Financial Services

Financial services professionals understand their industry is subject to ever-increasing
scrutiny. So do we. New initiatives like the Justice Department’s Financial Fraud
Enforcement Task Force and the Consumer Financial Protection Bureau highlight this

Ifrah Law offers financial services professionals industry know-how and legal
exceptionalism. We have a track record for trying and winning cases across venues
and successfully concluding matters with, for instance, the Department of Justice, the
Securities Exchange Commission and the Commodities Futures Trading Commission.
Our clients include individual brokers, hedge fund managers, financial advisers to
financial companies, community banks and national lenders.

Ifrah Lawyers welcome the challenge of complex matters, so often the mark of financial
services cases. Our team consists of a former special assistant U.S. Attorney, a
former assistant U.S. Attorney and Manhattan Assistant District Attorney, and highly
experienced veterans from some of the nation’s largest and most respected law firms.

As important as our legal prowess is our understanding of your business and your
concerns. We keep in mind the collateral consequences to your professional life and to
your company. We know how to balance aggressive legal tactics with practical concerns
in order to represent you most effectively, and recommend strategies that put you at the
least personal and professional risk. And we stay with you and your case throughout the
entire process, representing you from start to finish.

Clearing SEC Charges Against a Former Securities Broker

When the U.S. government pushed Frederick O’Meally, the former Prudential Securities Inc. broker pushed back – and won.

Ifrah Law partner David Deitch acted as co-lead counsel in obtaining a jury verdict, rejecting claims by the U.S. Securities and Exchange Commission that O’Meally defrauded 60 mutual fund companies. The jury also rejected the SEC’s negligence claims with respect to 54 of the funds and found only that O’Meally was negligent in his conduct with respect to six of the funds.

Mr. O’Meally had fought the SEC for eight years, claiming his innocence and sticking up for his rights. The SEC asserted that the mutual fund companies had tried to prevent O’Meally from market timing on behalf of his clients, and that he had continued doing so through deception involving multiple account numbers and numerous financial advisor identifying numbers used in trades. But after a four-week trial, the jury found that the defendant did not commit any intentional fraud against the mutual fund companies. Evidence at trial showed that O’Meally had not misused these tools and that, in fact, all of his trading practices had been approved multiple times by his supervisors, by Prudential Securities lawyers and compliance personnel, and even by outside regulators.

The O’Meally case was one of the very small number of SEC compliance cases that go to trial each year, and one of an even smaller number of cases in which a jury has completely rejected SEC claims of fraud. While Prudential Securities and a number of other brokers targeted by the SEC negotiated settlements, Ifrah Law was part of the team that helped Frederick O’Meally vindicate his claims that he was innocent of the SEC’s fraud accusations.

(Securities and Exchange Commission v. O’Meally, No. 06-Civ-6483 (LTS) (S.D.N.Y.), No. 13-1116 (2d Cir.) )


Obtaining a Reversal of Conviction and Sentence Reduction for Securities Fraud

Ifrah Law represented a former executive, Stuart Wolff, who was indicted for securities fraud. During a six-year battle with the U.S. Attorney’s Office for the Central District of California, the trial and appellate teams worked together
to secure a reversal of the client’s conviction and a new trial.

In the months leading up to the second trial, the defense team, which included Jeff Ifrah of Ifrah Law, leveraged irregularities with discovery to obtain dismissal of all charges related to PricewaterhouseCoopers, Homestore’s former accounting firm. As a result, the sentence on remand was reduced by 70 percent relative to the sentence imposed after the first trial.

Jeff Ifrah was the only attorney Mr. Wolff retained from the beginning of the case to its conclusion. Mr. Ifrah began managing the legal team after the first trial, continued through the appellate process, and also in the team’s preparation for trial on remand.

Jeff Ifrah was responsible for formulating and executing the strategy that resulted in the 70 percent reduction of Mr. Wolff’s sentence.

