United States: Flash Claims; Financial Institutions

Targeted for High Frequency Trading
Last Updated: November 3 2014
Article by Edward J. Kirk

Following the March 31, 2014 release of Flash Boys by Michael Lewis, an all-too-familiar story is playing out on Wall Street, this time focusing on high frequency trading ("HFT"). As in past financial scandals, the publicity surrounding HFT has fueled a growing wave of regulatory activity followed by investor lawsuits, and could result in significant claims under financial institution insurance policies. To date, these matters have arisen in the US, but similar investigations and lawsuits may eventually spread to other jurisdictions.

This article discusses HFT practices, the regulatory response, investor lawsuits and the potential impact on financial institution insurers.

High Frequency Trading practices

HFT involves the use of technological tools and computer algorithms to rapidly trade securities. In order to capture small profits on a large volume of trades, traders utilise trading models and computer programs to move in and out of positions in fractions of a second. This allows HFT firms to make enormous profits with virtually no risk. Proponents contend that HFT benefits securities markets by increasing liquidity and leveling the playing field.

Regulators and investors, however, allege that HFT firms often employ HFT with other strategies to electronically manipulate securities markets and obtain improper gains, including "front-running", "trading ahead", "latency and rebate arbitrage", "co-location", "pinging", "spoofing" or "layering", and "contemporaneous trading." While not all of these practices are illegal, they may constitute violations if used to manipulate the markets.

Regulatory investigations and actions

Long before Flash Boys, HFT was the subject of regulatory scrutiny. In early-2009, analysts questioned whether HFT firms had an unfair advantage, and the SEC considered the need for tighter controls on HFT.

On May 6, 2010, US stock markets lost and then recovered hundreds of points, all within a few minutes. Regulators later determined that HFT firms exacerbated the price declines and some commentators blamed HFT as the cause. This so-called "flash crash" further increased regulators' interest in HFT.

Following Flash Boys, authorities further increased their scrutiny of HFT and particularly the use of privatelyowned alternative stock trading platforms called "dark pools." In March 2014, New York Attorney General Eric Schneiderman (the "NYAG") announced an investigation into HFT practices as part of his "insider trading 2.0" initiative, and shortly after issued subpoenas to HFT firms regarding dark pools. The FBI and CFTC are also examining HFT practices, and the SEC has disclosed that it has multiple ongoing investigations into dark pools. Congress has held a number of hearings on HFT, and new HFT regulations are expected.

On June 25, 2014, the NYAG announced that he had filed fraud charges against Barclays for alleged misrepresentations it made to clients trading in its dark pool. The NYAG contends that Barclays reassured those clients that it would protect them from predatory HFT while it actively sought to attract such traders to its dark pool. At least three other European banks, UBS, Deutsche Banc and Credit Suisse, have reported that the NYAG is examining their dark pools.

Private civil lawsuits

Predictably, HFT quickly caught the attention of the plaintiffs bar in the spring of 2014. Investors have already filed an increasing number of lawsuits across the US against exchanges, brokerage firms and HFT firms.

On April 18, 2014, the City of Providence filed an ambitious lawsuit (the "Providence Action") on behalf of a massive plaintiff class against 16 stock exchanges, 14 brokerage firms and 12 HFT firms in the Southern District of New York ("SDNY"). The court later consolidated three similar lawsuits with the Providence Action.

Many of the allegations in the initial complaints closely tracked Flash Boys. The plaintiffs essentially alleged that by utilising non-public information and manipulating the securities markets through HFT, the defendants diverted billions of dollars from investors. The complaint described various types of manipulative, self-dealing and deceptive conduct, and alleged that the defendants paid each other kick-backs.

On September 2, 2014, five lead plaintiff institutional investors filed an amended complaint in the Providence Action. The amended complaint dropped many of the defendants, but named Barclays and seven stock exchanges. The allegations focus on the exchanges and Barclays' operation of its dark pool. According to the amended complaint, the defendants "paved the way" and incentivised the illicit activity of high frequency traders, allowing them to "prey on less sophisticated investors." The lead plaintiffs seek to represent a broad class of investors who traded on the defendant exchanges or in Barclay's dark pool between April 18, 2009 and the present.

The amended complaint asserts causes of action for violations of §§10(b) and 6(b) of the Exchange Act and SEC Rule 10b-5, and seeks, among other things, unspecified compensatory damages, restitution, disgorgement and forfeiture of illicit fees.

At the pleading stage of the Providence Action, the plaintiffs will need to overcome significant hurdles. Motions to dismiss are due on October 31, 2014, and the defendants will likely argue for dismissal on a number of grounds. For example, the defendants may argue that the amended complaint does not allege actionable misrepresentations or omissions as many of the practices were disclosed or otherwise known to investors. Also, the defendants may argue that their conduct was not manipulative and the plaintiffs have not sufficiently pled fraudulent intent as many of the alleged practices are not prohibited under applicable regulations, have been approved by the SEC, and benefit the markets and investors. Further, statute of limitation defences may apply as much of the alleged conduct occurred at an early date and may have been known to investors. With respect to the §6(b) claim, the defendants may argue that there is no private right of action under that provision.

If the amended complaint survives a motion to dismiss, the plaintiffs will have other significant challenges before trial, including class certification and the defendants' summary judgment motions. In particular, the plaintiffs may not be able to demonstrate that common class-wide issues predominate over individual issues with respect to the broad plaintiff class. Also, it may be difficult for the plaintiffs to prove causation and damages.

Investors have filed additional securities class actions against Barclays, as well as separate lawsuits against stock exchanges for securities law violations, breach of contract, common law fraud, aiding and abetting, constructive trust, unjust enrichment and violations of the Sherman Antitrust Act and the Commodity Exchange Act. Plaintiffs will likely file new lawsuits in the wake of regulatory actions and further disclosures about HFT practices, and continue to test different theories of liability and damages in various courts across the US.

Potential impact on insurers

Financial institutions and exchanges targeted by HFT regulatory investigations and investor lawsuits may seek insurance coverage under D&O, Professional Indemnity and other policies. While these matters are in their preliminary stages and the ultimate exposure is difficult to predict, those entities might seek reimbursement of significant defence costs and sizeable settlements or judgments.

Depending, of course, on the particular circumstances and contract terms, a number of coverage defences may arise. For example, in view of the early regulatory activity, coverage defences may arise relating to the timing of the conduct and the insured's prior knowledge, including whether the claim was first made in the policy period, whether notice was timely and whether the insured disclosed HFT risks in the underwriting of the policy. As many of the lawsuits seek disgorgement or restitution and allege fraud, whether the claims allege insurable "Loss" or are barred by public policy may be significant issues.

Further, the HFT matters may trigger a number of policy exclusions, including with respect to, among other things, dishonest or fraudulent acts, improper personal gain or advantage, professional services, regulatory claims, notice to prior insurers and prior wrongful acts. Finally, additional coverage issues may arise with respect to other insurance clauses and allocation of costs between covered and uncovered loss or parties.

In view of the potential exposure and related coverage claims, financial institution insurers should closely track developments with respect to HFT litigation, regulatory actions and new regulations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions