industry, or dealing with issues of public integrity and corruption, you need cooperation from the good actors.
I hear a lot of the time from friends on the Street that there are concerns of high-frequency trading. But I see very little being done by the industry to addresses this clear-and-present danger. And the combination of that high-frequency trading with early access to information I think is something that has to be on all of our agendas. I don’t just want to keep hearing anecdotes from my friends about it – I would like to see industry leadership as well as leadership from the federal government.
My office has a hotline for financial industry insiders to report any activities that combine high-frequency trading with early access to date. We’re focused on it, very intently. But it’s a problem we can only solve if we work together.
I would urge you to get this on the agenda of any trade association group or at your own firm. We all need to get on the same page, and we need to work together if we’re going to address this.
I am not someone who believes in doing things “my way or the highway” – I like to work collaboratively. But sometimes everybody – whether it’s in government or the private sector – needs a nudge. We’re prepared to give you guys a nudge. We’re prepared to give all of the folks on the Street a nudge.
We need to address this problem together.