Brad Katsuyama was mystified. A Royal Bank of Canada trader whom RBC sent from Bay Street to Wall Street – where he met “more offensive people in a year than I had in my entire life,” he told writer Michael Lewis – Katsuyama discovered a strange thing: staring at his screen, and deciding to buy a stock, he'd hit “Enter,” and presto, in that moment the shares vanished. But they'd pop up a penny or two higher.
Those pennies added up to billions. Briefly, some high-frequency traders (HFTs) were “front-running” the market, an old trick of those with some advance information allowing them to unfairly shoot ahead of the crowd, thus gaming the system.
What was new? Technology, and a burst of new exchanges, allowed trades at insanely fast speeds – an edge over others of as little as three milliseconds (a millisecond is one-thousandth of a second).
As Lewis wrote in Flash Boys: A Wall Street Revolt, the boys “played only when they had an edge. That's why they were able to trade for five years without losing money on a single day.”
Lewis' book predictably has furious critics.
Front-running is nothing new, Financial Post editor Terence Corcoran scoffed. Besides, “study after study has shown that HFT has produced uncountable benefits to stock investors, making the prices they pay for stocks more accurate and less prone to manipulation than they had been in the past.”
But Jan Simon, who spent 11 years with Goldman Sachs and is now a senior lecturer at Simon Fraser University's Beedie School of Business, drily told me: “Just because some people are still robbing banks doesn't make it right. … Those billions being made using this strategy are taken from [all investors] – big, small, everybody.”
Nan Ning, an assistant professor and computer expert at University of British Columbia's Sauder School of Business, stressed that she wouldn't deal with the moral issue. But she praised Lewis for “a great job of explaining. … [The issue] has huge implications for all stock market locations.”
Several prominent Vancouver figures begged off as not being experts in this specific area and suggested someone else, who did likewise. A well-known newsletter editor didn't respond. But my own broker, Dwight Mann of National Bank Financial, replied to questions with candour and even-handedness:
“Lewis' premise is that … high-speed traders have an unfair advantage by anticipating a trade coming into the markets. They move in first, then flip the trade and skim one to three cents' worth of profit. [They] have come into play because of technological innovation and for liquidity needs in the markets.
“Are markets rigged? Yes, probably, but to what degree is this impacting the average investor? These issues have always been around … because even worse than Flash Boys were the market ‘specialists' who took $0.12 per trade when the stock market worked on a fractional system [versus the current decimal system].” (The undersigned was a newspaper proofreader in those days of one-eighth-of-a-dollar increments, the day's quotations listed in small print – thus my hollow eyes.)
Mann continues: “I am not saying it's right, and public awareness about the issue is good. … [But] one's decision should not be dependent on pennies but whether that stock represents good long-term value.”
Katsuyama left RBC – strongly applauding its integrity – in 2012 to form IEX, an exchange that “slows down” its link with HFT firms through a 350-microsecond delay that puts all prospective traders of a stock on the same time footing.
Tiny IEX struggled, but it arrived when giant Goldman Sachs made a sizable trade through it.
Prof. Simon praised Wilfrid Laurier-educated Katsuyama, whose persistence shook up Wall Street's culture as only an outsider could: “It's people like him who will make it change.” •
