By Pam Martens and Russ Martens: February 9, 2021 ~

Yesterday, reporters at the Washington Post provided important new information about the insidious machinations of high frequency traders’ efforts to rig U.S. markets in their favor. WaPo reporters Douglas MacMillan and Yeganeh Torbati revealed the following:

“Hedge funds have started to build algorithms or hire outside firms that specialize in scanning conversations on Reddit and Twitter for clues about what retail traders are thinking. Several of these services, with names like Swaggy Stocks, Robintrack and Quiver Quantitative, popped up in the past two years…

“Last year, prominent hedge funds including Point72, D.E. Shaw, Two Sigma and Capital Fund Management were all found to be siphoning trading data from a popular app called Robintrack, which collected information on which stocks users of Robinhood bought and sold. Casey Primozic, the programmer who created the now-defunct app, tweeted his finding in May that he had traced large volumes of traffic back to servers that appeared to belong to those firms.”

This is the latest chapter in the long running saga of how Congress, the Securities and Exchange Commission and the Justice Department are allowing high frequency traders to fleece the public under the pretext of providing liquidity to markets.

It was almost seven long years ago that bestselling author Michael Lewis, a former veteran of Wall Street, went on 60 Minutes to promote his new book, Flash Boys, and told approximately 12 million viewers that “stock market’s rigged.” Lewis called high frequency trading by hedge funds “legalized front running,” where traders use high speed computers and algorithms to obtain an early peek at stock prices and what other investors are doing. News about the book and the 60 Minutes interview went viral around the world. Congress quickly assembled a series of hearings.

The question was, should high frequency traders’ ability to get information ahead of the general public be considered an illegal form of insider trading. One of the high frequency trading firms mentioned in the Lewis book was Virtu, which is currently paying for order flow from online brokerage firms like Robinhood. Lewis wrote:

“In early 2013, one of the largest high-frequency traders, Virtu Financial, publicly boasted that in five and a half years of trading it had experienced just one day when it hadn’t made money, and that the loss was caused by ‘human error.’ In 2008, Dave Cummings, the CEO of a high-frequency trading firm called Tradebot, told university students that his firm had gone four years without a single day of trading losses. This sort of performance is possible only if you have a huge informational advantage.”

During a June 18, 2014 hearing by the Senate Banking Subcommittee on Securities, Insurance and Investment, Senator Elizabeth Warren sized up what Virtu was doing as follows:

“For me the term high frequency trading seems wrong. You know this isn’t trading. Traders have good days and bad days. Some days they make good trades and they make lots of money and some days they have bad trades and they lose a lot of money. But high frequency traders have only good days.

“In its recent IPO filing, the high frequency trading firm, Virtu, reported that it had been trading for 1,238 days and it had made money on 1,237 of those days…The question is that high frequency trading firms aren’t making money by taking on risks. They’re making money by charging a very small fee to investors. And the question is whether they’re charging that fee in return for providing a valuable service or they’re charging that fee by just skimming a little money off the top of every trade…

“High frequency trading reminds me a little of the scam in Office Space. You know, you take just a little bit of money from every trade in the hope that no one will complain. But taking a little bit of money from zillions of trades adds up to billions of dollars in profits for these high frequency traders and billions of dollars in losses for our retirement funds and our mutual funds and everybody else in the market place. It also means a tilt in the playing field for those who don’t have the information or have the access to the speed or big enough to play in this game.”

The New York Stock Exchange, Nasdaq and others are aiding and abetting this scam by allowing high frequency trading firms to co-locate their computers next to those of the stock exchanges to gain faster access to trading data ahead of what the public sees. They charge expensive fees that the general public could never afford. Congress took testimony on this following the release of the Lewis book but has allowed it to continue.

As these hearings were taking place, the New York Stock Exchange was boasting in an online promotional offering that it could provide a “fully managed co-location space next to NYSE Euronext’s US trading engines in the new state-of-the-art data center.” It said it was for “High frequency and proprietary trading firms, hedge funds and others who need high-speed market access for a competitive edge.”

The SEC has also known for quite some time what has been going on. In December 2013 the SEC actually filed this rule change in the Federal Register announcing that the New York Stock Exchange was changing its pricing for some of its co-location services and computer cabinets for outside users. The NYSE stated it would offer: “a one-time Cabinet Upgrade fee of $9,200 when a User requests additional power allocation for its dedicated cabinet such that the Exchange must upgrade the dedicated cabinet’s capacity. A Cabinet Upgrade would be required when power allocation demands exceed 11 kWs. However, in order to incentivize Users to upgrade their dedicated cabinets, the Exchange proposes that the Cabinet Upgrade fee would be $4,600 for a User that submits a written order for a Cabinet Upgrade by January 31, 2014…”

The stock exchanges, which previously functioned along the lines of a utility to provide a level playing field for the public good, were now treating abusive high frequency traders as their best customers, deserving of concierge services.

As far back as October 28, 2009, the U.S. Senate Banking Committee took testimony from Larry Leibowitz, then head of technology at the NYSE, on how it was offering co-location to outside trading firms.

High frequency traders are also using direct access to business news feeds carrying market moving company and economic reports, exotic order types, artificial intelligence algorithms and a host of other devices to front run the trades of retail investors as well as those of pensions and 401(k) funds.

At an April 4, 2014 hearing before the House Appropriations Committee, then U.S. Attorney General Eric Holder was asked what the Justice Department was doing in regard to high frequency trading. Holder responded:

“As I indicated in my opening statement, I’ve confirmed that the Department of Justice is looking at this matter, this subject area, as well. The concern is that people are getting an inappropriate advantage, information advantage, I guess competitive advantage over others because of the way in which the system works. And apparently, as I understand it, and I’m just learning this, even milliseconds can matter, and so we’re looking at this to try to determine if any federal laws, any Federal criminal laws, have been broken. This is also obviously something that the head of the SEC, Mary Jo White, would be looking at as well.”

Holder came from, and returned to, the law firm that fronted for Big Tobacco for forty years. He did nothing to curtail high frequency trading.

Mary Jo White, then head of the SEC, came from, and returned to, Debevoise & Plimpton, which represented the biggest players on Wall Street. White appeared before the House Financial Services Committee on April 29, 2014 – one month after Michael Lewis presented his evidence on 60 Minutes – and flatly told Congress and the public: “The markets are not rigged.”

Co-location is still going on. High frequency trading has been ginned up to new heights. And what happened in the Reddit message board, WallStreetBets, with the stock of GameStop, is the culmination of Congress, the SEC, and the Justice Department turning a blind eye to rigged markets for years.

The WaPo reporters add this additional fascinating detail to their report:

“GameStop has 47 million shares available to trade in the stock market. And yet, on its roller coaster ride from a share price of $17 to $483 in the span of three weeks, investors bought and sold those shares hundreds of millions of times. Over three of the stock’s most volatile trading days, GameStop shares changed hands 554 million times — more than 11 times the number of total shares available.”

The source of that kind of trading can only be high frequency traders using algorithms. The nutty idea that the young, novice traders at Reddit were somehow democratizing Wall Street is a fanciful movie script that didn’t hold up from the get go. Now there is evidence that hedge funds may have been tracking the activities of Reddit traders and commenters like lab rats in order to front run their trades.

We’re going to have new people in charge at the Justice Department, SEC, and Senate Banking Committee. We’ll be watching their actions carefully to see if they finally tackle this mess.