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This space is normally devoted to commentary on one or more companies’ share price. Today it is about exposing what may be the biggest scandal ever to hit stock exchanges around the world. The problem in the U.S. is so bad that the FBI is now investigating the massive fraud being perpetrated on U.S. investors. I first learned about this on the March 30th edition of the popular CBS news program “60 Minutes.” What worries me is that the practice cannot possibly be confined to the U.S. markets.
It was in the mid-1980’s that I first heard someone say that information would become more important than speed. Soon, we were in the midst of the Information Age. The problem now appears to be that technology has thrust speed back into the equation, making the speed of obtaining information as significant as the information itself. If someone has the information in advance of others, that person has the ability to act upon that information first. In this case, we are talking about milliseconds meaning millions of dollars.
Highway Robbery
Highway robbery has moved from dirt and paved roads to the Information Highway. But now, it’s not like having your money stolen while you are staring down the barrel of a gun. It’s happening so fast that it’s more like having your pockets picked on a speeding subway train at rush hour. Only, in this case, you never really notice that you have been robbed. It’s not an illusion where “Now you see it; now you don’t.” It’s more like “You never see it and you never will.”
Michael Lewis, author of “Flash Boys,” the recently-released book on the subject of high speed trading, claims that “The stock market is rigged, and even the richest, most sophisticated investors are getting screwed every day.”
How It’s Done
We tend to think that when we hit the “Enter” key, our transaction is done. But just think about it for a minute. Often, when we hit “Enter,” a screen pops up and says something like “Processing.” Even though every day transactions happen quickly, there is still some processing time involved, albeit short. But that consumer processing takes a long time compared to the speeds used in the highly sophisticated systems used in stock trading. There are at least several ways that the thieves are robbing us blind.
- Placing a group of trades to create an illusion of market activity, then cancelling those trades before they are consummated. It’s kind of like yelling “Fire!” to empty a crowded theater.
- Observing client orders and reacting in a way that puts money into a broker’s own pockets.
- Cutting in line. I’m going to use one of Michael Lewis’ stories to illustrate this point. Let’s say that you want to order four tickets to a concert at £100 each. You place your order. You get a message that you have received two tickets and “Thank you very much.” Moments later, you try to order two more tickets only to find that the other two seats that you originally ordered are still available. But now they cost £150 each. Someone jumped in, bought the two at £100, then sold them back at a higher price. You get the idea.
How Do You Prosecute a Computer?
That would be the problem. All of these actions are the result of the use of extremely complicated algorithms embedded in the computer programs. You’ve got to be a computer guru to write them . . . and you’ve got to be a computer guru to catch them. And, if you do catch them, whom do you prosecute? The CEO? The CIO? Or the programmer?
Perhaps more importantly, how do you stop them for making the game faster and harder to beat?