(U.S. v. Wolff, Case No. 2:05-cr-00398 (U.S. District Court, Central District of California))


Obtaining a Winning Verdict After a Business Relationship Dissolves

Our client, Learning Annex, is a national leader in the post-secondary education industry. In three decades of business success, it has established many professional relationships. After Learning Annex created a unique strategy to promote the business of a financial self-help guru through free preview seminars and found a perfect partner for the execution of that strategy, those parties then cut Learning Annex out of the deal. Ifrah Law was part of the legal team that helped Learning Annex vindicate its rights.

David Deitch of Ifrah Law was co-counsel in a lengthy jury trial in the United States District Court for the Southern District of New York in which Learning Annex sought to recover the value of the services it had provided under theories of quantum meruit and unjust enrichment. The jury found in favor of Learning Annex and awarded damages of over $14 million, which together with pre-judgment interest totaled over $20 million. The court upheld the verdict on liability, but ordered a new trial on damages. After a retrial of damages in April 2012, a second jury awarded Learning Annex even more: $15.8 million plus interest.

(Learning Annex Holdings, LLC v. Whitney Education Group, Inc., No. 09- Civ-4432 (SAS) (S.D.N.Y.))


What Expats Need to Know Now about their Taxes, FATCA and the IRS


Are you an American abroad living in perpetual fear of the IRS? Do you wake up every morning wondering if today you’ll receive a formidable notice that the taxman cometh? You are not alone. Expats around the world are facing (and fearing) the painful reality that the IRS’s global tax enforcement effort is underway. While you may want to stick your head in the sand, a brief review of where we are and how we got here may encourage you to confront your IRS situation.

It started in 2010 with the passage of the Foreign Account Tax Compliance Act. FATCA was billed as an effective way to tackle offshore tax evasion. The legislation requires foreign financial institutions (FFIs) to report on U.S. taxpayers’ accounts or face hefty withholding penalties on transactions passing through the U.S. Affected institutions include not only banks, but any entities substantially engaged in holding or investing financial assets for others. These institutions are required to comply with the law regardless of conflict with the laws of their home country. That means FFIs have been put in the position of potentially violating local data privacy or bank secrecy laws or getting hit with significant penalties on funds passing through the States.

While the PR for the legislation presented it as an important means to tackle rich and greedy tax cheats, the reality is that FATCA impacts a lot more people than Swiss banking billionaires. The legislation has plenty of repercussions for the seven million plus U.S. citizens living abroad. Suddenly, dual citizens with negligible ties to the U.S. (say, they were born in the States but haven’t lived in the U.S. since infancy) realize they are supposed to be reporting their income and assets to the IRS, regardless of foreign location. Many of the unwitting lawbreakers and quiet law deniers have been waiting out the storm, not seeking resolution with the IRS as they think FATCA is not a fixed reality.

There is good reason why some people have hoped FATCA would be repealed, overturned, or perhaps ignored by other countries: (1) the conflicts between local laws and FATCA reporting requirements, (2) the significant costs to FFIs to implement FATCA compliance programs, (3) the unintended consequences to average expats that makes the legislation politically unpopular. The Alliance for the Defense of Canadian Sovereignty launched a legal challenge to FATCA in the Canadian courts. U.S. super lawyer, James Bopp Jr., has helped Republicans Overseas launch a challenge to the law in U.S. courts. And Senator Rand Paul has reintroduced legislation to effectively repeal the law. One would think Senator Paul’s efforts should get traction since there is a Republican-controlled Congress and the party has made FATCA repeal a part of the Republican National Committee platform. But power assumed is hard to retract.

Meanwhile, implementation of the law has trudged on. After a few delays, the law took effect July 1, 2014, and reporting has begun. More than 100 countries have entered treaties (intergovernmental agreements) with the U.S. to facilitate reporting and to get around local law conflicts. Countries with data privacy laws have agreed to have FFIs report to local tax authorities who in turn will report to the IRS. Even countries known for bank privacy protection and bank secrecy (like Switzerland, Hong Kong, and Austria) have agreed to comply with FATCA, eliminating secrecy for U.S. taxpayers.

