The MTTLR Blog

Microsoft’s long awaited cloud computing platform, Azure, opened for business this week.  Now available in 21 countries, the platform comes with a flexible and transparent payment schedule.  This might not sound as nifty as the iPad, but startups with small budgets are sure to take notice, particularly with the free trial options Microsoft is offering.  Azure represents a major step in the development and dissemination of cloud computing, as Microsoft associates its stable, business-oriented brand appeal with the cloud.

In December, MTTLR reported on the regulatory problems posed by cloud computing.  Weighing in on this ongoing debate two weeks ago at the Brookings Institution, Microsoft’s General Counsel Brad Smith suggested the role the United States government should take in regulating cloud computing.  A recent survey, commissioned by Microsoft, concluded a majority of Americans use cloud computing services despite being unfamiliar or only vaguely familiar with the concept of cloud computing.  These survey results could be misleading, as even industry leaders seem to disagree on the proper definition for cloud computing, but the survey does highlight the significant knowledge gap that presents one of cloud computing’s biggest challenges:  What happens when most Americans store their emails, financial files, photographs, and other personal information in something as nebulous as (appropriately) the cloud?

Several indicators point strongly toward regulation:  Transaction costs of public action on this matter are extremely high, the knowledge gap between users and providers is severe, and the chance of getting caught misusing information obtained over the internet is… well, certainly not a sufficient deterrent.  Microsoft suggests a federal regulatory scheme that takes a three pronged approach, addressing issues of privacy, security, and international sovereignty. 

Microsoft’s statement about the privacy and security of consumers and businesses is obviously well-timed and serves to strengthen reliance on Azure.  It also raises questions about whether or not it is desirable to impose comprehensive regulation on the internet.  Nonetheless, their proposal for regulation is persuasive, and contributes significantly to an ongoing debate that is sure to ramp up in 2010.

From a technical/efficiency standpoint, it’s hard to imagine solar energy not becoming a significant contributor to our national grid.  Unlike conventional energy sources, photovoltaic cells contain no moving parts, produce minimal waste heat, and have no thermodynamic losses from fluids.  Of course, they emit no pollution and, operate safely and silently.

Unlike other energy sources, solar cells can be fully integrated into individual buildings throughout urban areas, minimizing transmission losses.  As their energy densities rise and production costs fall, solar cells are positioned to become attractive environmental and economic alternatives to traditional sources of domestic power.

Obama announced a three-part funding increase for clean energy at the annual meeting of the National Academy of Sciences in April, 2009:

• The creation of a new research agency (ARPA-E), modeled on the defense-minded DARPA, to research alternative energy sources with a proposed $400 million budget.
• Designating 46 universities and research agencies as ‘Energy Research Frontier Centers,’ and providing them with $777 million in research grants.
• Creating a link (RE-ENERGYSE) between the Department of Energy and the National Science foundation to promote energy careers among students.

In addition to environmental and efficiency benefits, Obama is using green energy as a much-needed injection of skilled positions to help ease strains on domestic employment.

Last May saw over $467 million of federal funding devoted to renewable energy from the American Reinvestment and Recovery Act.  The Department of Energy has earmarked $117.6 million dollars of this funding to the research and implementation of new solar technologies.  The bulk of this ($51.5 million) will be devoted to photovoltaic technology research.

In May 2008, the California Supreme Court held that the Equal Protection Clause of the California Constitution required same-sex marriages be recognized. However, the voters passed Proposition 8 just a few months later, redefining marriage as only between a man and woman. Last May, after a second round in the state courts, the California Supreme Court upheld the state constitutionality of Proposition 8. The court’s ruling eliminated the right of same-sex couples to marry, but the court rejected the nullification of the marriages of couples that had already received marriage licenses.

Today marked the next phase of the battle, a challenge to Proposition 8 under the United States Constitution. The plaintiffs are attempting to show that the sponsors of Proposition 8 unconstitutionally proposed the amendment with discriminatory intent.  The plaintiffs hope to make such a showing by placing the sponsors on the witness stand.

