The ticking sound from the nostalgic 60 Minutes stopwatch had barely faded from our screens before Wall Street pros took their turn to respond to Michael Lewis’ salacious comments about a rigged stock market. Within seconds, Twitter posts from some of The Street’s most seasoned ambassadors unsurprisingly agreed about the toxic world of High Frequency Trading (“HFT”); but many wondered aloud how this story didn’t break any news.
In the fall of 2007, NYSE honcho, Duncan Niederauer spoke at the annual Argus Investor Conference at the Yale Club and dropped a line that many suspected in thought, but never heard in public: The NYSE intended to convert itself into an all-electronic, 24/7, market center. The idea was to utilize technology to match buyers with sellers, which could easily be obtained by eliminating the human element.
The reaction from the crowd of analysts, economists and strategists in attendance was compelling: This would be a game-changer for the markets and, more importantly, for investors. The idea of an all-world, all-day stock exchange would be a tough sell for the traditionalists on Wall Street, but it was clear this was the wave of the future.
It was also the credible green light moment for already-existing HFT technology-heavy organizations, and those smart enough to realize speed/execution/transparency would be the three must-have attributes to survive in 21st century Wall Street. Without them, you were a dinosaur because the human brain will never be able to keep up with the speed of a Supermicro Hyper-Speed HFT server.
The issues raised by Messrs. Lewis and Kroft in the 60 Minutes piece are far deeper than discussed on the news program. Most on Wall Street were already familiar with Lewis’ claims of electronic front-running. However, many algorithms crafted don’t just simply look at the pending buy/sell trade; the most sophisticated code will be able to capture newsworthy market-influential movements or even trading/investment language used in social networking sites. It’s almost a virtual secret society that can pick-up on the most delicate Wall Street issue: Insider Trading.
The critical skill for many would-be Wall Streeters is the ability to write code, or at least be an influential author of it. It’s not about studying finance anymore. But lines of computerized language can easily mask the ultimate fishing experiment: The ability to discover communication (albeit, public in a social networking capacity), which can give an investor—or, in this case, a computer—a distinct trading advantage. Shaving milliseconds off of a trade is one thing, but the crowd is building in this area. The challenge for HFT coders is to remain competitive beyond a reasonable doubt.
This is where the regulators will always run into trouble. It’s no secret why the bulge bracket banks are now campaigning for a “fairer” trading environment, because they realize the risk is greater than the reward in a crowded pool. How best to get in front of the problem, which—to be direct—many had participated in, but by being the superhero that saves the day. The SEC will need help and support from the bigger banks if they wish to get ahead of, and control, this world of underground trading.
But one thing is crystal clear: A high-tech Wall Street will need to work with a high-tech SEC if it wishes to police a high-tech HFT world. Otherwise, the integrity of what we do on The Street will remain suspect, which doesn’t benefit anybody—regardless of the level of your investment-IQ.
Todd M. Schoenberger is the managing partner of hedge fund firm, LandColt Capital LP. Follow him on Twitter @TMSchoenberger.