Last week Knight Capital Markets, a brokerage firm that was responsible for over 10 percent of all trading in U.S. company stock, suffered a raft of computer glitches that executed millions of non-existent orders in less than 30 minutes. Knight lost $440 million and its stockholders took a bath. As usual, the reaction on Wall Street was to describe the event as nothing to worry about.
I think there is plenty to worry about, and I sure don't mean I worry about Knight's stockholders. I worry about what the series of High Frequency Trading computer malfunctions we have experienced -- Knight being just the latest -- are doing to the confidence level of individual investors in our markets.
That confidence level was certainly shaken by the Flash Crash of May 6, 2010, when the markets fell 9 percent in minutes. It took regulators five months to install some ineffectual circuit breaker band-aids without addressing the fundamental market structure problems. This year, before Knight, we had already seen the BATS Global Markets and the Facebook fiascos. HFT played a major role in both.
HFT didn't really exist before 1999 and is essentially unregulated, much less understood. During the 12 years HFT has expanded to account for over 50 percent of all trading, and we grew from two regulated stock exchanges to over 50 different venues including essentially unregulated "dark pools." I believe our markets, once the envy of the world, have been allowed to run amok.
In August 2009, before the Flash Crash, I wrote SEC Chair Mary Schapiro pointing out the explosive growth of HFT and the new off-exchange trading venues. I asked the agency to institute a consolidated audit program (CAT) to investigate the effects of HFT and these venues on the operation of our markets, and what the impact these new developments had on retail investors.
Shortly thereafter, Ms. Schapiro endorsed the importance of a CAT and the intention of the SEC to implement one. It took three years, until last month, for the agency to announce a CAT. Unfortunately, I agree with SEC commissioner Elisse B. Walter that the result is "disappointingly weak."
In August 2010, I wrote the SEC again. This time I proposed a comprehensive review of the market structure issues that had accompanied HFT's rapid evolution. I requested an independent zero-based regulatory review of a broad range of market structure issues, "analyzing the current structure from the ground up before piecemeal changes built on the current structure increase the potential for execution unfairness." My proposal included eight pages of possible market structure solutions.
A month later, speaking before the Economic Club in New York, Ms. Schapiro endorsed a comprehensive investigation of market structure issues, saying:
We must carefully consider whether our market structure rules have kept pace with the new trading realities... The important questions are to what extent is our structure meeting or failing to meet its goals of fair, efficient and transparent markets, and how can we modify the structure to preserve the advantages and eliminate the flaws?
"Answering these questions," she said, "will not be easy, but I do know this: hard and careful work to strengthen our equity market structure will bring important dividends to investors, companies, and the economy as a whole."
Two years later, it remains a good speech. Nothing resembling a truly zero based, comprehensive investigation has been presented.
Part of the blame for this must go to the current House of Representatives, which not only opposes virtually any new Wall Street regulations but has actually proposed cutting SEC funding by $200 million.
Thomas Joyce, Knight Capital Group's CEO, has for years been a leader in the fight against any regulation of HFT. Defending his firm's fiasco on Bloomberg Television, he said, "You cannot keep people from doing stupid things. That is what happens when you have a culture of risk."
Really? The fact that people do stupid things in a culture of risk is the very reason I have been fighting for at least a basic understanding of the effects HFT has had on our markets. The markets don't belong only to people like Mr. Joyce; they should and must belong as well to individual investors. Congress and the regulators must recognize that action is long overdue.
Originally published in The News Journal on August 12, 2012.