Last Wednesday, Chief U.S. District Judge Vaughn Walker in San Francisco ordered a delayed YouTube stream of the trial. However, the Supreme Court has issued a stay for the YouTube streaming (streaming to other rooms within the courthouse will continue).  According to the stay, it will expire on Wednesday at 4PM unless extended. The stay contained no reasoning as to why it was ordered, however, one would think that the court worried about witness harassment. Justice Breyer, while pleased at the limited duration of the stay, dissented by cursorily arguing that delayed video streaming would not cause irreparable harm.

The Supreme Court granted certiorari to City of Ontario v. Quon on December 14, 2009 (No. 08-1332).

Quon was a SWAT member who had sent and received text messages on his work-issued pager. While the city’s written policy was that employees should have no expectation of privacy when using their work network, the supervising lieutenant who had issued the pagers had an informal policy that employees could use them for personal communications and their messages would not be inspected as long as they personally paid for any overage fees. However, when the higher-ups decided to audit the texts to determine if they should increase the texting allotments with the outside service provider, they read transcripts of Quon’s sexually explicit messages to his wife and someone it appeared he was having an affair with.

Quon, his wife, his alleged girlfriend, and another employee sued the city, claiming Fourth Amendment violations. The Ninth Circuit found that the employees had a reasonable expectation of privacy in the content of their text messages because the formal policy was in effect overridden by the supervisor’s informal one. It also determined that the search was unreasonable because there were less intrusive ways to investigate the employees’ personal usage levels.

The main issue is whether Quon, as a public employee operating under this informal policy, is protected by the Fourth Amendment against warrantless searches of the content of his text messages because of a reasonable expectation of privacy. The other issue is whether the sender of a message to a government employee on the employee’s work device (i.e., Quon’s wife) has an a reasonable expectation of privacy from employer review.

In O’Connor v. Ortega, 480 U.S. 709 (1987), the Supreme Court dealt with similar issues of employees’ right to privacy in the workplace. The plurality opinion, written by Justice O’Connor, found that there was a reasonable expectation of privacy in the public workplace, but also that a balancing test of “the employee’s legitimate expectation of privacy again the government’s need for supervision, control, and the efficient operation of the workplace” should be applied to determine whether a search is reasonable. Scalia concurred with a broader take on privacy. While the justices couldn’t all agree on whether the employee had a reasonable expectation of privacy in his office, all of them agreed that he had a reasonable expectation of privacy in his desk and file cabinets.

How to apply O’Connor’s holding to electronic communications is one of many questions courts face with our evolving use of technology in the Internet age. Some courts still try to analogize this to wire-taps on phones; anyone with a BlackBerry would disagree. Laptops, cellphones, pagers, and other digital devices are used so ubiquitously that today the line between personal and non-personal communications is blurred.

Will the Court be as divided as in O’Connor? The Court has changed since then, and of the five for public employee right to privacy, only Scalia remains. It’s expected that Sotomayor will side with the employer in Quon. She previously ruled in a 2001 case that a workplace search of an employee’s computer was reasonable, balancing the “modest intrusion” with the “need to investigate allegations of improper conduct.”

While whatever the Court decides here will only be binding on government employers (who would be subject to Fourth Amendment restrictions), it is very likely that lower courts will be applying this to private employers as well.

[ Washington Post: Supreme Court will decide whether employees' text messages are private ]

[ Wall Street Journal: Supreme Court to Review Employer Access to Text Messages ]

[ Double X: No more Sexting with Sotomayor on the Court ]

[ Oyez case summary of O'Connor v. Ortega ]

