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Editorial

Big shadow hangs over big data

Big data is watching. And if misused, it could betray both investors and traders. Regulators should seriously consider guidelines on how that data can be used.

For a start, the Securities and Exchange Commission should impose a moratorium on the sale of deep market data until it can do a thorough study of the collection and the potential uses and misuses of that data.

As computer power and cloud storage have increased, so have data collection, analysis and sales. Some of the data is seen as potentially beneficial to investors, and some is seen as a threat because an analysis of trading patterns might reveal the underlying algorithms.

Money managers and institutional investors have expressed concern that analysis of the enormous amount of stock and bond market data could lead to front running.

Concern spiked late last year when Nasdaq filed with the SEC to begin selling an enhanced customer data product, called The Intellicator, "that is designed to analyze options market transactions and synthesizes that analysis to assist investors in assessing the equities underlying those transactions."

The product was to have been offered in three bundles of increasing sophistication levels and was designed to provide "the benefits of sophisticated analytical techniques to firms without the technology or staff … to conduct a comparable analysis of their own."

Nasdaq admitted in its filing that a purchaser might, "under certain circumstances, be able to reverse-engineer factor calculations to obtain transaction-specific information not otherwise available on the Exchange's data feeds … to determine the type of customer. … Such information may be useful in identifying the investment strategies of particular customer categories."

The Securities and Financial Markets Association objected that such reverse-engineering would provide those who bought the product with trading information that could be used for market manipulation.

In December, Nasdaq withdrew its filing with the SEC, saying it would refile at a later date.

Before that happens, the SEC should step in and begin the process of reconciling the apparent clash between a desire for transparency, which regulators believe will provide better execution and lower costs, and the danger that some traders might take advantage of that transparency to front run strategies of others.

It should also examine the extent to which sophisticated firms with highly qualified staff already are carrying out such deep data dives on their own and using the insights they gain to earn trading alpha. The Nasdaq filing implies there are such firms.

On the other hand, it might well be that the product proposed by Nasdaq could even the playing field for smaller institutions, at least for those that are prepared to pay for the data, against more sophisticated firms.

The SEC might have to define what information the exchanges gather from the trading through their portals can be sold, or how it can be sold. It might have to require them to screen the data before it can be sold to assure it can't be misused.