Deutsche Börse’s News Service for Traders Draws Scrutiny of Investigators; A look at Need To Know News sheds light on growing concerns about data releases

August 11, 2013, 10:38 p.m. ET

Deutsche Börse’s News Service for Traders Draws Scrutiny of Investigators

A look at Need To Know News sheds light on growing concerns about data releases

BRODY MULLINS  and SCOTT PATTERSON

Need To Know News was formed in 2004 by a Chicago investment firm, Allston Trading, whose traders thought they sometimes weren’t getting economic data as fast as some competitors. John Harada, pictured here, is an Allston co-founder who later became the news service’s owner.

WASHINGTON—Several times a month, the Labor Department invites news reporters to a sealed room for an early look at soon-to-be-released reports such as the unemployment rate. One organization attending in recent years stands out from the rest. Founded by an investment firm and now owned by the Deutsche Börse stock exchange, Need To Know News has operated with an overriding mission: sending data directly from the government through high-speed lines to financial firms that are able to trade on it instantly. Some have paid $375,000 a year for the service. The ability of such an organization to gain a position at the heart of the government’s system for releasing economic reports turns on its head an embargo arrangement created decades ago to give writers time to digest complex data and produce reports for broad public dissemination.It is legitimate, though, under the Washington press corps’ loose rules on what counts as a media outlet. It also is an example of how in an era of Internet speed and algorithmic trading, finance professionals have figured out how to take advantage of the federal system for releasing reports in ways ordinary investors can’t.

Concerns about the fairness of this, along with suspicions that market-moving data sometimes leak out a fraction of a second early, are leading some in the government to rethink whether the current system still works. The suspicions of leaks also lie behind a long-running, still-unresolved federal investigation that has entailed scrutiny of a wide range of news organizations.

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Need To Know News has been close to the center of this probe. A look at the service sheds light on growing concerns about data releases.

In 2011, the Securities and Exchange Commission subpoenaed computer hard drives used by Need To Know News’s reporters, documents reviewed by The Wall Street Journal show.

The same year, the Federal Bureau of Investigation installed a hidden camera at a Labor Department room where reporters gather to see economic reports a half-hour in advance of their release, under a news-embargo system that is known as a “lockup.”

Last year, the Labor Department took the unusual step of essentially banning Need To Know News from its lockups.

Need To Know News retained access at other federal agencies as well as several foreign governments and private groups that release market-sensitive reports.

While declining to comment on the FBI or SEC moves, Deutsche Börse said that it “always operates its financial news and other market data businesses strictly in compliance with applicable laws, regulation and other codes of conduct.” In addition, “we strive to maintain good and appropriate relationships with governmental and regulatory bodies,” it said in a statement. “Our standard practice is to cooperate fully with regulatory process reviews and investigations conducted by these government entities.”

Bloomberg LP, Thomson Reuters Corp. and News Corp‘s NWSA -0.93% Dow Jones & Co., publisher of The Wall Street Journal, compete in sending government economic numbers to traders as soon as released. In contrast to Need To Know News, they also produce articles about the reports for broad public dissemination. The three declined to comment on Deutsche Börse’s organization. As for the federal probe, all said they had done nothing wrong.

Driving the competition to transmit data as fast as possible is the rise of high-frequency trading—rapid-fire investing done by computers, often after receiving data sent in “machine readable” form. Defenders say this procedure, by more rapidly feeding economic information into the market, helps make prices more efficient, benefiting all investors.

But the machine-readable-data process has its critics, some outspoken. “It’s a ruse for getting what is essentially insider information ahead of the public,” said Michael Greenberger, a former senior official at the Commodity Futures Trading Commission, who spoke generally and not of any particular organization.

At the National Association of Realtors, which uses media lockups to release home sales data, spokesman Walter Molony, also speaking generally, said, “Some of these firms came in sneakily without clarifying who they were…It was like a slow revelation over time as we came to understand the competition for this data on a nanosecond basis.”

A news event on Sept. 2, 2011, shows the critical role of speed in trading. Investors were expecting a positive monthly employment report that morning; instead, the economy added no net new jobs.

A Swiss investment fund, Da Vinci Invest AG, got this number a fraction of a second after its release via Need To Know News, zapped from its seat inside the Labor Department. Da Vinci’s computers instantly made trades on European markets that within minutes showed a 16% gain, said the firm’s founder, Hendrik Klein.

Need To Know News “was the fastest service” when the firm became a client in 2009, he said, and “they’re still the best.”

Deutsche Börse said providing news is an important part of its offerings to investors. It also owns a service called Market News International, with which it said it now is combining Need To Know News’s resources.

Need To Know News was formed in 2004 by a Chicago investment firm, Allston Trading, whose traders thought they sometimes weren’t getting economic data as fast as some competitors, said John Harada, an Allston co-founder who later became the news service’s owner.

To get direct access to government reports, it needed media credentials. That was a test made easier to meet by a quirky, inconsistent procedure in Washington.

Handing out media credentials isn’t done by the government but by volunteer boards of journalists operating out of Congress. The purpose is to prevent the government from regulating the press, a matter fraught with First Amendment sensitivities. Congress has press “galleries” that credential journalists from various kinds of news outlets. Applicants must be “bona fide news gatherers” who give their attention chiefly to that activity or get more than half of their income from it.

Beyond that rule, criteria vary. The press gallery that includes magazines, for instance, excludes organizations owned by financial exchanges; other galleries don’t.

Once people have a credential from a gallery in Congress, most federal agencies let them attend press events such as lockups.