European Union (EU) regulators closed their investigation of  Qualcomm Inc. after all of the companies accusing Qualcomm of charging excessive royalties on technology patents withdrew their complaints. In 2005, six technology companies filed complaints alleging that the royalties Qualcomm has charged since its patented technology became part of Europe’s 3G standard are unreasonably high. Two of the companies, Nokia and Broadcom, withdrew their complaints after reaching separate outside settlements. Ericsson said in a statement that it is withdrawing the complaint and continuing “its ongoing dialogue with competition authorities around the world in relation to Qualcomm’s licensing practices.” Since all complaints have now been withdrawn, the EU dropped its investigation and is focusing its resources elsewhere. Qualcomm still faces antitrust scrutiny elsewhere in the world. Japan’s Fair Trade Commission said in September that Qualcomm coerced Japanese mobile-phone makers into agreements that prevented them from asserting their intellectual property rights, impeding fair competition and ordered Qualcomm to rescind the restrictive provisions. Earlier this year Qualcomm was fined 260 billion Won ($220 million USD) by South Korea’s antitrust agency for deterring competition through unfair fees and is currently appealing the fine. While the EU closed its four-year old antitrust investigation without levying a fine, Qualcomm was not absolved of wronging and the investigation could be restarted if another complaint is filed.

When teen pop star Justin Bieber’s signing became a riot of teens on Friday around 2:30pm, police were called in to control the crowd. Unable to quickly contain the situation, they asked his label’s VP, James A. Roppo, to send out a tweet to cancel the event and disperse the crowd.  When Mr. Roppo failed to do so, they took him into custody, reasoning that “he put lives in danger and the public at risk.”  At his arraignment on Saturday, Mr. Roppo pled not guilty to the charges of felony assault, endangering the welfare of a child, obstruction of governmental administration, reckless endangerment and criminal nuisance.

(Curiously enough, Justin’s Twitter page has a tweet at 4:30pm finally asking his fans to leave the event.)

[Via Gizmodo]

[Video clips]

“So if I know about a stock’s activity one day before it’s insider trading, but if I know about a stock’s activity one second before it’s high frequency trading?”

-Samantha Bee, The Daily Show

Ms. Bee doesn’t have it quite right, but mainstream comedy shows rarely feature such topics.  The term high frequency trading (HFT) encompasses various trading methods that employ sophisticated algorithms and powerful computer hardware designed for speedy trading.  Wall Street banks and investment institutions spend billions on HFT.  HFT algorithms can read market data and implement market-wide strategies in milliseconds.  As the name suggests, high frequency traders aren’t buy-and-hold investors.  HFT profits are aggregates of small profit margins on enormous trading volume.  In fact, HFT is thought to be responsible for huge increases in trading volume in recent years.  Estimates vary, but algorithmic HFT accounts for as much as 70% of daily equities trading volume in all markets.  The enormous profit potential of HFT has fueled competition for talent and a technology arms race.  Many institutions pay exchanges monthly rental fees to “co-locate” their hardware on the exchange premises, bypassing order routing infrastructure and improving latency to get ahead of other traders.

What strategies do high frequency traders use?  The answer is largely guesswork, as proprietary trading algorithms are closely-guarded secrets.  Among other practices, HFT facilitates “iceberging,” or disguising large orders by parceling them out into numerous smaller orders.  But critics allege that HFT is used in connection with unfair or illegal practices like flash trading, front-running (placing bets in the market based on pending client orders) and bullying other market participants into disclosing price limits and giving up profits.

In a climate of heightened public scrutiny of Wall Street, HFT made waves in the mainstream media this summer.  In late July, Senator Chuck Schumer urged the SEC to address flash trading, an instance of HFT where some exchange participants view and trade on price quotes immediately before they are publicly visible.  When an exchange first receives a buy/sell order, it determines whether any exchange participant has publicly displayed interest in the desired security at the stated price.  If not, Rule 602 of SEC Regulation NMS requires the exchange to include the order in public consolidated quotation data, routing the order to other exchanges.  However, an exception to Rule 602 allows exchanges to first “flash” the order to paying exchange participants as little as three-hundredths of a second before routing.  Those exchange participants with HFT capabilities are fully capable of acting on such a short timeframe.

