A new book from Michael Lewis, “Flash Boys,” has set off a firestorm on Wall Street. Lewis, a former bond trader, has taken aim at sacred cows, vested interests and deep pocketed institutions that have gamed the system for buying and selling U.S. stocks.
The primary charge in the book is that high frequency traders (HFTs) have used “front running” to profit off the purchases of retail investors. In front running, a HFT sees a retail customer’s market order before it is executed and buys it at the current market price. When the customer’s order finally arrives, the HFT sells the stock at a more expensive price.
How do the HFT’s get an advanced copy of customers’ orders?
Discount broker Charles Schwab sold its order flow for $285 million. According to one analyst, HFTs made at least a billion dollars with this information.
TD Ameritrade sold its order flow as well. According to the book, high-frequency trading firms flew to the company’s headquarters to do handshake deals “because no one involved wanted to leave a paper trail.” The payment for the order flow is as off the record as possible, buried in the company’s accounting under “Other Revenue.” There were no emails or phone calls to leave a trace.
Is this inside information? How could this not be illegal?
In interviews, the author, Michael Lewis, has indicated the practice may not be technically illegal because the purchases were executed through programmed computers, rather than an individuals manually placing the orders.
To date, the FBI has announced it is working with the U.S. Commodities Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to review the legality of these activities. The New York Attorney General has revealed he is investigating as these practices may have violated the state’s securities laws.