Paving the way for large scale reporting, the IRS recently launched its web application, the International Data Exchange Service (IDES), for FFIs and foreign tax authorities. IDES is supposed to allow these FFIs and tax authorities to submit U.S. taxpayer information efficiently and securely by an encrypted pathway.

With treaties in play, reporting underway, and technological platforms built, the chances of FATCA getting repealed, overturned, or ignored are dissolving. This is especially true as more countries take their cues from FATCA and consider their own global tax enforcement efforts. Moving in this direction, the Organization for Economic Cooperation and Development has issued a new standard to facilitate intergovernmental sharing of financial data.

Expats that are behind on their IRS reporting need to face this fact and bite the bullet before they shoot themselves in the foot. It is important to address options, like whether or how to use the IRS’s Online Voluntary Disclosure Program or whether and how to renounce U.S. citizenship (note, you’ll still have to pay up for past deficiencies). But the reality is that FATCA is in force and the IRS is invested in ensuring all U.S. taxpayers comply. You may disagree in principle and you may (and perhaps should) advocate for repeal or revision. But in the meantime, find a way to face Uncle Sam.


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More Money, More Problems – Another Billion Dollar Settlement for the DOJ


This summer BNP Paribas, one of the five largest banks in the world, agreed to a $9 billion settlement with the U.S. Department of Justice. The settlement figure may seem nothing short of economic shock and awe; indeed it was the largest criminal penalty in U.S. history. What could justify such a staggering fine and was the DoJ too heavy-handed in its tactics against the French-based bank?

The $9 billion figure was not created out of thin air. It correlates to the value of transactions that BNPP helped to push through the U.S. financial system on behalf of Sudanese, Cuban and Iranian interests. These countries have been subject to U.S. sanctions under the U.S. International Emergency Economic Powers Act (IEEPA). The sanctions restrict, among other things, trade and investment activities involving the U.S. financial systems, including processing U.S. dollar transactions through the States. BNPP chose to ignore those sanctions. What’s worse, the Statement of Facts that the DoJ published with its press release states that BNPP used cover payments to conceal the transactions it processed through its New York location and other U.S.-based banks. It also removed identifying information about the sanctioned entities and used complicated payment structures in order to prevent the transactions from being blocked when transmitted through the U.S. BNPP helped to finance oil and petrol exports for both Sudan and Iran. And the bank’s involvement in Sudan has been instrumental to the country’s foreign commerce market. All told, BNPP’s actions effectively undermined the U.S. sanctions, opening the U.S. financial system to those countries.

BNPP’s actions justify DoJ prosecution as U.S. authorities certainly have jurisdiction over U.S.-based activities. A stiff penalty also seems in order, given the bank’s blatant disregard for both the legal violations and their ramifications. The DoJ quotes a May 2007 BNPP Paris executive memorandum: “In a context where the International Community puts pressure to bring an end to the dramatic situation in Darfur, no one would understand why BNP Paribas persists [in Sudan] which could be interpreted as supporting the leaders in place.”

But did the DoJ go too far when it imposed $9 billion in sanctions? As of the date of the settlement, the fine more than doubled the enforcement agency’s highest criminal penalty on record. (Of course, big settlements with banks are becoming the norm: the DoJ recently settled with Bank of America for $16.5+ billion and with JP Morgan Chase for $13 billion.) The $9 billion penalty may not have had the desired impact of shock and awe the U.S. may have sought. Instead of being perceived as a show of force with a deterrent effect, some of the international community has reacted with disdain. Not surprisingly, this includes the French, who have been quite vocal about their feelings. The French Foreign Minister, Laurent Fabius, said the fine was an unfair and unilateral decision.” The French Finance Minister Michel Sapin questioned its legality by pointing out that the offending transactions were not illegal under French law.

