(Bloomberg) — The U.S. stock market is a rigged game where high-frequency traders with advanced computers make tens of billions of dollars by jumping in front of investors, according to author Michael Lewis, who spent the past year researching the topic for his new book "Flash Boys."
While speed traders' strategies, developed over the past decade with help from exchanges, are legal, "it's just nuts" that they're allowed, Lewis said during an interview televised yesterday on CBS Corp.'s "60 Minutes." The tactics are too complicated for individual investors to understand, he said.
"The United States stock market, the most iconic market in global capitalism, is rigged," Lewis, whose books "Liar's Poker" and "The Big Short" highlighted Wall Street excesses, said during the interview. The new book comes out today. "It's crazy that it's legal for some people to get advance news on prices and what investors are doing," he said.
Everyone who owns equities is victimized by the practices, in which the fastest traders figure out which stocks investors plan to buy, purchase them first and then sell them back at a higher price, said Lewis, a columnist for Bloomberg View. To show how lucrative the tactics are, Lewis said a technology firm spent $300 million to build a line that would shave three milliseconds off the time it takes to communicate between New Jersey and Chicago, then leased it out to securities companies for $10 million each.
Industry obsession
The author's comments follow the decision New York Attorney General Eric Schneiderman to investigate privileges marketed to professional traders that allow them to place their computers within feet of exchanges and buy access to faster data streams. Officials at the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission have also said market rules may need to be examined.
Lewis is adding his voice to a debate that has obsessed the securities industry for almost a decade while only periodically surfacing in public via events such as the May 2010 flash crash, in which the Dow Jones Industrial Average posted an almost 1,000 point loss. Previous books by the one-time Salomon Brothers Inc. trader have focused attention on everything from mortgage derivatives to baseball statistics and contributed to the outcry over the events leading to the 2008 financial crisis. His latest target, high-frequency trading, comprises a diverse set of software-driven strategies that have spread from U.S. equity markets to most developed countries as computer power grew and regulators tried to break the grip of centralized exchanges. While the tactics vary, they usually employ super- fast computers to post and cancel orders at rates measured in thousandths or even millionths of a second to capture price discrepancies on more than 50 public and private venues that make up the American equities market.
Dominating volume
High-frequency traders account for about half of share volume in the U.S., a statistic that shows their pervasiveness and hints at the obstacles faced by proposals to rein them in. Exchanges rely on HFTs for profits as well as liquidity, with electronic market makers all but eliminating the old system of human floor traders who oversaw the buying and selling of equities. While critics such as Lewis see a Wall Street plot, proponents say the new system is faster and cheaper.
In the U.S., the biggest high-speed traders include Virtu Financial Inc., which filed in March to sell shares to the public. Bats Global Markets Inc., the Lenexa, Kansas-based equity exchange that merged with Direct Edge Holdings LLC this year, was founded by a high-frequency trader.
Book's hero
"We believe Lewis's book can have a big impact on complex market-structure issues that have been simmering for years," Joe Saluzzi, co-head of equity trading at Themis Trading LLC and a frequent critic of the status quo in markets, said before the "60 Minutes" interview was broadcast. "Hopefully this type of publicity will finally force regulators to take action on issues that they've been sitting on for way too long."
One of the heroes of Lewis's book is Brad Katsuyama, who left Royal Bank of Canada in 2012 to form a new market, IEX Group Inc., along with other former traders from the Toronto- based bank. David Einhorn's Greenlight Capital Inc. hedge fund invested in the platform, which started trading in October and was established to minimize the influence of predatory strategies, Goldman Sachs Group Inc. has endorsed IEX and is the venue's biggest broker.
Ticket prices
IEX was established partly to address concern that technology advances and fragmentation have made the $22 trillion U.S. equity market too fast and opaque. The platform, a dark pool with ambitions to officially become an exchange, imposes a delay of 350 microseconds, or 350 millionths of a second, on orders — enough to curb the fastest trading firms. IEX aims for greater transparency by making its trading rules available for public review, unlike some other electronic venues. During his own interview with "60 Minutes," Katsuyama described how the stock market rips off investors. While still at Royal Bank, he noticed that prices seemed to move against him when he was trading.
"The best analogy I think is that your family wants to go to a concert," he said. "You go onto StubHub, there's four tickets all next to each other for 20 bucks each. You put in an order to buy four tickets, 20 bucks each and it says, 'You've bought two tickets at 20 bucks each.' And you go back and those same two seats that are sitting there have now gone up to $25."
Katsuyama concluded that his intentions became visible on some exchanges faster than others. The most fleet-footed traders could take advantage of that by submitting bids and offers on the slower markets.
Lewis said, "I spoke to dozens of investors, big investors, famous investors who said that, 'When Brad Katsuyama came into my office and laid out to me how the market was rigged, my jaw hit the floor. I mean, I knew something was wrong. I just didn't know what it was and no one had told us.'"
Eric Ryan, a spokesman for the New York Stock Exchange, and Nasdaq OMX Group Inc.'s Rob Madden declined to comment on Lewis.
"We completely disagree with allegations that the U.S. equity market is rigged," Bats President Bill O'Brien said in an e-mail. "While we should never stop trying to improve our market structure, it is unfair and irresponsible to accuse people simply because they use technology and enhance competition. This has helped make our market the most competitive and liquid in the world, greatly benefiting individual investors."
New York
