High-frequency traders: The ‘Al Capones’ of Wall Street?
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The battle over high-frequency trading is heating up on Wall Street as regulators and traders face off over the decade’s most controversial financial practice.
in New York
It began with a cutting exposé in April this year, “Flash Boys, a Wall Street Revolt,” which sent shockwaves through the financial hub and provoked an FBI inquiry into high-frequency trading (HFT) after author Michael Lewis claimed that the market was “rigged”.
The book, which occupied the New York Times’ best-seller spot for four consecutive weeks, also prompted regulatory agencies, the Securities and Exchange Commission, the Financial Industry Regulatory Authority and even the New York state attorney general, to launch something of a witch hunt against high-frequency traders, or “flash boys,” as they are known in the industry.
Flash boys pay to receive trading data just milliseconds before others (something which previously wouldn’t have any worth), and then use in-house algorithms, which work at otherwise impossible speeds, to buy and sell shares hundreds of times over, changing the price by a fraction each time. Those price changes amount to not only hundreds of thousands of dollars, but also the manipulation of stock market.
One of the first people to cry foul over HFT was Chicago-based market data analyst Eric Hunsader, who has become one of the practice’s most vocal, and colourful, critics.
Long before the infamous “Flash Crash” of 2010, (an HFT-sparked stock market crash that caused the Dow Jones Industrial Average to plunge 1,000 points and then recover within minutes), Hunsader noticed “a lot of egregious behaviour” in the market feeds he monitors.
“There were a lot more odd quotes; bizarre things -- somebody’s willing to pay $20 for stock and then a second later it’s $20 and one penny and a second later it’s $20 and two pennies, three pennies,” he said.
Easily concealable and painstaking to uncover
Hunsader says that he initially struggled to convince people of the seriousness of the problem because HFT is so difficult to understand. Today, he is full of layman-intelligible metaphors that convey what he finds absurd about the practice.
Speaking of the traders, he says it’s as though “you went on eBay and changed your mind a thousand times a second”. For the customer, “it’s like if there were no prices at the grocery store and prices were determined when you got in the line and then the [final] price would be based on how much the store thinks it can charge you before you give up and put the stuff back on the shelves.”
In the material world, “people would say no, you are not allowed to do that, we are not going to play with you,” he said.
In the eyes of the law, however, high-frequency traders are, technically, doing nothing wrong. Only if it can be proved that they are trading at high speed specifically in order to manipulate stock -- easily concealable and painstaking to uncover -- can the authorities bring a case against them.
“It’s going to be a very long process,” Keri Geiger, a Bloomberg business reporter, told FRANCE 24 at her office on Wall Street. “Firstly, they have to determine if any illegal activity happened and secondly, they have to examine the very structure of the market, and that could take months or years,” she said.
In October, the SEC announced a first settlement in what it described “the first high-frequency trading manipulation case” against New York firm Athena Capital Research. The prosecution benefited massively from the sloppiness of the firm’s employees, who spoke openly over email of intent to manipulate. But those emails were sent in 2009, when HFTs felt less scrutinised. Negligence of such magnitude would be unlikely today.
Targeting HFT firms for misdemeanors other than manipulation might be a more efficient way to shut them down, Hunsader says. “We didn’t bust Al Capone for murdering people or running alcohol, we busted him for not paying his income tax,” he said.
In September, New York-based HFT firm Latour Trading (whose traders stem from French bank Société Genéralé) was fined 16 million dollars by the SEC for “violating the net capital rule that requires all broker-dealers to maintain minimum levels of net liquid assets or net capital”. Any alleged manipulation was left unaddressed.
The growing scrutiny has seen flash boys, a formally discrete group, grow bolder in defence of their trade, arguing that their activities provide a boon to the stock market overall. A number of HFT firms has ganged together to form the Modern Markets Initiative (MMI), a Washington DC-based advocacy group.
In response to Lewis’s best-selling exposé, the MMI is advocating a new book, “Flash Boys, Not So Fast: An Insider’s Perspective on High-Frequency Trading”.
Author Peter Kovac, who used to run a trading firm, dismisses Lewis’s claim that “the market is rigged”. “Michael Lewis’s front-running scam is impossible, and I want to restore the debate,” Kovac told MarketWatch.com on Wednesday.
The MMI and its affiliates are also busy on Capitol Hill. In 2013, firms involved in HFT spent more than a million dollars lobbying Congress. Political campaign contributions from such groups increased eightfold between 2008 and 2012. And in August, the MMI notched a victory when they recruited one of HFT’s fiercest adversaries, regulator Bart Chilton, to lobby on their behalf.
Back in Chicago, Hunsader watches the developments with dismay. “They’ve essentially bamboozled Congress into believing that everything is okay,” he argues. “And the reality is, that it’s so hard for Congress to realise that, because it’s such a difficult topic.”