Following the release of Michael Lewis’s book about high frequency trading, Flash Boys: A Wall Street Revolt, multiple putative class action lawsuits were filed against the stock exchanges relating to their agreements with certain traders that permitted high frequency trading. Recently, a federal judge for the Northern District of Illinois followed the Southern District of New York’s lead and dismissed one such lawsuit, concluding that the investors failed to state actionable claims in Braman v. CME Group, Inc.
High frequency trading uses sophisticated computer algorithms to engage in trades at extremely high-speeds, and without human intervention, so as to exploit small changes in stock prices before other market participants are even aware of the price changes. High frequency traders often enter into “co-location agreements” with the stock exchanges that allow the high frequency traders to place their computer servers at the same location as the stock exchanges’ servers, which in turn allows the high frequency traders to access price data and place orders milliseconds faster than other market participants. This difference in the time between when a high frequency trader can see the data and make a trade and when other market participants have access to the data is known as the “latency loophole.” This latency loophole gives high frequency traders the chance to place buy or sell orders based on advanced notice (of only a few milliseconds) of which way a stock price is moving.
The plaintiffs in Braman alleged that the Chicago Board of Trade and the Chicago Mercantile Exchange (the “exchange defenants”) entered into agreements with high frequency traders that gave the traders exclusive advantages that were concealed from other traders, effectively creating a two-tiered trading structure that permitted the high frequency traders to engage in predatory tactics. The Braman plaintiffs brought a putative class action and alleged causes of action for violations of the Commodity Exchange Act (the “CEA”) and the Sherman Antitrust Act, fraud, and unjust enrichment. The district court determined that the plaintiffs’ allegations failed to state a manipulation claim under Section 9 of the CEA because any artificial effect on the market would have been caused by the high frequency traders, not by the exchange defendants or any of their co-location agreements. In other words, without the actual trades by the high frequency traders, there would have been no impact on the market. In doing so, the district court relied heavily on a recent opinion from the Southern District of New York, In re Barclays Liquidity Cross and High Frequency Trading Litigation, which considered a similar lawsuit brought against seven stock exchanges, including the New York Stock Exchange and NASDAQ, and determined that the alleged activity did not violate Sections 10(b) or 6(b) of the Securities Exchange Act.
The district court also concluded that the Braman plaintiffs failed to state an actionable false information claim under the CEA because the exchange defendants made no false statement to the Commodity Futures Trading Commission, and the plaintiffs failed to allege that the exchange defendants knew that any high frequency trader was violating the CEA to give rise to an aiding and abetting claim under the act. Plaintiffs’ fraud claim failed because the alleged fraudulent representation that all traders receive data “from one pipe” was technically true. As to plaintiffs’ antitrust claims, they also failed because the plaintiffs did not show any unreasonable restraint on trade—in fact, the agreements between the high frequency traders and the exchange defendants actually promoted trade—or any barriers to entry that existed for the exchange defendants’ competitors. While high frequency trading may face continued scrutiny from government regulators, such as the SEC, the Commodity Futures Trading Commission, and the Department of Justice, the Braman and Barclays decisions demonstrate that private lawsuits brought against the stock exchanges themselves will have to allege more than just an environment of high frequency trading if they are to be successful.