It is not as though the U.S. is jumping across the pond and punishing a French bank on French soil for activity in France.  The actions in question took place through U.S. markets and therefore make U.S. prosecution justifiable.  But the French finance minister’s statement demonstrates the U.S.’s waning credibility abroad. Sapin did not stop at the BNPP settlement – he went on to question the entire monetary regime based upon the U.S. dollar: “Shouldn’t the euro be more important in the global economy?” The U.S. should not ignore this growing antipathy. Nor should we take for granted our economic or political authority. Examples like this settlement, or the largely resented Foreign Account Tax Compliance Act, may not be seen as a show of force but rather as an act of bullying. As we throw our weight around, others are considering whether the cost of doing business with us is just too high. If we keep it up, we could find ourselves at a table of one.

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FATCA: Trapped by the Land of the Free?


The Foreign Account Tax Compliance Act (FATCA) has been billed as the U.S.’s bold effort to go after tax dodgers and cheats. The picture painted is that of greedy rich people secreting their fortunes in offshore accounts and away from poor Uncle Sam. But this is not a fair representation of FATCA’s impact or reach. Since the law took effect July 31, there is increasing blowback as people of varied means are feeling the repercussions.

One of the most publicized reactions is a lawsuit filed in Canada by two Canadian-American citizens with negligible ties to the U.S. In their suit against the Canadian Attorney General, the plaintiffs contest the validity of the Canada-U.S. agreement to enforce FATCA in their country. The plaintiffs claim that the agreement violates provisions of the Canadian Charter of Rights and Freedoms and that it undermines the “principle that Canada will not forfeit its sovereignty to a foreign state.” The complaint, drafted by notable Canadian attorneys Joseph Arvay and David Gruber, alleges that Canada’s enforcement of the U.S. law violates affected people’s right to liberty and security by:

– failing to protect them from unreasonable search and seizure, and

– discriminating against them on the grounds of their country of birth.

The plaintiffs, Virginia Hillis and Gwendolyn Louise Deegan, are U.S. citizens through no willful action. They were born in the U.S. but both left the States for Canada when they were five years old. Neither has a U.S. passport and neither has significant contacts with the U.S. They are what you could call “Accidental Americans” – people who happen to be citizens because they were born here but otherwise identify with another country of citizenship. The plaintiffs hardly fit the image of the fancy tax cheats FATCA purports to target.

Here are some examples of people falling under FATCA’s umbrella of U.S. tax cheats:

(1)   Accidental Americans – dual citizens with nominal ties to the U.S. (e.g., they were born in the U.S.) who have not opted to undertake the tedious and costly process of renouncing citizenship. The group includes others who only recently learned they are U.S. citizens – many thought they effectively renounced citizenship but find themselves repatriated through changes in U.S. law or policy.

(2)   Snowbirds – citizens of other countries (generally Canadians) who think they do not face U.S. tax liability because they spend less than 183 days a year in the U.S. The 183-day maximum has been understood by many to be the U.S. tax code’s threshold to avoid tax liability. However, they are learning that the threshold is not so straightforward.  A “substantial presence test” also factors U.S. presence the year prior and year subsequent to a tax year, reducing the amount of time people can regularly visit in the U.S. without tax penalty.

(3)   Non-Americans who have ever worked in the U.S. or appear to have a “substantial” connection to the U.S. Since the law does not fully define what “substantial” means for reporting purposes, lots people are getting swallowed up into compliance and reporting requirements.

But also getting caught up in compliance requirements are Non-Americans who have joint accounts with a U.S. citizen, such as non-American spouses and “at-risk” trusts and investments with no U.S. ties. A recent article by the U.K.’s Telegraph noted that thousands of British families’ trusts are being reviewed for possible ties to the U.S. Many of these are run-of-the-mill family trusts. Regardless of outcome the customers are being billed for the review some £200-500 (roughly $300-750).

Compliance costs for the 77,000 + financial institutions worldwide that have signed onto to FATCA enforcement are staggering. It has been estimated that the 30 largest non-U.S. banks alone will be saddled with $7.5 billion related expenses. These costs are going to have to be absorbed by someone… and will invariably be passed on to those institutions’ customers in the form of increased fees for products and services.

