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“Front running” scandal hits us markets

A firestorm in raging in the US over whether high-speed trading has resulted in a rigged stock market.

According to Michael Lewis, author of a new book “Flash Boys: A Wall Street Revolt,” the U.S. stock market is rigged in favor of high-speed electronic trading firms, which use their advantages to extract billions from investors, The process is called front running.

“It’s very clear people are being front-run,” Lewis said.

High-frequency trading (HFT) is a practice carried out by many banks and proprietary trading firms using sophisticated computer programs to send massive orders into the market, executing a small portion of them when opportunities arise to capitalize on price imbalances, or to make markets. HFT makes up more than half of all U.S. trading volume.

High-frequency trading firms, however, aren’t villains, Lewis said. They’re simply profiting off loopholes in the system.

Blaming HFT firms is “like blaming the lion for eating the antelope,” Lewis said. “They are wired that way. The system is screwed up.”

Senator John McCain said Congress, as well the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission, should investigate high-frequency trading issues and “pursue proposals that can minimize systemic risk and bolster trust in our markets,” according to a statement.

The Federal Bureau of Investigation (FBI) are also getting involved, making an unusual public plea for the financial industry to bare its secrets, by openly solicited traders and stock-exchange workers to blow the whistle on possible front-running and manipulation via high-speed computers.

The technological arms race among professional equity traders threatens to destabilize U.S. markets and more should be done to limit their speed, according to New York Attorney General Eric Schneiderman.

Schneiderman, whose office is examining privileges marketed to high-frequency firms such as enhanced data feeds, said Lewis’s book will help focus attention on the debate.

“I would not be quite as hyperbolic as that,” Schneiderman said in an interview with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “Market Makers” program. “The race for speed is inherently dangerous. That leads people to take more and more chances to try and get an advantage, and that could lead to destabilization.”

While Lewis sees exploitation rampant among the more than 50 public and private venues that make up the American stock market, his thesis has drawn rebuttals from executives such as 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.

The report has already begun to affect the markets. Virtu Financial Inc., delayed the marketing of its initial public offering to weeks later than bankers anticipated, two people with knowledge of the matter said.