Have high-speed stock traders rigged the market?
At a time when public trust in Wall Street already is at a low, new allegations about high-speed stock trading threaten to further erode confidence in the financial markets.
The furor centers on accusations that professional traders armed with ultra-fast computers have rigged the stock market. High-speed firms engage in what critics say amounts to insider trading, using super-charged systems to decipher trading patterns.
Criticism of high-frequency trading has long swirled in financial circles, and multiple regulators are conducting investigations. The FBI confirmed Tuesday that it is in the middle of a months-long investigation to determine whether high-speed firms use unfair practices to get a leg up at the expense of average investors.
The issue has burst into public view in a new book by Michael Lewis, a noted chronicler of Wall Street whose bestsellers include “Liar’s Poker” and “The Blind Side.” Lewis and his book were featured in a “60 Minutes” segment Sunday.
The furor has consumed Wall Street in the last two days.
“Michael Lewis basically lit a torch and threw it in a crowded theater,” said Larry Tabb, a trading expert at Tabb Group in Westborough, Mass. “He’s basically calling the U.S. equity markets rigged. This is one of the cornerstones of the system that the world economy is built upon. Yeah, it’s going to get a lot of people really upset.”
Many analysts agree with the basic gist of Lewis’ argument: that savvy traders exploit loopholes that need to be closed. But they dispute the notion that the market has been fundamentally corrupted.
“Rigged implies that there is someone out there or a collection of entities that controls the market, and that’s not the case,” said Benn Steil, an expert on stock trading at the Council on Foreign Relations.
The primary risk to small investors is not that they could be taken advantage of by speedy traders, Steil said. The bigger danger is that individuals might forfeit long-term gains by shying away from the market.
“To conclude that you will not hold any stocks because of the possibility that a high-frequency trader will impose a fraction of a fraction of a 1% toll on your transactions is not rationale,” Steil said.
Skepticism of Wall Street remains high in the aftermath of the 2008 global financial crisis and resulting scandals.
Only 15% of Americans trust the stock market, according to a survey in December by the University of Chicago’s Booth School of Business and Northwestern University’s Kellogg School of Management.
Concerns have existed for years that Wall Street traders unfairly profit at the expense of small investors. Regulators have enacted several measures in the last decade intended to reform the system.
However, individuals never will be on an even footing with the best and brightest on Wall Street, who are paid millions of dollars a year to churn out profits.
A basic allegation in Lewis’ book is that high-speed traders routinely “front-run” other investors.
In its simplest form, front-running means a trader detects that an investor wants to buy a certain stock. The trader swoops in to buy it first, then quickly sells it to the investor at a slightly higher price.
High-speed traders defend their industry, saying they simply harness publicly available trading information and don’t engage in front-running or insider trading.
“If [traders] were using some special information that only they had access to — yeah, that would be a problem,” said Manoj Narang, chief executive of Tradeworx Inc., a high-speed firm in Red Bank, N.J. “But nothing like that is going on.”
Some experts say the debate may be rendered moot because the high-speed phenomenon is showing signs of slowing down. A combination of regulatory reforms, changed trading patterns by mutual funds and a placid stock market has eaten into profits of high-speed firms.
The collective revenue of high-speed firms fell to $1.1 billion last year from $7.3 billion in 2009, Tabb said.
Still, the debate is unlikely to die down any time soon.
“This is the big issue right now,” Steil said. “Everybody is focused on it.”