FATCA is an expensive headache for Americans and non-Americans, financial institutions and foreign governments. It is running roughshod over other countries’ privacy laws, banking laws and national sovereignty. While these countries and banks have buckled to U.S. pressure because otherwise they would face 30% penalties on U.S.-generated payments, some may start to consider whether compliance is worth it. As highlighted in the Huffington Post, the Japanese Bankers Association is weighing whether divesting of U.S. assets may make better economic sense. Not only may countries sever their U.S. ties, U.S. citizens are renouncing their citizenship in record numbers. In a sign of poor-sportsmanship, the State Department has recently raised fees for renunciation more 400%, from $450 to $2,350; Senator Charles Schumer (D-NY) has introduced a bill to double exit taxes. Who would have figured that the U.S. would become the “Hotel California” from the 1972 Eagles’ album: you can check out anytime you like, but you can never leave.


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The Taxman Cometh for US Holders of Foreign Bank Accounts

U.S. citizens and residents with unreported assets abroad may be feeling a steady increase of pressure these days. The July 1, 2014 effective date of the Foreign Assets Tax Compliance Act (FATCA) is looming. The number of countries that have agreed to enforce FATCA is growing (almost daily). That means the banks in those countries will be required to report U.S. citizens’ assets to the IRS. It seems inevitable that if you don’t report your income and assets, your bank will. This point has been reinforced through bank-issued letters, from foreign banks to their U.S. clients, notifying those clients of the impending reporting requirements. If you want to stick your head in the sand or hide in a dark corner, we feel your pain, but we highly recommend against denial. The consequences of doing nothing could be severe – from staggering monetary penalties to jail time.

Taxpayers who are behind in reporting foreign assets and paying taxes on foreign-based income have a few options before the gloom and doom of the taxman cometh. Since the passage of FATCA in 2010, the IRS has offered citizens three rounds of its Offshore Voluntary Disclosure Program (OVDP), whereby taxpayers can reconcile their status with the IRS through reporting assets, paying past due taxes, interest and penalties. The penalties can be fairly steep – 27.5% on unreported assets alone – but they are preferable to an enforcement action by the feds. For taxpayers considered low risk, i.e. those that owe less than $1500 a year, the IRS offers a Streamlined OVDP that is penalty-free and involves a less onerous reporting process.

Below we provide some additional detail on who should consider making a date with the IRS, what steps to take, and possible consequences of doing nothing.

Who Is Covered:

U.S. citizens and residents with foreign accounts who have failed to file U.S. tax returns, failed to report income from foreign accounts, failed to file a report on foreign assets (FBAR), or failed to file other forms on foreign-based assets (e.g., Form 3520 on foreign trusts, Form 5471 on controlled foreign corporations, Form 926 on transfers of property to a foreign corporation, or Form 8865 on interest in foreign partnerships), need to address what and how to report to the IRS.

Foreign assets that must be reported include (1) accounts containing $10,000 or more of assets at some point during the tax year in which you have a financial interest or over which you have signature authority (FBAR); (2) your interest in assets worth at least $50,000 on the last day of the tax year or $75,000 at any time during the tax year (Form 8938). The problem for many is that what constitutes a foreign asset is somewhat broad and includes not only foreign accounts, stock, and mutual funds but also foreign partnership interests, debt issued by a foreign person, interests in foreign trusts or estates, and certain derivative instruments with a foreign counterparty.

Options Available:

If you have unreported foreign-based income or assets that pass the threshold amount outlined above, the time is right to consider the disclosure options currently offered by the IRS. The IRS’s website provides guidance on several options available to taxpayers, based upon the level of failed disclosure.

à Delinquent FBAR Filing: Those who reported all taxable income, but were not aware of the need to file an FBAR on foreign assets can file an FBAR with an explanatory statement. There will be no penalty for those who fall under this category.