Why would the SEC create an exception for flash trading in the first place?  When Rule 602 was enacted in 1978, it apparently didn’t consider the possibility that technological developments would eventually enable automated traders to capitalize on the “flash,” rendering an administrative convenience exception into a substantial loophole.

Prompted by Senator Schumer, the SEC issued a proposed rule in September to ban flash trading in all markets, concluding that the flash trading exception is “no longer necessary or appropriate in today’s highly automated trading environment.”  The Commission found that flash trading promotes a two-tiered market where material price data is available to some traders before the general trading public.  Because flash trading creates disincentives for exchange participants to publicly display interest in trading (when they can instead act in secret on flash data), the proposed rule also voiced concerns about transparency, market efficiency, and the need for publicly displayed liquidity.  In addition, under the Securities Exchange Act, the SEC is required to consider whether market practices damage public confidence in the fairness of securities markets.  The SEC found that long-term investors might consider flash trading an unfair practice that damages the integrity of the market.  To the extent that the interests of short- and long-term investors conflict, the SEC has a “clear responsibility” to protect long-term investors.

Goldman Sachs submitted comprehensive comments to the SEC concluding that flashes should be subject to the same regulations as standards quotes.  In other words, co-located high frequency traders should no longer have a head start.  Of course, HFT maintains a distinct edge against less technologically sophisticated competition.  To allay this concern, Goldman points out that technological developments like HFT have lowered bid-ask spreads, increased market efficiency, injected considerable liquidity into securities markets, and increased accessibility to markets via automated market makers, “primarily benefitting retail investors.”  In broad strokes, Goldman cautions against throwing out the HFT technology baby with the bathwater, instead proposing better regulation at the margins, where technology has outpaced SEC oversight.  Flash trading lies at the margin and is per se unfair.

But is Goldman correct that the benefits of HFT outweigh the costs?  The question is difficult to answer, primarily due to a lack of empirical data.

Critics contend that HFT promotes a two-tier system – HFT-armed institutions in the first tier, retail and individual investors in the other.  To some, HFT is a “sophisticated bid-rigging scheme” that amounts to a multi-billion dollar tax on unsophisticated investors, redistributing wealth to large banks with institutional savvy and the resources needed to exploit technology-capability disparities and loopholes in SEC rules.  Paul Krugman came out guns blazing, arguing that HFT also fosters excessive speculation and concluding unequivocally that “what [high frequency traders] do is bad for America.”  Viewing HFT through the lens of social utility, Krugman cites scholarship showing that speculation based on private information “combines private profitability with social uselessness,” wastes resources, and undermines market integrity.  To the extent that HFT represents a sub-optimal level of speculation, it falls on the negative side of the ledger.  The problem: we don’t have enough data on HFT to quantify the scope of these problems.

What about liquidity and pricing?  There’s no denying that HFT provides liquidity, and lots of it.  Liquidity – the ability to safely buy and sell an asset – is so important in financial markets that many exchanges offer rebates to liquidity providers like high frequency traders.  Some markets might not even exist without HFT.  Critics respond that HFT injects unhealthy, destabilizing liquidity into the financial system.  HFT is also said to contribute to price discovery.  One rebuttal to this claim is the argument that HFT algorithms primarily trade against each other in a game of speculation, as opposed to value investing that contributes to proper pricing of securities.  Again, limited available data makes it difficult to draw solid macroeconomic conclusions on these issues.

Some have suggested that HFT poses a systemic risk to financial markets and the broader economy.  An HFT algorithm with free reign could transform into a “rogue algorithm” that inflicts extreme market fluctuations.  Extraordinary events could trigger a chain-reaction of massive unloading by HFT algorithms, a not-so-far-fetched scenario given one likely cause of the 1987 stock market crash.  HFT may have contributed to excessive volatility during the oil spike of 2008 and the recent market-wide collapse.  The presence of substantial systemic risk may delineate a line of optimal technological innovation in the financial markets.  A public policy discussion of HFT should at least consider the possibility that we have crossed this line.

