The Two Second Head Start: Implications of Exclusive Access by Private Companies to Publicly-Funded Research

On June 12, 2013 it was revealed that news agency Thompson-Reuters has been giving a small and elite group of stock market traders access to the highly-influential “Consumer Sentiment Index” (CSI) through high-speed data connection two full seconds before releasing the report to its other paying customers at 9:55 a.m., and before it publicly releases the data to the general public at 10:00 a.m. on the day of its release (Javers, 2013).

This case study presents two ethical problems.  First, the unethical act of Thompson-Reuters in secretly offering an advantage to its wealthiest clients over all other paying clients.  Second, it serves as an example of the larger problem of private sector profit from the products of taxpayer-funded public institutions.

Secret Advantages

The CSI was first developed by Professor George Katona at the University of Michigan in 1940.  It has grown into a monthly randomized survey of US consumers that assesses participants’ view of their own financial situation, as well as their short- and long-term views of the US economy.  It has a significant impact on not only stocks and bonds, but on the value of the US Dollar.  Its findings are even folded in to the Leading Indicator Composite Index by the US Department of Commerce, Bureau of Economic Analysis.

Insider trading (the practice of making trades based on relevant information about companies traded in the stock market) has decidedly negative consequences on the markets in which it occurs.

In recent decades, as technology has evolved the pressure to pass information about the stock market has increased multifold.  Stock tickers and telephones have given way to computers, algorithms and high-speed Internet connections.  The vast majority of all trading on the stock market (as much as 74 percent) is no longer done by human beings, rather bids are placed by computer algorithms running at lightning speed.

Image: Racerun

Image: Racerun

A two-second delay sounds insignificant, but with today’s hardware it may as well be an eternity.

Presently there is a digital arms race as trading firms seek faster access to the networks in the geographic locales where markets are located.  The pressure to eke out mere milliseconds of efficiency has driven some companies to invest in expensive microwave beam transmission systems which offer an advantage over traditional buried fiber-optic cable (which allow data to travel 4.6 milliseconds faster from Chicago to New York).

To that end, CNBC reported that in the two-second window between 9:54:58 and 9:55:00 the volume of trades spiked considerably.  To wit:

On May 17 [2013], for example,trading volume exploded in the Spider ETF at exactly 9:54:57.975. More than 100,000 shares traded hands in the first ten millisecond of the burst of activity, reports the analysis firm Nanex, LLC. Within less than 100 milliseconds, the price of SPY jumped from $165.90 to more than $166.06. (Javers, 2013, par 12).

Thompson-Reuters asserts that it publicly announced that this two-second advantage existed, however the disclosure was buried on an infrequently-visited section of its website under several layers of navigation.  Several economists contacted by CNBC’s Eamon Javers were unaware that this delay existed, and when it came to light former Securities and Exchange Commission Chairman Harvey Pitt was quoted as saying:

“I worry that there’s both a fairness and a disclosure issue […] if I’m paying a lot of money, I should know whether I have the best deal possible. If there was no disclosure of the tiered structure, that would be a serious problem” (Javer, 2013, par. 9).

Aside from ethical concerns, there are practical consequences for this sort of manipulation of information.  This early access to information mirrors the situation that arises in Insider Trading, when a party with advance knowledge of relevant information is able to profit from that knowledge.  Numerous studies have documented the negative effects on the overall market from insider trading.  It extends from the damage to a lost of opportunity for individual investors, to damage to the reputations of trading firms.  Perhaps the most compelling is the possibility of market failure:

Akerlof [1970] has shown that a market characterized by unconstrained opportunism in the presence of asymmetric information can result in a market failure. This market failure need not be a total collapse of the market (as pictured by Akerlof), but may instead be a narrowing of the market. (Cho and Schaub, 1991, p. 88).

In addition to threatening the stability of the overall market, there is another issue at play that similarly damages the public as a whole; the transfer of public resources to private corporations.

The Threat of the Tech Transfer Boom to Academic Freedom and Research Quality

The sale of once-public data to a private corporation for the purposes of profiting by closing off access to that data highlights an exacerbating problem in US higher education.  As university funding has declined in recent decades relative to enrollment resources (particularly at the state level), schools have increasingly privatized or sold off products, assets and resources to compensate for the lost appropriations.

The University of Michigan’s CSI has been in existence for over 60 years, during which time it was funded by the university until 2007 when an exclusive partnership was struck with Thompson-Reuters for $1 million dollars.  University spokesman Rick Fitzgerald maintained that the university could not afford to conduct the research without private sector funding, however the University of Michigan has one of the largest college endowments in the United States estimated to be $7.7 billion.

The net effect of the University of Michigan’s sale of the CSI to Thompson-Reuters was to remove once-public data from circulation long enough so that a small group of investors could wield an unfair advantage over the rest of the market in order to game the system.  On both ethical fronts, it is difficult to argue that this practice represents sound policy.

References

Adler, J. (2012).  Raging Bulls: How Wall Street Got Addicted to Light-Speed Trading.  Wired, 3 August, 2012.  Accessed 15, June 2013 from http://www.wired.com/business/2012/08/ff_wallstreet_trading/all/

Albinus, P. (2012).  Regulators Contemplate Slamming the Brakes on High-Frequency Trading.  Advanced Trading, 7 March, 2012.  http://www.advancedtrading.com/regulations/regulators-contemplate-slamming-the-brak/232601735

Cho, J. and Shaub, M.K. (1991).  The Consequences of Insider Trading and the Role of Academic Research. Business & Professional Ethics Journal. Vol. 10, No. 4 (Winter, 1991), pp. 83-98.

Fernandes, N. and Ferriera, M. A. (2009). Insider Trading Laws and Stock Price Informativeness.  Rev. Financ. Stud. (2009) 22 (5): 1845-1887 first published online July 23, 2008 doi:10.1093/rfs/hhn066

Javers, E.  (2013).  Thomson Reuters Gives Elite Traders Early Advantage.  CNBC 12 Jun. 2013.  Accessed 15 June, 2013 from http://www.cnbc.com/id/100810549

Woodhouse, K. (2013).  10 things you should know about University of Michigan’s multibillion dollar endowment.  Ann Arbor News, 26, March 2013.  Accessed 15 June 2013 from http://www.annarbor.com/news/10-things-to-know-about-the-university-of-michigans-endowment/

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