à Delinquent CFC/Foreign Trust Filing: Those who reported and paid tax on all taxable income associated with a controlled foreign corporation or foreign trust, but failed to file Forms 5471 or 3520, may file these forms with an explanatory statement. (The IRS notes that Form 5471 should be submitted with an amended return.) Provided there were no underreported taxes, the IRS will not impose any penalties.

à Streamlined OVDP: Non-resident taxpayers (i.e. only citizens living abroad) owing less than $1,500 per year in taxes may file delinquent returns and related information returns for the last three years, and delinquent FBARs for the past six years, including tax and interest due.  These taxpayers will also need to file additional information for the IRS to ascertain compliance risk. The IRS will review these submissions to confirm they are low-risk (i.e. that amount owed is less than $1,500 per year). If confirmed, the IRS generally will not impose any penalties beyond interest owed. If the IRS determines you are a higher risk, then you may be subjected to a more intensive review, including additional tax years, and may be required to file according to the standard OVDP (below).

à Standard OVDP: Taxpayers who have failed to report foreign accounts and income, especially those who seek to avoid criminal prosecution, may participate in the OVDP, which is structured like a civil settlement. Those taxpayers will pay an offshore penalty (instead of other penalties at the IRS’s disposal). This program involves several steps: (1) the taxpayer must submit a request to the IRS to be accepted into the program; (2) once accepted, the taxpayer must submit many items, including amended tax returns with schedules outlining unreported income for past eight years, FBARS, and information returns for the previous eight years; (3) the taxpayer must submit full payment of all tax and interest due along with penalties (including a penalty of 27.5 percent of the highest aggregate balance of foreign assets held over the last eight years, and a penalty of up to 40 percent of taxes owed on unreported income from foreign accounts). Note that if you disagree with the penalties, you may opt out of the settlement and request a mitigation of penalties (in limited circumstances, some taxpayers will qualify for a five percent or 12.5 percent penalty). You may also choose to opt out if statutory penalties would be lower under relevant laws (which should be reviewed on a case-by-case basis).  Taxpayers who opt out are still protected from criminal prosecution.

à Quiet Disclosures: A final option, which is neither offered nor suggested by the IRS, but which some taxpayers attempt, is to simply start disclosing foreign assets and follow normal reporting requirements without addressing delinquent reports from prior years. Some taxpayers may choose to file amended returns under normal reporting procedures. These quiet disclosures are generally not recommended, as they do not safeguard the taxpayer from an IRS enforcement action, including criminal prosecution. They may at least trigger an IRS audit, which can come with stiffer penalties than those incorporated in the voluntary disclosure programs.

A Couple of Caveats:

If the IRS has already contacted you requesting information or already initiated an investigation, it is too late to follow any of the programs outlined above. As the name suggests, the programs are strictly “voluntary.” Also, the IRS may choose to close down its voluntary disclosure programs at any point. Many out there are warning taxpayers to file with the IRS right away before it is too late.

Although, a minor point of observation: while it is possible that the IRS will determine that it will get all the information it needs through FACTA bank disclosures, it is also likely that the agency will be happy to let the taxpayers do the work for them: to volunteer information and pay fines without the need to expend resources on investigators and prosecution. However, the more delinquent you are in taxes owed, the more likely the IRS will seek stiffer action and penalties. Therefore, if you are significantly behind on taxes owed, be aware that you are a more likely candidate for criminal prosecution. See, for instance, the growing list of former UBS clients who have faced incarceration and hefty fines for tax avoidance.

Why Make A Disclosure?

Some taxpayers may have a high risk tolerance and choose to take a chance that their foreign accounts will not be reported. Or they may think the IRS will be sufficiently inundated with new information from FATCA-compliant countries that it will take years for the IRS to identify them… and by that time perhaps FATCA will be repealed. While a number of activists and politicians have been working hard to repeal FATCA, the reality is, it is probably here to stay. Because dozens of international agreements have been signed, and once the legislation takes effect, it will be very, very difficult to unweave this work and convince the government to relinquish its new power. Taxpayers should presume FATCA is here to stay and reconcile their finances with Uncle Sam.

