By Eamon Javers
In the wake of an unusual trading pattern after the Federal Reserve's decision to continue economic stimulus last week, Fed officials have contacted certain news organizations to discuss rules and procedures for the central bank's advance release of sensitive information, CNBC has learned.
On September 18, the Federal Reserve shocked the financial world with its decision not to scale back its level of support to the economy as most market participants expected.
Financial markets reacted at the speed of light, pushing stocks dramatically higher in just moments. But it looks like the speed of light just wasn't fast enough for some traders.
Some traders in Chicago appear to have had access to the Fed's decision before anyone else in the Windy City. According to trading data reviewed by CNBC, they began buying in Chicago-traded assets just before others in that city could possibly have been aware of the Fed's decision. By one estimate, as much as $600 million in assets changed hands in the milliseconds before most other traders in Chicago could learn of the Fed's September surprise—a sharp contrast to the very low volume of trading ahead of the Fed's decision.
Eric Hunsader, founder of the market analysis firm Nanex, first spotted the unusual trading pattern and alerted CNBC to it.
It's not exactly clear how the information got to Chicago markets so quickly. But the Federal Reserve is concerned enough about the unusual event that it has begun discussions with news organizations. In response to specific questions about the unusual trading activity, the Fed released a statement to CNBC saying, "We will be conducting follow-up conversations with news organizations to ensure our procedures are completely understood."
And, the Fed said, "As is generally the case with other releases of market-sensitive information by government agencies, news organizations receiving embargoed information from the Federal Reserve agree in writing to make no public use of the information until the time set for its release." A Federal Reserve spokesman declined to name the organizations it is in discussions with. The spokesman did not respond on the record when asked whether any of the organizations broke the Fed's rules.
The precise timing of the release is crucial because information can travel only as fast as the speed of light—a physical reality first laid out by Albert Einstein. Information—like a Fed decision—released in Washington takes as much as 7 milliseconds to travel to Chicago, where futures and other assets are traded. And because high-speed trading firms are now able to execute trades at the millisecond level, there is a brief window of time in which information can be publicly available in Washington but is still traveling to Chicago, where computers won't receive it until milliseconds later.
Thanks to modern technology, that window is long enough for some to profit if they know which direction the market is about to go and can place millisecond-level trades accordingly. None of this trading would typically involve a human being—it takes slow-moving humans about 300 milliseconds just to blink an eye, making them much too slow to react to news at the millisecond level. Instead, high-speed data feeds are plugged directly to algorithmic trading computers, which in turn analyze the news as it comes in and execute preprogrammed trading strategies.
So how did information about the Fed's decision apparently get into computers in Chicago faster than the speed of light would allow?
Here's the chronology of what happened on Wednesday. In advance of the release of the market moving decision, Federal Reserve officials followed a standard procedure to choreograph a tightly planned embargo operation that gave reporters advance copies of the Fed's decision. Inside a secure so-called lockup room on the top floor of the William McChesney Martin Jr. Building, Fed officials instructed reporters not to send information about that decision to the outside world before precisely 2 p.m. EDT as measured by the national atomic clock in Colorado.
The doors were locked at 1:45 p.m., and Fed staffers handed out copies of the statement at 1:50 p.m., allowing reporters a few minutes to digest the complicated document before reporting on its contents. At 1:58 p.m. television reporters were escorted out of the room to a balcony where cameras had been positioned. The Fed's security rules dictated that television reporters were not allowed to speak before precisely 2 p.m. Print reporters were told they were allowed to open a phone line to their editors at headquarters offices a few moments in advance of the hour, but not allowed to interact with people on the other end of the line until exactly 2 p.m.
On top of those precautions, every media person entering the lockup—including two employees of CNBC—was required to sign an agreement that read: "I understand that I may make no public use of the documents distributed by Federal Reserve Board (FRB) staff or the information contained therein, including broadcasting, posting on the Internet or other dissemination, until the time the FRB has set for their public release."
All of the security precautions were taken to prevent the details of the Fed's decision from leaving the building before the precise deadline to make sure that editors, technicians, producers and even computer techs in media offices all over the country could not learn of the decision ahead of time.
On Wednesday, that tiny sliver of time saw a burst of trading. Nanex said as much as $600 million of assets changed hands in Chicago in the milliseconds before the rest of the market there was aware of the decision by the Fed.
In the eMini futures market, Nanex spotted a buying increase that began just 3 milliseconds after 2 p.m., which is earlier than the information could have reached Chicago if it were traveling by the speed of light from Washington. Similarly, gold futures began to accelerate just a millisecond or two after 2 p.m., which also would be physically impossible if traders were relying on information transmitted from the Federal Reserve's lockup room.
In essence, the trading represented an arbitrage of the speed of light itself.
The Fed's outreach to media organizations comes amid a broader effort by a variety of federal and state government entities to grapple with ways to protect investors in an era of superfast computerized trading and light-speed communications. At issue: when, exactly, does information become public—and when do enough people know about it that it becomes appropriate to trade. That's a particularly thorny question for government agencies releasing market-moving news and struggling to ensure that no one has an unfair trading advantage. But it also applies to private groups that release information of their own that has the potential to instantly affect markets.
Last year, the FBI and even the nuclear security experts at Sandia National Laboratories became involved in an effort to boost security at the Department of Labor, which releases market-moving jobs data to the media in a lockup procedure similar to the one at the Fed last week. In the end, the Department of Labor trimmed the list of firms allowed access to the lockup room and instituted new regulations over the types of computer and telecommunications equipment allowed there. CNBC first reported the involvement of Sandia National Laboratories in that security overhaul.
Similarly, New York State Attorney General Eric Schneiderman announced in July that he had secured an agreement by Thomson Reuters to stop providing high-speed traders with a two-second-early look at the market-moving University of Michigan consumer survey. That followed reporting by CNBC and others that the news service offered such early looks at the data to customers for a fee.