If it were run-of-the-mill criminal prosecutions, a couple of investment banks would not be so nervous. At stake is their bread-and-butter; i.e., profits from high frequency trading. Two former traders, Sergey Aleynikov and Samarth Agrawal, were accused of stealing proprietary software codes when they left Goldman Sachs and Societe Generale, respectively. Mr. Agrawal was convicted last week of software theft in his trial. Judge Rakoff, who presided over the trial, was so perplexed at Agrawal’s sworn testimony that he remarked that Mr. Agrawal appeared to be defending himself by appealing for sympathy from the jury. Mr. Aleynikov’s trial is about to start. Somehow, Goldman got the FBI to arrest Mr. Aleynikov within 48 hours after they realized he had stolen their software algorithms. Such a feat is impossible for mere mortals, but not for Government Sachs. Even more impressive is how the FBI and the prosecutors have jealously guarded the purloined proprietary code as if it was Fort Knox .
It is obvious that Aleynikov and Agrawal would not have copied the proprietary software codes and risked their freedom unless the software was of extremely high value. What market orders do the software algorithms execute in order to derive this value? What is the functionality? Prosecutors in the Aleynikov case have asked the presiding federal court judge, Judge Denise Cote, to close the proceedings off from the public. This request shows how protective the government is of Goldman Sachs and should be cause for concern in itself. Judge Cote should deny the request. She should have done so as soon as prosecutors made the motion. Sunlight is the best disinfectant and needs to shine brightly on this trial.
What is it that these banks and prosecutors do not want us to know? Why would Goldman say that the stolen software could be used to “manipulate the market in unfair ways”? Are we supposed to infer from this comment that the software is safe only if it is in Goldman’s hands? That is a bold statement coming from one of the most distrusted firms on Wall Street. Could it be that a gang of thieves blew the whistle on a fellow thief, who tried to abscond with the combination of a safe that holds the money of investors? The gang called the cops who arrested the thief before he could turn over the combination to a rival gang that could use it to crack open the safe. Is it a crime if a thief steals illegal goods from another thief? Wouldn’t both parties be guilty of stealing?
We know of many ways in which high frequency trading can be used to cheat investors. See www.nytimes.com/2009/07/25/business/25trading.html?_r=1&scp=11&sq=flash%20high%20frequency%20trading&st=Search and investmentwatchblog.com/the-wave/ for some examples. Does the criminal justice system even care if the purloined software is used to manipulate the market? In course of their investigation, did the FBI or the SEC bother to see if proprietary software could be used to bilk investors through the use of computerized front-running and pump-and-dump manipulative trading? If not, who is telling the FBI and the SEC to look the other way? Could it be that the ranks of the SEC are so infiltrated with former Wall Street employees that it is impossible for them to meet their responsibilities and protect innocent investors from the depredations of Wall Street high frequency traders? Has our watchdog turned into a lap dog?
The whole edifice of high frequency trading is emitting a bad odor and has for some time. The more one looks at the practice, the more one suspects that a scandal of biblical proportions lies behind the massive profits generated with statistically impossible regularity. When one couples this suspicion with the reluctance of the SEC to regulate high frequency trading, one may be pardoned for suspecting foul play on a scale that makes all former financial scandals mere child’s play.
Since high frequency trading accounts for 70% of market volume and 70% of the profits of Wall Street investment banks, it follows that a scandal involving high frequency trading would shake the very foundations of our financial system. Main Street ’s confidence in Wall Street is at an all-time low. Americans believe the market is rigged and that big Wall Street investment banks and hedge funds cannot be trusted. High frequency trading tilts the playing field in favor of Wall Street and the government appears to be protecting the traders at every turn. If a mega-scandal breaks out in this sour environment, it would be the mother of all scandals. See investmentwatchblog.com/high-frequency-trading-a-trilogy-of-angst/.
In fact, high frequency trading has grown so big that the government cannot control it, never mind ban it, without bringing down the entire market. See investmentwatchblog.com/the-market-is-cornered/. The tail is wagging the dog. If high frequency trading is severely curtailed or banned, 70% of market volume would dry up. Market liquidity would evaporate along with it and so would stock prices. As frightening as this may be, the alternative is worse. A perverted and distorted market militates against everything a capitalist system stands for. It is better to purge the system of the poison than allow it to consume us. There is a point where things are so corrupt that the system implodes in on itself. Americans sense we are near a tipping point. It is never a good idea to take sides against America , whether it is Wall Street or our own government.