Yesterday, the WSJ reported that the SEC is looking into Merrill Lynch’s trading activity for potential front-running violations. To quote the article
The trading probe is a broad look at the relationship between big, institutional investors and the brokerage house. Specifically, one area of inquiry involves whether certain Merrill employees improperly stepped in front of orders placed by Fidelity Investments, the large mutual-fund operator, these people said. The period under scrutiny covers 2002 through 2005.
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The practice is known as “front-running,” and previous regulatory scrutiny has resulted in regulatory fines and changes in industry practice. It gives an unfair advantage to traders because orders from big investment houses such as Fidelity often move stock prices.For example, if a trader received an order from an institutional investor to buy stock, the trader could then step ahead of the order to buy shares for the house account that could then be sold to Fidelity at a higher price, locking in a profit.
While I have no insight in this case in particular, and know that all firms watch for front-running as part of their standard surveillance activities, I do wonder if better business analytics could be useful in finding and rooting out potential regulatory issues before the regulator finds them. Main Street firms such as FedEx, Apple, Dell, and Wal-Mart routinely use business analytics to make business decisions, to improve business processes, to streamline logistics, to target customers, to influence customer behavior, and ultimately to generate income and profits.
Why doesn’t Wall Street follow Main Street’s example in their use of business analytics? Why doesn’t Wall Street use business simulations to model the behavior of traders and trading floors? As the business of Wall Street is more and more automated, Wall Street firms are not following Main Street’s example and building analytics and simulations. Why not? The tools are there. The data is there. The technology is mature. Is it that Wall Street trading houses are still focused on the day-to-day trading P&L and are unwilling to take a step back to look at ways to incorporate best practices from Main Street to their processes? Is it ego? Wall Street is not some mysterious dark place where the lessons of business analytics, simulation, supply chain, and customer experience do not apply. It is a place where these lessons have not been applied.
What a shame. An NGE would look to use business analytics and simulation as part of its standard day-to-day work.