Proposed approaches to the HFT problem range from laissez-faire attitudes, an armistice in the technology arms-race, investing in new technology (e.g., anti-HFT algorithms), fiscal policy measures (e.g., a tax on all trading, aiming at HFT speculation), and, most helpfully, enhanced regulatory oversight.  The necessary starting point for more regulation, however, is properly measuring and quantifying the effects of the HFT “problem.”  This means more transparency, and the SEC’s approach, focusing on greater disclosure and reporting requirements, is right on track.

First, on October 21 the SEC voted to draft a proposed rule concerning dark pools, largely unregulated private exchanges that implicate many of the same issues as HFT.  Second, the SEC is planning a reporting system for HFT firms.  After the 1987 market crash, Congress enacted the Market Reform Act of 1990, amending the Securities Exchange Act.  Under Section 13(h), the SEC may require persons meeting the Act’s definition of “large trader” to file with the SEC and self-identify when they trade.  The prospective reporting system will gather information to enable the SEC to determine the impact of HFT on the marketplace, with special interest in the possibility of harm to long-term investors, disparities of market access and speed, and market efficiency.

At a recent Senate committee hearing on HFT, flash trading, and dark pools, Senator Edward Kaufman articulated widespread concerns about systemic risk and a two-tiered “trader’s market” where retail investors are at a substantial disadvantage.  The CFTC has also expressed concerns on the impact of HFT in the energy futures market.  Coordinated regulatory action – and possibly new legislation – will be necessary to the extent that loopholes, concessions and limited statutory authority restrict the scope of SEC regulation.  A comprehensive effort to achieve transparency is essential to understanding the full impact of HFT technology in the financial markets.

Given investor reliance on highly beneficial liquidity, it’s unlikely that HFT is on its way out.  But valid concerns about the impact of HFT have been raised, and regulators need to learn more about what they’re dealing with.  In light of recent market failures and inadequate regulatory oversight of financial markets, it would be unwise to give the market free reign on HFT technology.

The New York Times reported Wednesday that a man arrested in connection with a robbery got the charges against him dropped by proving that a status updated was posted to his Facebook account at the time. Rodney Bradford, 19,  hired a criminal defense attorney who informed the Brooklyn DA that Mr. Bradford had posted an update stating “on the phone with this fat chick… where’s my i hop.” at the time of the robbery; the DA then subpoenaed Facebook and determined that the update was posted from Mr. Bradford’s father’s apartment at the time in question.

While in the abstract this might seem like a great idea for defendants, Facebook’s quick acquiescence to a prosecutorial subpoena without judicial review raises troubling questions. User privacy continues to be an issue for Facebook, which has faced criticism from multiple groups about its poor record on protecting its users’ privacy from data mining, government intervention, and other sources. Even if Facebook’s overly lax policies are now benefiting defendants rather than just plaintiffs or the government, it may not be something to celebrate.

Law firms have empirically been a pretty conservative group, and they are not usually known for embracing technological fads very quickly, if at all.

This is why it is all the more surprising that Bloomberg reported yesterday that social networking sites, including Facebook and Linkedin, are becoming crucial to firms in drumming up new business and ultimately helping attorneys becoming better lawyers.

“Many lawyers believe that social networks are no more than the playthings of their teenage offspring,” Richard Susskind, the author of numerous books on legal technology, said in an interview. “I disagree. The business-oriented versions will fundamentally change the way law firms are chosen and the way lawyers work with their clients.”

Susskind’s predictions have already started to come true.  Sites like LinkedIn, which are geared toward business in general and other, legal-community specific sites, such as Legal OnRamp, are providing opportunities for lawyers never before imagined.  Legal OnRamp, founded in 2007, is an invitation-only networking site that offers legal blogs, guest commentaries, and private discussion spaces for members to seek advice from lawyers in other jurisdictions about everything from billing rates to local judge preferences.  The site boasts almost 10,000 members, among them Latham and Watkins, the Los Angeles Angels baseball team, and the Royal Bank of Canada.  The site even provides members a workspace where lawyers can have their work reviewed by other site members.  One in-house counsel publicly announced last month that he now drafts his own patent applications before submitting them to the pricier lawyers down the street at the outside counsel for final review.

