Senator Schumer apparently believes this is an unfair practice, and I agree.

July 24 (Bloomberg) -- Senator Charles Schumer asked the U.S. Securities and Exchange Commission to ban flash orders, saying the transactions give high-speed traders an unfair advantage over other investors.

Nasdaq OMX Group Inc., Bats Exchange Inc. and Direct Edge Holdings Inc. hold these orders for milliseconds, giving their customers the opportunity to gauge demand before traders on other exchanges get the chance to bid, Schumer said in a letter to SEC Chairman Mary Schapiro. Brian Fallon, a spokesman at Schumers office, confirmed the authenticity of the letter.

Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public, Schumer wrote. That allows those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity, he added.

The senator said that if the SEC doesnt prohibit flash orders, he will introduce legislation that would.

This is my view:

1. Getting a look at orders before someone else does is commonly called "cheating".  The National Market System (NMS) was supposed to prevent that; this was the so-called "innovation" of Nasdaq, remember?  No specialists, no balancing of orders to open a stock, all done by computer.  Equality of access.  Up until it became profitable to make some people more equal.  The intent of a public stock exchange is to insure equality of access to information so that the markets are orderly, not rigged.
2. Using flash order information (or anything else) to front-run is illegal.  In all of its forms, this is an extremely serious matter and it must be stopped.
3. To the extent that these HFT systems are in fact using flash (or other) traffic to get in front of orders and advantage themselves they are dramatically increasing the violence of market moves.  A stock trading at $20 that has a bid come in with a limit of $20.10 would normally fill (assuming sufficient depth) at $20; this does not materially move the market.  But if a HFT system "sees" that order, steps in front of it and buys up all the shares at $20 and then re-sells them to the customer at $20.04 (one penny better than the next best offer at $20.05) it has caused the current "last" price to move where it otherwise would not. Multiply this by millions of shares an hour and the impact on price moves could be tremendous.  While I understand that many people like the move of the last two weeks in the market, the fact remains that what goes up can also come down with equal violence.
4. HFT systems that front-run are able to garner risk-free profits.  This is in fact the reason such a practice is banned - their "risk-free" profit is your guaranteed loss.  Remember, the markets are in fact a negative-sum game (due to trading costs) - if there is a "risk-free" opportunity out there it can only exist because someone else is guaranteed a screwing.

I call upon The SEC to conduct a full and public investigation of the HFT systems in use today, along with immediately banning the "flash" traffic in accordance with Senator Schumer's request.  I specifically want to know:

1. Have any of these HFT systems been using flash traffic (or any other mechanism) to "step in front" of a flashed order?
2. What part did these systems play in the October and March meltdowns, along with the ramp job of the last two weeks?  Specifically, were they stepping in front of orders in these cases, thereby dramatically amplifying market moves while skimming off their pennies?

Public and fair markets demand transparency.  All users must obtain access to order flow at the same time, without exception, and attempts to "step in front of the line" must be met with both civil and criminal sanction for market manipulation.

I can think of three relatively-minor changes that would leave those who are using HFT legitimately unharmed but would destroy most of the ability to cheat.  These are:

1. Eliminate the 'flash order' entirely.  All market participants must get order and flow information at the same time - no exceptions.
2. Force all orders (e.g. IOC, etc) to be valid for a reasonable minimum period that allows human response.  1 second would meet this criteria; it would destroy the ability of the "robots" to use abusive order patterns without preventing the legitimate use of "immediate or cancel" orders.  The time selected must be greater than the average human reaction time plus round-trip network transit time within the nation; visual recognition time for young adults averages a bit over 200 milliseconds (0.2 seconds) exclusive of the response (e.g. a mouse click) and round-trip transit time on high-speed circuits cross-country (corner-to-corner) is approximately 100ms.  Thus the minimum acceptable time is in the neighborhood of 500ms assuming no intervening computer computational delays (e.g. brokerage servers, etc); doubling this to provide for a margin (not all people are 20 years old, there are typically multiple computers between the exchange and end user, charting or display software requires time to post the event on the screen, etc) seems reasonable.
3. Define as "front running" by law any scheme or practice that exposes or discovers orders to any select group of players before the market as a whole, irrespective of how.  The unfortunate reality is that there is no mechanism available to prevent computers from exploiting asymmetric information; ergo, you must define the provision or discovery and use of any such asymmetric information in the public markets as a criminal offense.  Penalties should include treble forfeiture of all profits gained from such an abuse and a permanent ban on all access to the securities business as well as prison time.

"Arms races" are inherently negative-sum games; the only winning party is the guy who is selling the weapons.  In this case the losers are the public and institutions who are attempting to invest or trade in the equities markets.

It is time to put a stop to this part of The Bezzle.