Hold on before you call the market 'rigged'

In his new book about high-frequency trading, "Flash Boys," Michael Lewis declares that the financial markets are rigged — but that may be a little hasty.

It's worth noting that Mr. Lewis clearly never gained access to anyone who was doing high-frequency trading to gain their viewpoints. There is no bibliography or index. And, there are some clear misstatements. Canadians are among the world's biggest debtors — not debt averse as the book claims. And apparently, HFT traders do go bankrupt — unlike the book's claim that no one in the industry has lost money in five years.

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The issues being raised by Mr. Lewis are meaningful despite those glitches but their presence does raise credibility issues.

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Perhaps more importantly, here are the broader issues that I think need clearer definition before we make the blanket statement that the market is rigged:

Oligopoly to multiplicity

The book indicates that the United States has gone from an oligopoly of three equity exchanges to what is now over 50 exchanges and dark pools competing for business. Is this bad, as the book intimates, or good? For decades the number of brokerage dealers have been dying and business has become more and more concentrated in fewer and fewer hands. Mr. Lewis is actually describing the expansion of the brokerage system due to advanced technology. This is actually very interesting and needs to be explored.


When I entered the business in the mid-1960s, the New York Stock Exchange fixed prices on trades at levels well above costs. Prices are now negotiated. They have, in fact, fallen in every sector of the equity trading business. If the current system is rigged to charge the investor trader more than what is acceptable, prove it. Prove that the principal gains being obtained by the HFT traders are greater than the commission or agency costs to the customers of the past.

Specialist system

It's also necessary to clarify why the current function of the HFT traders is different from the specialist system that operated on the legacy New York and American Stock Exchanges. For example, does the current system cost investors more or less than the old system?

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Cost structure

What does it cost to operate a broker dealer? If prices have fallen consistently in providing the services that they offer and costs have not fallen at the same pace, should these firms simply go out of business or should they seek new ways to obtain profits? Are dark pool profits simply providing the missing revenues that are needed to keep the business going now that pricing is more punitive than beneficial?

The biggest unanswered question

Is the price of Facebook or any other company's stock selling at a higher or a lower price than it should as a consequence of the actions of the HFT traders? This is at the core of the market-rigging argument. One must prove that stock prices are being fundamentally altered by the new practices in a fashion that now makes it impossible for them to reflect true value of the companies that they represent. The book does not make this claim. In fact, it hints at the possibility that HFT traders provide liquidity which facilitates purer valuations.

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This is a must-read book because it explains to investors many issues that require further discussion. However, if it is to be regarded as more than a marketing piece for the IEX Exchange, some of the core issues raised here need to be addressed in a second and more thoroughly researched edition.

Richard X. Bove is an equity research analyst at Rafferty Capital Markets and the author of "Guardians of Prosperity: Why America Needs Big Banks" (2013).