For faculty members with retirement savings in TIAA-CREF or brokerage accounts, market events of summer 2015 might prompt the conclusion that August is the cruelest month of all. Along with millions of other small investors, academics throughout the United States could only watch helplessly as volatile markets took shareholders on a daily roller-coaster ride resulting in devalued accounts.
In the wake of the 2008 market crash, small investors have become increasingly educated about the structural and institutional drivers of extreme market volatility: automatic, computerized trading techniques over which the small, individual stakeholder has little knowledge or control. Most prominent among these market innovations has been the advent of computerized, high-frequency trading (HFT), driven by mathematical algorithms.
In her thoughtful and innovative comment, Too Fast, Too Frequent? High-Frequency Trading and Securities Class Actions, Tara E. Levens explores the interesting question whether the prevalence of HFT techniques resulting in massive financial losses to small-stake investors will open the door to new securities class actions. Her general conclusion is that current legal theories undergirding various types of securities law violations are mismatched with the harms induced by HFT. Consequently, Levens attempts to formulate a jurisprudence for new securities class actions based on the unique injuries resulting from HFT manipulation. In essence, Levens’ task is a riff on the theme of fitting new wine into old bottles.
Levens first describes the types of investor harms addressed under current securities laws, most notably liability for fraudulent misrepresentation under § 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934. She suggests that the harms induced by HFT are a poor fit for conventional securities fraud claims. Instead, she pivots to theories of open-market manipulation, which she believes better capture the factual basis for seeking relief.
She notes that plaintiffs may bring claims of open-market manipulation under § 10(b), although “such claims have received ‘curiously little attention’ from plaintiffs, prosecutors, and the courts.” (Pp. 1514–15.) She further suggests that plaintiffs might bring claims of open-market manipulation under § 9 of the Act, but such actions require a showing of specific intent. Because of the difficulty in pursuing relief under § 9, Levens indicates that plaintiffs and prosecutors rarely rely on this provision when bringing manipulation proceedings.
To provide context for her recommendations, Levens analyzes developments in securities class litigation, focusing on the Supreme Court’s elaboration of the fraud-on-the-market presumption that relieves plaintiffs of the necessity to show individual reliance in fraud cases. She suggests that the Court’s 2014 Halliburton decision changed the landscape of securities-fraud class litigation by enhancing the role of expert witness “impact studies” used to demonstrate the effect of an alleged fraud or misrepresentation on a stock’s price, which may determine whether the fraud-on-the-market presumption applies. However, she refrains from concluding whether the increased use of impact studies will benefit either plaintiffs or defendants, or result in more or fewer class certification approvals.
Against this doctrinal backdrop, Levens discusses in great technical detail what constitutes high frequency trading, a subset of algorithmic trading. She explains two types of HFT: market-making activities and more aggressive strategies such as statistical arbitrage. Levens’ article provides an intelligible, accessible account of HFT for less-knowledgeable readers. She concludes by surveying the heated debate over the effects of high frequency trading on market efficiency.
Levens highlights exactly how novel the problem of HFT is on the legal landscape. She notes that the SEC has yet to promulgate formal rules or regulations relating to HFT. According to Levens, the SEC increased its enforcement efforts after the Flash Crash of May 2010, but studies are inconclusive whether HFT or other factors triggered that market collapse. The SEC brought its first market manipulation case against an HFT firm only in October 2014. That action was pursued under Rule 10b-5 and the alleged perpetrator agreed to pay a fine and to cease and desist from further violations of the securities laws.
Levens believes that the spread of HFT and consequent market collapses has set the stage for a resurgence of the open-market manipulation theory. She suggests that plaintiffs who wish to bring claims against HFT firms might succeed by combining various theories of open-market manipulation with the fraud-on-the-market presumption; this hybrid strategy allows plaintiffs to avoid the more stringent intent requirements of § 9, while also availing themselves of the liberal fraud-on-the-market presumption to avoid potentially difficult reliance issues. Levens notes that the fraud-on-the market presumption generally has not been available to plaintiffs alleging market manipulation claims, but she contends that in some situations courts have held otherwise.
Finally, Levens addresses whether high-frequency traders ought to have a private right of action to redress their own injuries, something no commentator has addressed. While noting that traders do not represent the most sympathetic group of claimants, she indicates that traders also may suffer losses from HFT. Analyzing this problem, Levens concludes that HFT traders most likely will have a very difficult time satisfying the requirements for certifying a class action under Fed. R. Civ. P. 23, showing loss causation, or proving reliance.
As Levens correctly points out, HFT issues are likely to continue to surface in litigation, presenting litigants and courts with an array of novel legal problems. She concludes that “regardless of whether high-frequency traders come to court as plaintiffs or defendants, the advent of HFT marks a changed circumstance that the securities-litigation bar will have to wrestle with in the near future.” (P. 1557.)
Levens, the incoming Editor-in-Chief of the University of Chicago Law Review, has produced an impressively sophisticated piece. She has identified a set of emerging legal issues and grappled with existing doctrine as applied to new problems. Even if her hybrid approach proves unsound, she is to be commended for undertaking such an ambitious, challenging topic and, in the best tradition of young scholarship, thinking outside the box.