"Americans are angry at Wall Street, and rightly so," begins Paul Krugman in his most recent New York Times Op-Ed lambasting Wall Street's most recent sins.
Wall Street bashing has become the activity de rigueur of both the media and Congress. Much of which is accurate and well-deserved; the list of recent Wall Street transgressions could fill up many pages. What is not accurate, though, are the recent assertions by Krugman and Senator Charles Schumer (D, NY) that the rise of High Frequency Trading and the use of "flash" orders amount to a "tax on investors." The accusations that Wall Street is up to its dirty tricks again and that the SEC should move immediately to ban this relatively obscure practice are also without merit. In this case, Wall Street is correct.
Flash orders have very little to do with the current political attitude toward Wall Street and certain types of investors. The reality is that high-frequency "flash" orders account for a very small percentage of the total volume of orders, and their inclusion or exclusion from the market place is extremely unlikely to have a measurable positive or negative impact. As with any complex system, it is impossible to accurately predict how the market will function with the addition or removal of a new component because the change will cause participants to modify strategies, routing preferences, and even create new order types.
The real problem is the utter lack of methodology or research that has gone into this crusade against flash trading, either by its promoters or enforcers. Three weeks ago, it was unlikely that 1 in 100 op-ed writers or members of congress even knew what a flash order was; now they make it appear that the majority of them have been arguing for their abolition for months. Even worse, the SEC, which is charged with the duty to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation", has yet to release any concrete examples proving the use of flash orders impaired any of their aforementioned duties. In fact, the only study that appears to have been conducted on how flash trading has impacted retail investors on "main street" actually showed that retail investors were receiving better executions in the last few months than at any time in the previous eleven. If flash orders are harming retail traders, shouldn't their execution quality in recent months be declining instead of improving? (This analysis on the rise of High Frequency Trading performed by S3, a company I work for).
Unfortunately, the above is likely to sound like deja-vu to anyone who followed the SEC's haphazard implementation of the ill-fated short sell bans last fall The regulatory agency severely changed the overall structure of the market literally overnight, thus causing anything but "fair, orderly and efficient markets." In that scenario, as in this one, there was a purported boogeyman, yet no examples or data analysis to back up the allegation that this boogeyman even existed. Further, regulators had no evidence that short selling was behind the precipitous fall in financial stocks.
In this post-Madoff environment where the SEC needs all the credibility it can muster, it is critical that the agency not provide a knee-jerk response to every whim of the media and politicians and that it instead take these concerns seriously and publicly release the necessary analysis prior to announcing a new policy shift. If the SEC does release data that shows specific cases and scenarios where flash orders are disadvantaging retail customers, the ban will have achieved a necessary burden of proof and will likely enjoy nearly unanimous support. Until then, the SEC looks like nothing more than an impulsive, reactionary organization making decisions based on daily opinion polls.
And opinion polls, history has shown, are no way to run a country.
Follow John Standerfer on Twitter: www.twitter.com/S3_jstanderfer
Loading comments… 
