By Pam Martens and Russ Martens: June 19, 2014
Outside of the Washington Times, there was a virtual corporate media blackout on the high frequency trading hearing held yesterday by the Senate Banking Subcommittee on Securities, Insurance and Investment – which came one day after Senator Carl Levin’s hearing on the same topic.
The media blackout did a deep disservice to the brilliant perspectives brought to the table by Senators Elizabeth Warren and Mark Warner and two witnesses who deal every day of their lives with the corrupted and disfigured trading venues the SEC has allowed to evolve in what used to be the most trusted stock market in the world.
On the Senate’s witness panel were Jeffrey Solomon, CEO of Cowen and Company, an investment bank with roots dating to 1918 and Andrew Brooks, Head of U.S. Equity Trading for T. Rowe Price (who has been a trader for 34 years) at a firm which now manages $711.4 billion of the life savings of Americans.
The third witness was Professor Hal S. Scott, the Nomura Professor of International Financial Systems at Harvard Law School – who has been teaching at Harvard for 39 years and has never worked a day as a trader. (Harvard, by the way, received a donation of $150 million in February of this year – the largest donation in its history – from Ken Griffin, CEO of Citadel – a hedge fund that profits from high frequency trading. The sponsor of Professor Scott’s chair at Harvard, Nomura, runs NX, a dark pool in Europe which also benefits from high frequency trading. If you are guessing that Professor Scott came down strongly on the side of high frequency trading, you will not be surprised by his testimony.)
Scott’s written testimony launched right in to an attack on the Michael Lewis book, Flash Boys, which has set off public awareness of just how rigged U.S. markets have become. Scott said the debate about high frequency trading can’t be based on “a journalistic tale that makes for a best seller—rather it must be informed by verifiable facts.” (Lewis, actually, went out of his way to verify his facts in the book. It’s those facts which the high frequency enablers don’t want to discuss.)
Scott’s testimony can be summed up with this one liner: “Let me be clear at the outset, that I believe the net effect of HFT activity in our equity markets has been positive.”
Senator Elizabeth Warren got the ball rolling with this statement:
“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.”
During questioning by Senator Warren, Brooks of T. Rowe Price delivered an impassioned plea for Congress to show some backbone and at least start to move in the right direction. Brooks said:
“The markets functioned pretty well prior to high frequency trading strategies being adopted. If 95 out of a hundred times that you’ve said you want to buy 100 shares of GE you cancel that trade – that expression of trading interest – before anybody can get to you, I sort of question the true intent of what you’re doing…So much of what a high frequency trading strategy might be is to act, to draw a reaction, and then to profit from your reaction. So they flank you, they pivot around you. They really have no intention of trading, they just sort of want to see what you’re going to do. And once they know what you’re gonna do, they can step in front of you…
“What we’ve been led to understand about market structure and the quest for speed is when you’re interested in speed you’ve removed safeguards, and you’ve removed some of the infrastructure and the underpinnings of the market. Fortunately, the SEC put in the limit up, limit down and some market-wide circuit breakers and that’s been great but both the Flash Crash and the Knight Capital situation were maybe driven by speed. And if that’s the case, that’s not good for anybody.
“As investors, it’s rare, it’s rare that speed is important to us. Our average holding period is like three years. Why do I really care what’s going to happen in a nanosecond…And that speed advantage, if it destabilizes, it seems to us that that’s wrong. That’s not right and we ought to push back on that. Our view is we really ought to just slow down. Not walk away from technology but let’s take a deep breath here and really look at what we have…
“We’ve got to make some progress. You know my boss says to me, I don’t really care how fast you’re moving toward the goal, but please move in the right direction will ya. If I’m not moving in the right direction, I’m in trouble. We have not been moving in the right direction. Oh my God, we’ve got Dodd-Frank, we’ve got Volcker, we’ve got ba-ba-ba. All these things out there, they’re always there. There’s always a reason why you can’t do it today…Can we just start to make some progress – please.”
Senator Warren responded that she wanted to “see the SEC, the state agencies push forward in their investigations and I think we should continue to do the same.”
Cowen’s Solomon made outstanding points on the serious and real potential for the market to be destabilized in a downturn, explaining that under the current wildly fragmented structure, there was no buyer of last resort as previously existed at the New York Stock Exchange.
Senator Mark Warner, who said he came from a venture capital background, expressed deep concern that four years after the May 6, 2010 Flash Crash, the SEC was still dragging its feet in creating a consolidated audit trail – so it could actually figure out who is to blame when markets wildly gyrate for no obvious reason.
Public confidence in Wall Street continues to erode. This was an important hearing that shed significant sunlight. It was just plain wrong for the business press to ignore this hearing.