Regulators and prosecutors in the U.S. and Europe are looking at whether high-speed trading impairs market stability and gives some investors an unfair advantage. New York Attorney General Eric Schneiderman sued Barclays in June 2014, claiming it favored high-frequency traders at the expense of other customers, a claim the bank denies. The U.S. Securities and Exchange Commission settled two cases in January 2015 involving similar accusations, one with the Direct Edge stock exchanges and one with UBS. Despite these investigations and others, no one has proven that high-speed trading hurts conventional traders. Concerns about the potential for speedy markets to crash led the SEC to tell stock exchanges to improve their technology. Among the high-profile breakdowns: In August 2013 the price ticker for Nasdaq stocks malfunctioned, leading to a three-hour trading halt in thousands of shares, including those of Apple, Google and Microsoft. The flash crash of May 2010 erased more than $800 billion from the value of U.S. stocks in a few minutes; five years later, an obscure London trader was arrested and charged with contributing to the disaster through market manipulation and fraud. In between there were three malfunctions that made headlines in 2012, with stock market operator Bats Global Markets canceling its own initial public offering after errors on its computers; Nasdaq stalling Facebook’s IPO, and Knight Capital Group losing about $450 million in a day after barraging markets with errant orders.
Stock markets have never been problem-free. The NYSE ruled in 1927, for instance, that orders completed at wrong prices due to “mechanical error” would stand despite the mistake, the New York Times wrote at the time. In the late 1960s and early 1970s, a deluge of paperwork amid surging volume routinely prompted full-day closings and shortened hours, and several computer glitches halted trading. Although computers entered the scene in the 1960s, the modernization of trading really began in 1975, when the U.S. Congress mandated the creation of a “national market system” linking venues around the country. The advent of the Internet and lower-cost computer hardware fueled the emergence in the 1990s of upstart all-electronic trading platforms with names like Island and Archipelago, which offered better technology than the incumbents at a lower price. NYSE ultimately bought Archipelago and Nasdaq bought Island. The 2001 shift to pricing stocks in one-cent increments eroded profits for human traders, with speedy automated trading firms stepping in to fill their traditional role. The final major shift came in 2007 with Regulation NMS, which requires that a stock be traded on whatever market has the best price at any given time.
Critics of modern markets, including Warren Buffett, argue that they are too fast and too beholden to cutting-edge technology. The critics say the dangers of disruptive breakdowns has grown to dangerous levels; that speed traders, with their focus on short-term returns, hurt investors with a stake in the long-term success of companies; and that the worst abusers may be guilty of illegal manipulation. Despite their gripes, it’s unlikely that the role of computers will diminish or that trading will noticeably slow down. That doesn’t mean there won’t be changes: In recent public appearances, regulators and stock exchange executives have voiced a desire to improve the reliability of systems and establish back-ups to minimize disruptions when they do happen. It may be that, as with any other machinery, the best to hope for is fewer failures and little damage when malfunctions occur.
The Reference Shelf
- The Securities and Exchange Commission’s Concept Release on Equity Market Structure.
- Bloomberg Businessweek article on high-frequency trading and electronic markets.
- The SEC’s dedicated Market Structure mini-site.
- Senate Banking Committee page has transcripts and webcasts of testimony at a December 2012 hearing on electronic markets.
- Michael Lewis’s 2014 book, “Flash Boys,” argues that speed trading hurts ordinary investors.