Structural Insider Trading
43 Pages Posted: 29 Mar 2015
Date Written: March 27, 2015
This Essay identifies a new and important form of insider trading on U.S. securities markets: structural insider trading. As milliseconds assume outsized importance in securities trading, exchanges have responded by allowing traders, often for hefty fees, to “co-locate” their own servers next to those of an exchange. This accommodation shortens the distance that information and orders must travel between traders and exchanges, shaving precious milliseconds off the time it takes to execute a trade. Importantly, co-location brings meaningful economic gains. Early sight of exchange data can help co-located traders to systematically outrun and outfox the competition. Structural insider trading refers to transactions performed by high-speed traders co-located on or near public exchanges.
Structural insider trading profoundly challenges the law and policy underpinning the prohibition against insider trading. For one, the prohibition appears to have little impact on structural insiders despite their consistently superior informational and bargaining advantages vis-à- vis other traders. Viewed as critical to efficient markets, co-location has flourished in open view of the public and regulators, negating taint of deception. However, structural insider trading exerts an enormous impact on the law and policy of insider trading. In allowing a select group of insiders to receive and trade on market-moving data ahead of other investors, structural insider trading weakens the ability of policymakers to impose expansive liability costs on corporate insiders under the prohibition. It also inverts the traditional deference given to investor protection over market efficiency as a guiding rationale for the prohibition. In the case of structural insider trading, market efficiency wins as a policy priority over investor protection. With these deep doctrinal and policy fissures, this Essay concludes by outlining implications for policy to reform the prohibition for modern markets.
Keywords: Securities regulation, algorithmic trading, high frequency trading, market efficiency, price formation, insider trading, fraud, disclosure, long-term investing, co-location, exchanges, value efficiency, financial stability
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