SEC Proceeding against Athena Capital Research [pdf]
sec.gov
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They were wrong and got punished, but the market would have punished them eventually anyway, and it sounds like it was already doing so. The SEC filing states that this scheme lost them $3mm on an index rebalance day when activity in the closing auction peaks. That should be a great opportunity for anyone intermediating between the continuous and auction books, so it is very surprising that they'd lose. Someone probably caught on that they were manipulating the close and waited for a big day to take advantage of them, or there was so much activity that they didn't have enough ammo to goose the price like on slower days.
Also, to be clear, there is nothing illegal about HFTs intermediating between the continuous and auction books or the majority of HFT activity. These guys were charged because they committed fraud, the use of a computer was ancillary.
http://www.sec.gov/litigation/admin/2014/34-73369.pdf
Basically: Athena targeted stocks with closing time imbalances between buys and sells, where NASDAQ ran a special order routing process, and traded with itself to influence the price reported at market close.
The dollar amounts the SEC describes are insignificant (that's obviously not a defense for the firm charged with the behavior).
So imagine they sold 10000 shares imbalance-only in the auction at 3:50. They would then buy 2500 immediately, slowly pick up another 2500 in the next 9 minutes, then do the last 2500 in the last second. The initial trades would get them into their hedge at a low average price, and the last-second ones would push the price of the closing auction up, maximizing their return on their imbalance-only order.
If you read the case, it seems like this didn't always work if they had slippage on the close or they got so aggressive that they would "flip" the imbalance and not get filled on their closing order at all, instead being stuck with a bunch of shares from crappy prices. The people trading with them in the last two seconds could also keep replenishing their orders and prevent them from spiking the price. Sounds like a dangerous game of high-stakes chicken.
What the SEC really should be investigating is the rampant use (or probably misuse) of d-quotes on the NYSE. These effectively allow you to put on-close orders after the on-close cutoff time of 1545. These orders get routed to specialists and god knows what theyre doing behind the scenes.... I havent run the numbers but I would wager that last-15 minute volatility in NYSE names is way higher than on NASDAQ. Get rid of the d-quotes and get rid of the specialists....
> Respondent Athena cease and desist from committing or causing any violations and any future violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder
Why does the SEC order a firm to desist from committing violations of some rule? Aren't firms supposed to be not violating them anyway, regardless of whether they are specifically ordered by the SEC not to?