SEC Tried to Make Markets Fair. Here’s What Happened.Nick Baker and John Detrixhe
Two decades ago, a system for sending U.S. corporate filings over the Internet was hailed as a victory for transparency. Today, the Securities and Exchange Commission’s Edgar website is engulfed by concern over opacity.
Researchers checking whether documents are distributed to investors fairly by the SEC found evidence that some paying subscribers got the information first. The commission is reviewing how data is disseminated by the service, which was activated during the Clinton administration as a way to broaden access to potentially market-moving data, a spokesman said.
This is what happens when a technology designed to solve problems in the 1990s becomes the focus of scrutiny so many years later, said Manoj Narang, the chief executive officer of proprietary trader Tradeworx Inc. Thanks to high-frequency trading, every detail of how data is broadcast to U.S. markets is being reviewed in probes by the New York attorney general, the FBI and the SEC itself.
“It’s extraordinarily likely that this is an error of oversight that’s completely unintentional,” said Narang, whose company helped the SEC build its Midas market surveillance system. “High-frequency trading and latency and things like that in the trading process have only been in the public’s consciousness for a few years.”
Public companies in the U.S. have used Edgar, the SEC acronym for its Electronic Data Gathering, Analysis and Retrieval system, since 1993 to make electronic filings. The system is designed to enhance the efficiency of SEC processing and “make corporate and financial information available to investors, the financial community and others in a matter of minutes,” according to its website.
According to a working paper, researchers from the University of Colorado and University of Chicago found evidence of a two-tiered system for distributing documents on corporate insiders buying and selling stock. Subscribers to feeds sold by an SEC contractor sometimes saw filings 10 seconds before people using the Edgar website, according to authors Jonathan L. Rogers, Douglas J. Skinner and Sarah L.C. Zechman.
“The time lag described in that research paper is extremely excessive,” Narang said. “It shouldn’t be the case that some can selectively get data faster than others.”
Speed advantages came up in a June speech by SEC Chair Mary Jo White, who said there should be a review of exchange services that send stock prices to customers faster than what’s available on public feeds. While calling for enhanced oversight, White has rejected characterizations of U.S. markets as being broken or rigged.
“The SEC should not roll back the technology clock or prohibit algorithmic trading, but we are assessing the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them,” White said in June.
Edgar was fully implemented in 1996 as a public repository for corporate filings such as annual reports, proxy statements and disclosures of buying and selling by company executives -- which have the potential to sway stock prices. The documents were made available on the SEC’s website and to outside firms to resell the data.
The information is sent through the SEC’s Public Dissemination Service, which posts the forms on the regulator’s website and sends it to outside firms. That function was overseen by NTT Data Corp. during the period examined by the University of Colorado and University of Chicago researchers. Attain LLC took over on July 1. Edgar receives as many as 12,000 submissions per day, according to the SEC.
Edgar’s PDS service began on Nov. 1, 1998, as a way to “provide the public an accurate, complete and fast method of obtaining all accepted and valid Edgar filings,” according to the SEC website.
(Bloomberg News parent Bloomberg LP redistributes SEC filings and is a subscriber to the SEC feed. Bloomberg News competes with other news organizations in reporting details in the filings.)
An examination of almost 18,000 filings by the University of Colorado and University of Chicago researchers found the commission’s Edgar system usually posted documents to its website after an electronic feed run by the outside vendor sent them to subscribers. The study of Form 4s, which track changes to stock holdings by company directors and officers, showed an average timing advantage of about 10 seconds.
“These results raise questions about whether the SEC dissemination process is really a level playing field for all investors,” the authors wrote.
“We have reviewed the working paper and are taking the issues raised by it seriously,” SEC spokesman John Nester said by e-mail. “We are conducting a thorough assessment of the dissemination process, including timing increments, and will make any systems modifications that may be necessary to optimize the dissemination of information to investors and the markets.”
The researchers found indications that share prices and volume changed in related stocks. In cases when paying subscribers saw filings before posting on the SEC website, stocks moved about 30 seconds before the documents were posted publicly. “Abnormal volume” was also measured 30 seconds before the Internet posting.
“This implies that the process through which company filings are disseminated via Edgar provides certain intermediaries and their clients with a significant timing advantage and that some market participants trade on this advantage,” the authors wrote.
The study stops short of ascribing a reason for the discrepancies, saying “it is unclear why there are delays in the posting of Form 4 filings to the SEC site.”
Speed advantages harm investors’ confidence in the financial system, said Peter Berdeklis, head of algorithmic trading at Maple Securities Group Inc. in Toronto.
“This kind of advantage has a very detrimental effect on markets generally, not just in the affected stocks,” he said. “Knowing that they are at a persistent informational disadvantage causes traders to avoid leaving resting orders in the market, making markets thinner and more prone to violent swings.”
Arthur Levitt, who was SEC chairman when Edgar was implemented, said he’s not surprised that the speed difference seems to have fallen through the cracks at the regulator.
“The SEC has a myriad of responsibilities and a Congress that has starved them dry,” Levitt, a board member at Bloomberg LP, said today during a Bloomberg Television interview. “I give them a pass for missing things from time to time,” he added. Amid the regulatory overhaul mandated by the 2010 Dodd-Frank Act, he said, “probably the Edgar system was one of the last things on their mind.”