As of May 2014, more than 50 countries have agreed to comply with and enforce FATCA. (Some countries are enforcing the American law as a part of information share agreements with the U.S. whereby the U.S. will also report information on those countries’ citizens. Other countries are enforcing the American law to avoid the harsh withholding penalties that non-compliant countries would otherwise face.) This means that the financial institutions in these countries will be required to report income and asset information to the IRS. Finding a place to park your money outside of Uncle Sam’s purview is nearing impossible.

And the consequences of the IRS initiating an audit or enforcement proceeding against you are invariably going to be more severe than the voluntary disclosure programs (otherwise, what would be the incentive to disclose?). For those severely behind in IRS reporting, the protection from criminal prosecution should be one of the biggest carrots of the voluntary disclosure programs, especially as the IRS steps up its initiatives to help offset a perilous budget deficit. In the last five years, federal prosecutors have brought more than 100 criminal cases against taxpayers with unreported income overseas. FATCA enforcement will likely increase this number significantly. Regardless of political, philosophical, or moral objections you may have to accept Uncle Sam’s reach abroad, unless you want to risk your estate and possible jail time, the time is right to make an appointment with counsel to address your situation with the IRS.

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Are High Frequency Traders Playing Fast and Loose With the Rules?

When high frequency trading (HFT) first crept into the public consciousness, it related to primarily to the question of whether rapid, computer driven trading posed risks to the safety and stability of the trading markets.  Now it appears that HFT may have also been a means for some traders to gain a possible illegal advantage.

High frequency trading involves the use of sophisticated technological tools and computer algorithms to rapidly trade securities.  High frequency traders use powerful computing equipment to execute proprietary trading strategies in which they move in and out of positions in seconds or even fractions of a second.  While high frequency traders often capture just a fraction of a cent in profit on each trade, they make up for low margins with enormous volume of trades.

High frequency trading is viewed by many as particularly risky.  While some participants disagree, the Securities and Exchange Commission and the Commodity Futures Trading Commission issued a report in which their staffs concluded that algorithmic and high frequency trading contributed to the volatility that led to the May 6, 2010 “flash crash.” 

More recently, high frequency trading has come under scrutiny by law enforcement.  A number of agencies are investigating such practices to determine whether high frequency traders are profiting at the expense of ordinary investors.  The Justice Department and the FBI have recently announced investigations, while U.S. securities regulators and the New York Attorney General have said that they have ongoing investigations.

Heightening the recent HFT craze is renowned author Michael Lewis, who recently authored Flash Boys:   A Wall Street Revolt. In the book, Lewis claims that computer-driven stock trading has taken over the market at the expense of ‘the little guy’. According to Lewis, Wall Street is rigged by a combination of insiders – stock exchanges, big Wall Street banks and HFT. Lewis claims that HFT’s advantage is so severe that traders are able to predict which stock a common investor wants to buy before he or she can buy it, and drive the price up before the investor can initiate the purchase.

Not everyone is buying the claims Lewis makes in his book.  There have been many on record stating that HFT actually does not prey on mom and pop investors. Additionally, many individualsbelieve Lewis’ claims are overblown and that HFT does not provide traders with a huge profitable advantage.

Inevitably, the most pressing question about high frequency trading is whether any such businesses are given an unfair – and illegal – advantage in placing trades.  On April 11, three futures traders filed a federal class action lawsuit against CME Group, the owner of the Chicago Mercantile Exchange and the Chicago Board of Trade, claiming that high frequency traders are given an improper advance look at price and market data that permits them to execute trades using the data before other market participants.  While the plaintiffs claim that this practice has existed since 2007, CME denies the merits of the allegations.

Between the investigations and this lawsuit (and the others that will certainly follow), it will eventually be determined whether traders with high speed computers benefited improperly over other market participants.  Regardless of the merits of these accusations, it is unquestionable that high frequency trading, like all technological advances, poses special challenges to existing rules and laws that will require special consideration and possibly require new rules and regulations.

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