Author Michael Lewis’s argument that U.S. stock trading is rigged reflects a misunderstanding of how the market operates and its history, said Bill O’Brien, the president of exchange operator Bats Global Markets Inc.
“Shame on both of you,” O’Brien said during an interview today with CNBC, addressing Lewis and IEX Group Inc.’s Brad Katsuyama, a hero in the author’s latest book. “You don’t understand that the market has always had intermediaries,” O’Brien said.
O’Brien was on CNBC debating Lewis, whose new book “Flash Boys” says exchanges, Wall Street banks and high-speed traders are ripping off investors in the $23 trillion U.S. stock market. Bats runs four U.S. stock exchanges and was founded by a high-frequency trader, Dave Cummings of Kansas City, Kansas-based Tradebot Systems Inc.
Lewis said computers aren’t the problem, and neither is the pace of trading, which is now measured in thousandths or even millionths of a second. It’s that Wall Street brokerages use loopholes at exchanges to profit, mitigating the cost-reducing impact of improved technology.
“Wall Street has clawed back some of those benefits for itself,” Lewis said. “People are getting scalped in the market. Wall Street is capturing unnecessary sort of revenues. It’s a tax. Unnecessary intermediation is going on.”
High-speed traders aren’t necessarily to blame, he added.
“I think of the high-frequency traders as just basically exploiting a system that’s got these glitches in it,” Lewis said on CNBC. They have simply “found loopholes to jump through. You know, it’s sort of like, I don’t know, blaming the lion for eating the antelope.”
In “Flash Boys,” Lewis says large Wall Street brokerages let HFT firms pay for the right to trade in their dark pools, making the broker’s customers vulnerable to being taken advantage of by the fastest computerized firms. The current market structure also encourages needless transactions, Lewis writes.
With his latest book, Lewis added his voice to an increasingly loud debate about high-frequency trading. In March, New York Attorney General Eric Schneiderman said he’s scrutinizing practices that give some computerized firms a speed edge. Agents from the Federal Bureau of Investigation are investigating whether HFT firms break U.S. laws by acting on nonpublic information to gain an edge.
High-frequency trading comprises a diverse set of strategies driven by computers automatically buying and selling assets including stocks. Bats, the New York Stock Exchange and Nasdaq Stock Market rely on them to facilitate much of their volume, after more than a decade of regulatory and technological changes, including the pricing of shares in penny increments, cut profits and pushed humans out of the business.
Firms using the tactics 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. While critics such as Lewis see a Wall Street plot, proponents say the new system is faster and cheaper.
“What is missed in the book and in the general discussion of HFT is there are some HFT traders who respect the sanctity of the investor, and some who don’t,” said Arthur Levitt, who oversaw the Securities and Exchange Commission in the 1990s and is now a Bloomberg LP director. “When markets tank, some HFT traders disappear like specialists and over-the-counter brokers used to disappear. On the other hand, some HFT traders are there for the whole game.”
In the book, Lewis profiled IEX and its chief executive officer, Katsuyama. The five-month-old platform has curbs meant to combat trading practices the firm deems predatory.
“It’s a very, very old tactic to try to build a business on the planks of fear, mistrust and accusation,” Bats President O’Brien said today on CNBC. “This has certainly taken that to a new level.”
The CNBC anchor asked Katsuyama whether he thought the U.S. stock market is rigged.
“I think it’s really hard to put a word on it,” Katsuyama said.
“You said it in the book,” O’Brien replied. “It’s disgusting that you are trying to parse your words now, OK? You can’t say that.”
“OK, let’s walk through --,” Katsuyama said.
“Do you believe it or not? Because you said it,” O’Brien said.
“Let me walk you through an example,” Katsuyama said.
“It’s a ‘yes’ or ‘no’ question. Do you believe it or not,” O’Brien said.
“I believe the markets are rigged,” Katsuyama said.
“OK, so there you go,” O’Brien said.
“I also think that you are part of the rigging,” Katsuyama said. The IEX chief then explained how he thinks markets should work.
“When you look at an exchange or dark pool, the responsibility of that venue is to fairly price trades between slower participants and faster participants,” Katsuyama said during the CNBC interview at the New York Stock Exchange floor, prompting cheers from traders there, who’ve seen their business pressured by computerized trading.
O’Brien said Katsuyama misrepresents how markets work.
“You don’t understand that the market has always had intermediaries,” O’Brien said. High-speed traders use “technology to manage the risks of providing that service to the market.”
Later, O’Brien said technology improvements have cut trading costs for investors and reduced risks, though there are still flaws.
“Saying it’s not rigged and saying it’s perfect are not the same thing,” he said, referring to the structure of the stock market.
Katsuyama praised “Flash Boys” for examining the market’s imperfections.
“What Michael Lewis did is he lit a torch,” he said. “It’s the industry’s job to light more torches and carry them forward.”
To contact the editors responsible for this story: Nick Baker at email@example.com Michael P. Regan