Eric Schneiderman, Wall Street Time-Machine Sheriff

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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If you are an ambitious candidate for Sheriff of Wall Street, a problem you face is that, on the one hand, you need to tell everyone about how you are going after evil guys in order to level the playing field for ordinary investors, but, on the other hand, that is a very very tired metaphor. New York Attorney General and high-speed-trading data crusader Eric Schneiderman is up to the challenge:

"To put it in terms of a race, old-fashioned insider trading involved a few people sneaking over the starting line," Mr. Schneiderman said, speaking generally about [high frequency traders getting economic data early]. "These guys are moving the starting line halfway to the finish before their competitors even have their feet in the blocks."

I but what? Why? Part of the difficulty is that everything everyone does in the financial markets is about getting some advantage over their competitors, but the misbehavior he's going after -- high-speed leaks of economic data -- confers that advantage for only a couple of milliseconds. "To put it in terms of a race, these guys are starting the race five one-thousandths of a second before the gun goes off" doesn't exactly inspire terror.* "To put it in terms of a race, these guys are supergluing their competitors' feet to the starting blocks, then sawing their legs off and hopping in a Ferrari to drive to the finish line." I don't know, embellish his metaphor at your leisure, he will.

I don't want to trivialize this advantage too much: High frequency traders really can make bazillions of dollars with an advantage of a few milliseconds. On the other hand this is basically bunk:

When high-frequency traders have access to soon-to-be-released public information, Mr. Schneiderman said, individual investors get hurt and markets lose credibility.

"Who's going to invest knowing they're set up to lose? If investors don't have confidence in the essential equity of the markets, there will be no markets," he said.

One way you can tell it's bunk is umm there are markets and they are not essentially equal. This is a true story: Many banks employ analysts who write detailed research reports that include recommendations on whether you should Buy or Sell a stock, and they give those research reports to their paying clients and not to anyone else. Those clients are paying for an unfair advantage!** But it's not just banks. The Wall Street Journal employs journalists who find news and then make that news available only to paying subscribers. Bloomberg employs journalists who find news and then make that news available to anyone on the Internet, shortly after making it available only to paying Bloomberg terminal users.

The "essential equity of the markets" is bunk because the essence of the markets is inequity. You trade because you have, or think you have, better information than someone else. If everyone had the same information, and believed that they had the same information, there would be no markets.

That aside though! The five millisecond thing. Schneiderman's focus is not information asymmetries generally, but millisecond-level high-speed trading asymmetries specifically. These really are bad, in the sense that many of them seem to come from illegal leaks (and/or time machines), and in the sense that those who benefit from the leaks can profit rather substantially. But you gotta profit from someone. The mechanics are like:

  1. At 1:59:59.999pm, the order book for Thing X is a lot of bids at 99 and a lot of offers at 101.
  2. At 2:00:00.000pm, Good News comes out, moving the fundamental value of Thing X to 105.
  3. At 2:00:00.001pm, Evil High Frequency Trading Fund gets the news from its time machine.
  4. At 2:00:00.002pm, Evil HFT Fund puts in a bunch of bids at 101.
  5. At 2:00.00.002 through .006 inclusive, Evil HFT buys a bunch of Thing X from suckers at 101.
  6. At 2:00.00.007, the suckers get the information from public sources and update their markets to 104/106 or whatever.
  7. Evil HFT fund profits mightily.

What lesson do you draw from this? Eric Schneiderman seems to believe that the intuitive lesson is, "you are all dumb money, never invest," so he needs to stamp it out so there can be investing:***

Normal, average Americans thought that they and their brokers, if they were prudent, had an opportunity to buy low and sell high as the big-time Wall Street players did. And the new market manipulators, the new folks who do something that would have been unimaginable a decade ago, they refer to those average Americans as the dumb money. And ladies and gentlemen, a lot of us here may well be a part of that dumb money, because if you do not have access to a super-computer capable of flipping tens of thousands of shares in milliseconds and access to market-moving information a little bit ahead of everyone else, you may be in the dumb money, even if you think you're an insider who thinks they have an edge.

But this is a weird lesson to draw! The lesson is not that you are dumb for buying or selling Thing X at 1pm or 3pm or 10am, when there's no market moving data about. The lesson is that you are dumb for trying to buy or sell Thing X at 2:00:00.00whatever. Who is doing that? Mostly high frequency traders with slower time machines, one presumes.**** Humans take 300 milliseconds to blink, as the financial press will now tell you, so all you have to do to avoid being picked off by high frequency traders with illicit access to news is blink once before trading. There you go! The danger has passed.

The thing is that no matter what Schneiderman does, some high frequency trading firms will be faster than others: Even if they all get the information at the same time, some will have better computers and algorithms and connections, because that's how they compete. Telling "ordinary investors," on pretty much any definition of "ordinary investors," that they should be able to compete in a fair race for milliseconds of trading profits seems irresponsible. Telling them to give up that dream and invest for the long term -- longer than a few seconds anyway! -- seems right. These high frequency front-runners are, at least, conveying that correct information.

* Also how long is the race? I mean markets move fast. But they also, like, go on forever. I don't know, call it a 4x400 relay, this is not actually an interesting question.

** Schneiderman:

Mr. Schneiderman said his office was also concerned about investors getting early looks at Wall Street analysts' assessments of companies they are covering. "A firm with access to analyst assessments before they are officially released can front run the market," Mr. Schneiderman said.

Oh sure! But then when they're officially released to clients the clients can front run the non-clients, who cares.

*** Unlike other quotes here (which are from that Journal article ), this is from the transcript of Schneiderman's talk at the Bloomberg summit yesterday.

**** From pseudonymous finance blogger Kid Dynamite , a while back:

See, you can't just take the data, see it, and "trade" on it -- you need someone to *trade* with -- you need a counterparty to your trade: someone on the other side. My guess is that not every obviously-evil-HFT-Algobot processes the data in the same way, and they are largely trading with each other in those milliseconds after the release in which I can't even react. Who cares? If they're not trading with each other, who are these idiots who are leaving blind bids and offers out there during *scheduled* news release periods? And again, who cares? Don't leave bids and offers hanging in the market when you're flying blind on a data release that other people have access to.

Possibly a bit harsh? But basically right.

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Matthew S Levine at