Need To Know News applied to the radio-and-television press gallery, describing its intended audience as “financial traders sitting at their desks, listening to these live reports.” Although a similar applicant was rejected a decade earlier by a different press gallery, Need To Know News won the media credential it sought.

Among its first reporters was Dennis Moore, whose job was to produce a brief audio report for traders. He said he was often finished by midmorning.

In late 2005, the trading firm that owned Need To Know News agreed to sell it to Mr. Harada, a former trader at the old Salomon Brothers, where Michael Bloomberg, founder of Bloomberg LP, was his boss and onetime mentor. Mr. Harada developed sophisticated technology to route data directly from the government to traders with the goal of being the fastest. He hired a former trader, Mary Beth Slack, to run the Washington operation.

Mr. Harada said it charged $5,000 a month initially, and $10,000 once it was more established. The price evidently kept going up; a November 2012 price list reviewed by the Journal cites a cost of about $31,000 a month for data from Washington. Deutsche Börse said it doesn’t disclose pricing.

Clients included such fast-trading firms as Two Sigma Investments LLC in New York and Jump Trading LLC in Chicago, according to people familiar with those firms.

The timing was perfect: Wall Street was increasingly moving to trading by computers. High-speed algorithmic trading now makes up more than half of U.S. trading.

Salespeople for Need To Know News stressed that it was designed by former traders for traders. “We spoke their language,” Mr. Harada said. By 2007, it was in press rooms at the departments of Labor, Commerce and Treasury.

Trouble began in 2008.

Need To Know News faced accusations that it had transmitted the gist of remarks by Federal Reserve Chairman Ben Bernanke slightly before an embargo lifted.

A reporter was using “some sort of a ‘voice-activated algorithm’ that involves speaking numbers into a telephone line during the lock-up,” wrote Chad Pergram, then a member of the radio-and-TV press gallery’s board, in an email to other members. Press-gallery staff said the information “is in fact going to traders, which in effect, gives them an advantage because they know the Fed’s thinking before anyone else on the planet does,” he wrote.

The board informed Need To Know News in March 2008 that other media firms “have expressed concern as to whether your organization continues to meet the…membership criteria.” The board took no further action, though later that year it revoked the credential of a Need To Know News reporter who spent part of her time running a financial consulting firm. She signed an affidavit contending she met the rules, and a Need To Know News lawyer also defended her right to a credential.

Mr. Harada chalked up criticism of the service to sour grapes. “Our larger competitors didn’t like the idea of someone who could move faster with their technology, so they started rumors about us,” he said.

Concerns arose at the Labor Department as well. In June 2008, it accused Need To Know News of violating lockup rules in four consecutive sessions.

Need To Know News reporters in its lockups were allowed to have a phone connection starting one minute before news embargoes lifted. Reporters for Need To Know News “openly, willfully and repeatedly” violated the rules by talking during this minute, the Labor Department wrote to its bureau chief, Ms. Slack.

Confronted, she “shook her finger” at a Labor Department official and said: “You just try to shut us down. You’ll be hearing from our lawyers,” according to a summary of the exchange compiled by the department. Ms. Slack left in spring 2011. Deutsche Börse said it doesn’t comment on personnel matters involving ex-employees. Ms. Slack didn’t respond to a question about the incident.

In 2009, the Labor Department hired a media-relations chief who had briefly worked on Wall Street. The official, Carl Fillichio, worried that press lockups were sometimes being manipulated for the benefit of high-frequency traders, according to emails and Labor Department officials. Employees of his office began passing concerns to the department’s internal investigators.

Need To Know News may be a “front for a trading organization” and “gaming the system,” one media-relations employee told the department’s labor-racketeering and fraud division in a May 22, 2009, email reviewed by the Journal after an open-records request.

Deutsche Börse said it couldn’t comment on matters prior to its acquisition of the news service, which occurred later in 2009.

Mr. Harada said he sold because “eventually the other news agencies could throw enough money at their technological shortcomings and be faster than NTKN. I could see that this was going to become an increasingly expensive technology arms race.”

In 2011, prosecutors and regulators began acting on what documents reviewed by the Journal show were long-running suspicions of leaks to traders from press lockups.

The SEC collected hard drives from computers Need To Know News used at the Labor Department. The same year, the FBI installed a hidden camera in the ceiling of the Labor Department’s media room to monitor the activities of Need To Know News during lockups, according to emails and to officials familiar with the matter. The emails showed that officials suspected the organization was using technology to get around the system for blocking data until the release.

A recent report from the Commerce Department’s inspector general said the FBI found some technical ways this could be done. It didn’t link them to Need To Know News.

Besides Labor, one other department, Agriculture, has cameras, but in its case they aren’t secret. Earlier this year, a Dow Jones Newswires reporter was seen using an iPad, a device not allowed in lockups, and Newswires was suspended from the department’s lockups for a month. There was no accusation the reporter tried to beat the embargo.

In April 2012, the Labor Department made a rare departure from the long tradition of leaving it to journalist boards to decide who qualifies to attend press events. The department set lockup rules saying it would admit only “primarily journalistic” enterprises focused on “fostering improved public understanding of the data.” Organizations had to apply to attend. The department then didn’t accept Need To Know News and three others.

This year, Deutsche Börse found another way to send data from Labor Department reports to its trader clients: It set about combining Need To Know News’s operations with those of the exchange’s other service, Market News International. MNI produces articles for the public, and it had passed muster with the Labor Department.

Through MNI, Deutsche Börse said, it would continue to deliver government data in machine-readable form.

“We still do the same functions…even though now under the MNI banner,” an MNI official emailed one federal department in April, asking to transfer two Need To Know News reporters to the MNI staff.

The Labor Department declined to comment on Deutsche Börse’s move.