Senate probes conflicts in high-frequency trading

06/17/2014 8:44 AM

06/17/2014 9:43 AM

A Senate investigative panel put Wall Street’s high-frequency traders under the microscope Tuesday, spotlighting how these technology-driven companies can make money at the expense of unsuspecting investors.

High-frequency traders have been in a political storm since the release earlier this year of the book Flash Boys, in which famed financial author Michael Lewis documented how companies were allegedly rigging trading in their favor.

Since the April release of the book, the head of the Securities and Exchange Commission has called updating the rules governing electronic trading and on Tuesday the Senate Permanent Subcommittee on Investigations put the new era of high-frequency trading under a microscope.

“It’s an era in which stock market players buy the right to locate their trading computers closer and closer to the computers of stock exchanges – conferring a miniscule speed advantage yielding massive profits,” said Chairman Carl Levin, D-Michigan. “It’s an era in which millions of trade orders are placed, and then canceled, in a single second, raising the question of whether much of what we call the market is in fact an illusion.”

What concerns Levin and others is the way in which high-speed traders can detect market orders and then in fractions of a second buy the stock being sought and resell it at a slightly higher price. Most of this goes unnoticed to the buyer of the stock and the difference of the price is not huge. But when added up, it amounts to hundreds of millions of dollars.

It led author Lewis to allege in his book that markets were rigged in favor of high-tech traders. The protagonist in his book was Brad Katsuyama, a former executive at Royal Bank of Canada who started his own exchange, the IEX Group, to counter the allegedly predatory practices that were working against ordinary investors.

Katsuyama testified before the committee Tuesday, saying the allegation of rigged markets was an unfortunate term.

“It kind of gave our critics … a reason to talk about something else,” he told senators, cautioning that ordinary investors didn’t find fault with the term. “The people who took most offense to that word were on Wall Street.”

The Senate panel drilled down on a practice in which high-frequency traders could push to the back of the line orders made on behalf of ordinary investors. At times the price of a desired trade has moved beyond a target by the time the turn of the ordinary investor has come. And it all happens in seconds.

“Not everyone trading a price gets to trade,” said Robert Battalio, a finance professor at the University of Notre Dame University who has documented some of the allegedly abusive practices.

Better data, and in real time, is needed to bring more transparency and restore confidence in financial markets, he testified.

Grilled by Sen. Ron Johnson, R-Wisconsin, Battalio acknowledged that “data is a big problem” presently to conduct accurate analyses.

Johnson was the lone voice seeming to side with the high-frequency traders, objecting to the use of terminology such as the so-called dark pools, which he said gives a “sinister” connotation to this sort of trading.

“I am concerned about throwing out those types of terms,” he said, noting he’s had good experiences with Wall Street over the past two decades. “That’s not my experience, that’s not what I’ve seen.”

Financial markets, however, use term “dark pools” to refer to trading that happens through a private forum at investment banks such as Goldman Sachs and JP Morgan Chase. These are also the very area that SEC Chief Mary Jo White recently said need more transparency.

Criticism of technology-driven trading overlooks the fact that the efficiency of computers have brought down the cost of trading sharply for ordinary investors, insisted Johnson, noting that getting an extra 30 cents from a trade of 100 shares involves “miniscule amounts” of additional profit.

Those opposed to high-speed trading note the miniscule amounts when summed are astronomical and amount to a fleecing of ordinary investors.

Email: khall@mcclatchydc.com; Twitter: @KevinGHall.

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