Appearing on CBS' 60 Minutes last evening, Michael Lewis, author of a new book entitled Flash Boys, outlined how his reporting has revealed that the stock market is "rigged"....and that millions of people are losing millions of dollars to what is commonly known as "front running". Speaking to reporter Steve Kroft, Lewis put it this way:
Machines with secret programs are now trading stocks in tiny fractions of a second, way too fast to be seen or recorded on a stock ticker or computer screen. Faster than the market itself. High-frequency traders, big Wall Street firms and stock exchanges have spent billions to gain an advantage of a millisecond for themselves and their customers, just to get a peek at stock market prices and orders a flash before everyone else, along with the opportunity to act on it.
Michael Lewis: The insiders are able to move faster than you. They're able to see your order and play it against other orders in ways that you don't understand. They're able to front run your order.
(It) means they're able to identify your desire to, to buy shares in Microsoft and buy 'em in front of you and sell 'em back to you at a higher price. It all happens in infinitesimally small periods of time. There's speed advantage that the faster traders have is milliseconds, some of it is fractions of milliseconds. But it''s enough for them to identify what you're gonna do and do it before you do it at your expense....So it drives the price up, and in turn you pay a higher price. (from 60 Minutes website, March 31, 2014)
This process was initially discovered and exposed by a Canadian then working as a New York trader for the Royal Bank of Canada, Brad Katsuyama, who, following intense investigation realized that the "front runners" were costing investors money, simply because they were faster in placing his order than he was and were able to secure a higher price for orders placed by his clients through him and his team. After having what Katsuyama says was a very difficult conversation with his wife who was naturally sceptical, he decided to open his own stock exchange, iex, dedicated to putting trust and transparency back into the system, on behalf of investors. Katsuyama is almost amazed that such a simple concept, trust and transparency, achieved through technology that effectively thwarts the "front runners" by keeping them out of the game until the iex order has been completed, can be so powerful an instrument in stock trading.
According to those interviewed by the 60 Minutes crew, most predict that iex will be quite successful. For his part, Katsuyama turned his back on a considerable salary package from the Royal Bank to initiate iex (investor exchange), when he brought a number of his Royal Bank colleagues to the new exchange.
As a sidebar to the 60 Minutes story, we also learned that the New York Stock Exchange has become merely a photo-op for the industry, having been replaced by trading that takes place inside huge and very fast computers programmed to operate almost without human intervention, on behalf of those who own time and the software that directs the activity of these 'robots' now at the centre of the trading industry.
What Katsuyama and his former Royal Bank colleagues have done, initially for their own and their clients' protection, as well as for his employer's credibility and protection, is to expose how the system was rigged, and to provide an alternative route without 'front runners' who legally 'scam' the system and the client without either breaking any laws or having to account for their activity, simply because no one knew what was happening.
In stock trading today, and tomorrow in whatever sectors the computers become the 'runaway' opportunists, we will increasingly need to develop an army of people who are as persistent and as determined and as ethical and courageous as Katsuyama and his team.
And, what's more, it will take a different army of equally persistent, determined and courageously ethical reporters, with the resources to investigate and to report on the inside story from wherever the story develops, in whatever dark corners of our world, when dark includes activities previously kept secret by those whose insider knowledge and ambition and greed place the public, innocent and naïve, at great risk. At the current rate of atrophy in most large network newsrooms, including those with the capacity and the resources to probe the story behind the story with which the public has become almost etherized, there is a real danger that the public increasingly will be robbed of the kind of information that Kroft and his 60 Minutes crew exposed last night. And as the stories of the secrets that endanger the common folk grow in both complexity and frequency, the public good becomes increasingly more in need of protection and the resources that make that protection feasible.