Illegal Practices of High-Frequency Trading (HFT) firms

In recent years, the Securities and Exchange Commission (SEC), the Federal Bureau of Investigation and other regulators have announced crackdowns on suspected wrongdoing by high-frequency traders. The potential offenses include:

Front-Running

Generally speaking, front-running refers to making a trade based on non-public advance knowledge of a large transaction. This practice is banned by the SEC and FINRA. In the debate around HFT, the term front-running has been used by some to characterize a practice where HFT firms deploy algorithmic trading technology to detect large incoming orders for a security, and then automatically buy the security before the original large orders are completed. Almost immediately after they buy the securities, the HFT firms can then profit by selling the securities to the original investors at higher prices. While such conduct may not be unlawful if not based on material non-public information, there are questions about the value it provides and the extent to which it should be regulated.

Spoofing

Spoofing is an illegal trading tactic that involves the manipulation of a security’s price in order to profit off the resulting price movement. Here's how it works: The spoofing trader puts in a large order to buy or sell a security at an artificial price. Market participants who see that order may also offer to buy or sell the security at the same price. In the meantime, the trader cancels his or her order and takes advantage of others' offers, buying the security at a below-market price and selling it at an above-market price.

The practice was explicitly addressed by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and even before then FINRA rules prohibited the use of manipulative or deceptive quotations, but published reports indicate that spoofing continues to distort securities pricing. While spoofing isn't exclusive to high-frequency trading, the first criminal spoofing case announced by lawmakers did involve a high-frequency trader: Prosecutors in Illinois charged a Chicago trader with spoofing futures markets in 2014.

Layering

Layering is a form of spoofing in which a trader (or an algorithmic trading program at his disposal) will place multiple orders at varying price points, to create a false impression of the amount of interest in that security. The trader places new buy or sell orders to take advantage of the artificially low or high prices. As with general spoofing, following the beneficial execution, the trader then cancels those orders after they've helped artificially inflate or deflate the security's price. Because of ever-evolving technologies, such major market manipulation can occur within fractions of a second. But also as with general spoofing, layering is generally unlawful and prohibited by FINRA rules.