A Physics Breakthrough, Or A News Leak?

As far as we know, it is impossible to send information faster than the speed of light.

Yet according to trading data reviewed by CNBC, some traders in Chicago had early access to the content of the Federal Reserve’s announcement last week that it would not scale back its monetary stimulus program. The data suggests certain traders received the relevant information faster than it should have been possible to transmit from Washington. The advantage of milliseconds allowed $600 million in assets to change hands, by some estimates, before other Chicago-based traders could react.

Assuming no news organization has rewritten Einstein’s theory of relativity, the trading activity implies that the rules of the Federal Reserve’s “lockup” may have been broken.

Such a scenario was on my mind last year when I wrote about increased security standards for journalists who get an advance look at market-moving information. That column had to do with information released by the Labor Department, but the point is the same. Government agencies allow journalists the courtesy of early access to news in exchange for their promise not to release such information before the designated time.

As I observed then, the government does not exist to serve the press; both institutions exist to serve the public. Allowing reporters the time to digest the news and prepare their reports is done in the name of the public good. But even with the relatively new security procedures in place, and though the press has overall had a very good track record in respecting so-called embargos, some potential for abuse is probably unavoidable.

Eric Hunsader, founder of the market analysis firm Nanex, spotted the unusual trading pattern in Chicago. He told CNBC that the culprit was probably using a “low-latency” service, which feeds data directly into computerized trading systems, since humans are incapable of reacting usefully at the millisecond level. CNBC, in reporting the story, suggested that “A key question is whether or not any organization transmitted information out of the lockup room and into its own computer system before 2 p.m. If that was done, the data could have been moved to computer servers near Chicago before 2 p.m. and publicly released the information from there at precisely 2 p.m.”

The Fed has declined to say whether, if this is what happened, the move would technically be a violation of its rules. Whether or not it would be a violation of the rule as written, however, the outcome is one the Fed’s staff clearly took active steps to prevent. If a news organization took advantage of a loophole this time, I would expect at minimum that the loophole will be promptly closed. Given that broadcast journalists cannot say anything beyond one government-provided test word before the appointed time, and reporters with a phone line open to their newsrooms must remain completely silent until the appropriate moment, it should be clear to any observer that a transmission of any kind, public or otherwise, was not supposed to occur until the moment journalists got the go-ahead.

News organizations have a high opinion of their own importance to the public. Most of the time, that opinion is justified – but not to the extent that it gives the press the right to make certain people wealthy at others’ expense, whether deliberately or otherwise. Yet when someone has a chance to trade on data before the rest of the world, this is precisely what the press facilitates.

If the Fed had meant to allow news organizations to cue up its stories on servers outside the lockup room in Washington, that intention would have been made clear. Almost certainly, though, this incident violated the intent – if not the precise rules – of the Fed’s embargo.

I hope the Fed gets to the bottom of the apparent leak. If the press was responsible, it may be time for government officials to reconsider whether they want to release market-moving data under an embargo at all. The other option is to release the data on a public website, and let whoever can process and report it fastest reap the benefits. At least that competition would be fair.

About Larry M. Elkin 553 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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