Trader Talk

Michael Lewis' 'Flash Boys,' one year on

Michael Lewis
Getty Images

Its been one year since Michael Lewis' 'Flash Boys' hit the shelves. What has been the impact of the book?

It certainly sold books. Four consecutive weeks at Number 1 on the New York Times nonfiction list is quite a feat.

And it generated a lot of debate. Remember, at heart, it's a book about market structure. A book about market structure that makes the bestseller list? Wow.

It was the marketing that really made the book, and the timing. Lewis' main allegation—that the market is "rigged" in favor of high-frequency traders—fits in perfectly with the broader societal condemnation of the financial crisis and with the even broader folk mythology that the markets—and other human affairs—have always been manipulated by a small elite.

To a certain extent, the book reflects what Richard Hofstadter famously called "the paranoid style in American politics," the vague fear that there are dark, evil forces controlling us (and our money), that our fates are not our own.

Regardless, the book had a substantial impact, of that there is no doubt.

Let's try to keep this to a couple issues:


SEC Chair Mary Jo White emphatically stated that "the markets are not rigged" and, in Congressional testimony, said the retail investor was "well served, very well served, by the current market structure."

As for high-frequency trading (HFT), she said it "is not unlawful insider-trading."

That doesn't mean the SEC is delighted with all aspects of market structure. In January, White created a Equity Market Structure Advisory Committee to advise the SEC on what, if any, changes need to be made.

There is certainly a range of opinions on how much needs to be done to improve the markets at the SEC, but the lack of an emphatic response from them clearly indicates they do not believe the U.S. markets are in dire straits.

On the enforcement front, the book generated some smoke, though it's debatable how much fire has been generated.

The FBI, the U.S. attorney general, New York state prosecutors and the SEC have confirmed they are investigating the practices of high-speed firms.

New York state Attorney General Eric Schneiderman has been particularly active, even announcing that subpoenas were sent to exchanges to examine their relationships with HFTs.

Yet, there have been remarkably few "gotcha" moments. In one small case, the NYSE did pay a $4.5 million fine over violations regarding "co-location," or allowing HFTs to site their computers right next to the exchange's "matching engine" so that information can be accessed more rapidly.

In another case, the exchange Direct Edge (now part of BATS) was fined $14 million in December 2014 for failing to follow rules regarding disclosure of how it handled order types. That investigation was underway long before the Lewis book came out, but the publicity likely accelerated the investigation.

In perhaps the most high-profile case, the New York attorney general is currently embroiled in a dispute with Barclays over the way it has managed its dark pool, alleging that the bank did not tell traders about the presence of high-frequency traders in the pool.

But these are actions against exchanges and a bank. There are few actions against HFTs themselves that are engaging in "abusive" or "manipulative" behavior.

This is surprising, because I do believe that there are bad actors. I think it's highly likely that some HFT somewhere has tried to game the system, to engage in practices that could be considered "abusive" and "manipulative" under the law.

Why do I believe this? Because the entire history of trading—for hundreds of years, long before HFT—are filled with examples of individuals who have tried to abuse the system. Why should high-frequency trading be different?

That doesn't mean the whole system is rotten, it just means enforcement should be rigorous.

In the case of HFT, much of the problem is that it is extraordinarily difficult to catch blatant abuse. It's hard because intent can be difficult to prove, and it's hard because in many cases the data isn't sufficiently robust to demonstrate abuse.

The SEC is trying to remedy that. There are proposals out now for a Consolidated Audit Trail (CAT) that would allow regulators to efficiently and accurately track all activity throughout the U.S. markets. Let's hope the plan can be executed at a reasonable cost. Unfortunately, it appears to be years away from implementation.

And FINRA has proposed the creation of the Comprehensive Automated Risk Data System, which will gather trading data from some 4,000 brokerages in over 110 million investor accounts. That, too, is some years away.

Both of these proposals were well underway before Lewis' book.

One rule that needs to be implemented immediately: the SEC is trying to require high frequency traders to register with the SEC. It's about time: if HFTs are such a big part of the trading process, why doesn't the SEC even know anything about them? This is a first step and hopefully this will be done by the end of this year.


For the most part, the industry—big banks, exchanges, and the mutual fund industry (with a few exceptions) has rejected the claims.

It may not be surprising that the sell-side defends the status quo, but what about the buy-side? They, presumably, are getting the short end of the stick. Why, for example, haven't the big mutual funds issued denunciations? Even Jack Bogle, founder of Vanguard and no friend of high-frequency trading, has rejected the claim that the markets are rigged.

And what about the companies whose stocks are supposedly being manipulated. Why aren't there more complaints? Why, for example, haven't we heard issuers and companies themselves complain more? Maybe there is a company that has made an issue of this on a quarterly conference call, but I don't know of one.

Again, you can argue they are all corrupt, but do you really believe that? Isn't a more likely answer that: 1) this issue, if it is even a little true, is not among the highest priorities for funds, and 2) investors care a lot more about the long term returns of what they are buying, and those results have been excellent.

Still, there have been some moves to change things, though they are not related to Lewis' book. In one significant move, mutual fund giant Fidelity, in conjunction with several other firms (including T. Rowe Price, Blackrock, and JPMorgan) are getting ready to launch a dark pool of their own, called Luminex, designed to only trade large blocks between institutional firms. That, when it launches, will be a significant development.


The short answer is no, nor does it appear that any regulator has dramatically changed their course of action. You could say this is because: 1) the dark forces have totally corrupted all the enforcement agencies, or 2) the enforcement agencies are alert to the prospect of bad actors, but most do not believe the overall market structure needs to be completely overhauled.

If you believe that 1) is the right choice, nothing I'm going to say is going to change your mind.

But I've spent years with enforcement officials, and the NYSE, and the Nasdaq, and everyone else who built the current system. Most have told me that the current system is not being torn down because it is a vast improvement over the old system, and by "old" I mean the system controlled by the NYSE (specialists) and Nasdaq (screen-based traders) that was the dominant paradigm until about 20 years ago.

Remember, 30 years ago if you wanted to buy 1,000 shares of IBM it would have: 1) cost you hundreds, and possibly thousands, of dollars, and 2) taken anywhere from 20 minutes to the following day to get a confirmation of execution. This was a time when the spread between the bid and ask was $0.125, then $0.0625, and then finally a penny in the year 2000.

Today, you can buy 1,000 shares of IBM and the cost could be as low as $7.99, with a confirmation that will occur in a sub-second interval.

This advance has nothing to do with HFT, it has to do with technological progress, but regardless, it is an improvement over the old system for retail investors.

Still, I am not a complete apologist for the current system. I think it is way too complicated (40 dark pools, 3 exchanges) which leaves the system open to technological failure. I also am no fan of the idea that exchanges should be paying customers to trade on their exchanges.

To the extent that Lewis' book shed light on a rather obscure part of the market, it has been a valuable contribution to the debate.

But I also recognize that there's always been intermediaries, and that throughout history, people have bitterly complained any time someone steps between a buyer and a seller and tries to make a profit, big or small, justified or not. Check out my "Brief history of high speed trading in the 1800s" for a small sample.

Programming note: Michael Lewis will be on Squawk Box Monday on CNBC.