Sites like these are helping firms connect with expert witnesses too, as one lawyer observed.

“Online networks are a fantastic tool for identifying expertise in the fields in which general counsel are looking to rein in outside counsel,” Eugene Weitz, an in-house attorney at Paris-based Alcatel Lucent, said in an interview. “Experts bubble up who have the ability to show their knowledge online.

Certainly, the explosion of social networking is a double-edged sword.  When cash-strapped in-house counsels can now get many of their questions answered online for free, rather than paying hundreds of dollars per hour, this has the potential to cut in to law firm bottom lines.  Also, will be harder for firms to hide behind their reputations.  “Increasingly the key piece of information a general counsel uses to assess an outside lawyer’s reputation is not the renown of his or her firm, but the review by a trusted peer,” noted Lippe, the CEO of Legal OnRamp.

A recent LexisNexis practitioner survey reported that 40% of lawyers surveyed think that online networking sites will alter the legal business and practice of law in the next five years.  Frankly, this number seems shockingly low, perhaps attributable to the significant generation gap also reported by Lexis.  The survey found that older practitioners are much less likely to be using a social network in their practice than their younger associates.

In any case, it will be fascinating to watch how firms’ internal operations adjust and respond to these new social networks.  At the very least, these social networks have the capacity to foster collaboration and communication, both within firms as well as between them, which ultimately should go a long way toward providing better legal services to clients.

Speaking of destroying the internet, CBSNews.com reporter Declan McCullagh reports Senators Jay Rockefeller (D-W.V.) and Olympia Snowe (R-Maine) recently introduced legislation that would give the president the authority to seize control of the Internet and order a shut-down of Internet traffic during a “cybersecurity emergency.”

Despite vocal concerns from telecommunications companies and civil liberties groups, the bill’s sponsors maintain that the bill is necessary  to protect the nation’s cyber infrastructure security. “We must protect our critical infrastructure at all costs–from our water to our electricity, to banking, traffic lights and electronic health records,” Rockefeller said. Agreed. Sort of. “At all costs?” That might be  a bridge too far. Cybersecurity should be a top government priority, given our national infrastructure’s dependence on the Internet, but at what cost?

President Obama has acknowledged that the United States is “not as prepared as we should be,” when it comes to cybersecurity, and in May said that “[the government's] pursuit of cybersecurity will not — I repeat, will not include — monitoring private networks or Internet traffic.”

As with campaign promises, that may have been wishful thinking on the president’s part. The bill’s text takes a markedly different tack, calling for the White House to engage in “periodic mapping” of private networks to determine which of those networks are “critical” to national security. Those companies that maintain critical private networks are then required to share certain requested information with the government, but the Rockefeller-Snowe bill, in its current form, lacks the necessary internal checks on the vast power it grants the president over private networks and fails to spell out exactly what limitations would be placed on the government in the monitoring process. Before the telecommunications industry (not to mention the general public) can rest easily, the amorphous powers granted in the bill will need to be reigned in to curb opportunities for abuse of those powers.

Not everyone is concerned about the bill’s prospective reach, however. According to McCullagh, a Senate source familiar with the legislation likens the president’s authority to shut down the internet to President Bush’s grounding of all aircraft immediately proceeding the Sept. 11, 2001 terrorist attacks. The obvious difference between the two examples is that the government is not required to access vast quantities of sensitive personal information in order to ground airplanes. Shutting down critical networks in the event of a cyber emergency means knowing exactly which private networks are “critical,” which by necessity means some level of monitoring. Without an appropriate process for administrative review and healthy checks on the extent of the government’s monitoring power, the bill will have a hard time garnering the necessary support to get passed.