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Dennis M. Kelleher Headshot

Flash Boys Puts a Flashlight on Dark, Predatory HFT Trading

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It is no surprise that Michael Lewis' new book Flash Boys ignited a firestorm or, as a couple of the most knowledgeable observers called it, "Hurricane Flash Boys." He shines a bright light on dark, unregulated, predatory high frequency trading called "HFT." Too many manipulative and abusive practices are moving tens of billions of dollars from the pockets of investors and retirees into the pockets of HFT firms, Wall Street banks and their enablers like the exchanges.

None of this is news to Better Markets, which has been pushing regulators and policy makers for years to take action to stop predatory HFT, which is not only ripping off investors and retirees, but is also destroying confidence in our markets. Over the last three years, Better Markets has filed 15 comment letters with the SEC and CFTC focusing on or discussing HFT and has had numerous meeting urging them to take action. In addition, Better Markets' staff has testified often before Senate and House committees on the problems caused by HFT and the need for strong, clear rules to stop abuses and illegal conduct.

Much of the debate so far has centered on the phrase "the markets are rigged." It's a classic debater's tactic: pick out a single phrase, exaggerate and distort it, and then talk about nothing else as if it is the entire subject. An added twist to the HFT industry spin here is to then attack Lewis for "cruelly" causing investors and retirees to "needlessly worry" about the markets and their money and investments. That's rich. The very people who are lining their pockets at the expense of investors and retirees are attacking Lewis ostensibly due to their concern for those very same investors and retirees.

However, it simply cannot be denied that today's markets are overly complex, ridiculously fragmented and traveling literally at warp speed where few if any humans know what is really going on from minute to minute, day-to-day. There are now 13 so-called lit exchanges and something like 40 dark pools, internalizers and other trading venues and around 70 percent of the trading is computer driven, done in fractions of milliseconds. That's just the equity markets, not currency or derivatives markets where HFT is increasingly active.

Truth be told, the markets open every day on a knife's edge, with many wondering if today will be the day that yet another computer created or driven disaster happens that cannot be stopped and makes the euphemistically labeled "Flash Crash" look mild by comparison, i.e., billions if not tens of billions of wealth and value can vanish in minutes and not come back.

Rigged markets? By insiders for insiders? Of course they are. Don't take our word for it. In addition to Flash Boys, read Wall Street Journal reporter Scott Patterson's terrific book Dark Pools: The Rise of the Machine Traders and the Rigging of the US Stock Market and any of his outstanding reporting in the WSJ. Then read Joe Saluzzi's and Sal Arnuk's "Broken Markets: How HFT and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio and everything on their blog, including in particular their "take on Flash Boys" and "in advance of Flash Boys." And, don't miss globally respected Andy Haldane from the Bank of England talking about HFT here and here.

Not enough to convince you? Study the Flash Crash, the stock market bungee jump when it lost close to a trillion dollars in minutes and then regained it back almost as quickly. Or, the SEC case against the dark pool operator eBX or the other dark pool operator Pipeline Trading. Better yet, read about the $5 million fine the New York Stock Exchange paid for selling privileged access to secretly selected clients.

The industry counters by denying these facts and boldly claiming that they provide liquidity and lower costs, but it has been demonstrated that HFT is more often a liquidity taker than a liquidity provider and, if anything, raises the costs of trading. Here's just one quick killer rebuttal to the HFT industry's self-serving claims: "4 Bold Faced Lies about HFT." (And, remember, the HFT defenders like to call mere trading volume, often illusory trading volume at that, "liquidity," while knowing that to be false and misleading. As Andy Haldane puts it, HFT provides liquidity during a monsoon, but withdraws it during a drought.)

We know from Themis Trading, Nanex and others that this is just the tip of the proverbial iceberg. Unfortunately, regulators, policy makers and prosecutors have been mostly AWOL (the few SEC cases cited above are the exception) in fighting or stopping predatory HFT. While not all HFT is bad, there is a mountain of independent evidence demonstrating that too much of it is and that HFT provides too few benefits to investors, retirees and markets. It is past time for regulators and policy makers to stop predatory HFT by passing a few simple rules and require registration, reporting and disclosure as well.

What's at stake is nothing less than the integrity and functioning of the US markets that are essential for American families, businesses, our economy and our standard of living.