Schumer aka Flash Gordon

July 27, 2009

There’s an old joke in New York that the most dangerous place is the space between a TV camera and Sen. Chuck Schumer. And the New York Democrat’s love of the limelight certainly was on display late last week with regards to the increasingly controversial subject of high frequency trading.

Schumer’s staff didn’t waste time on Friday in announcing that the senator had sent a letter to the Securities and Exchange Commission, asking regulators to study some aspects of highly-automated stock and commodity trading.

Now rapid-fire trading, fueled by sophisticated computer programs, isn’t the kind of thing that naturally catches the attention of US senators. In all likelihood Schumer sent his letter to the SEC after reading a page one story in The New York Times, which focused on some of the concerns about HFT.

The Times story was a good one. Of course, I have to note¬† that the folks at Zerohedge have been writing about potential problems with HFT for a long, long time. And we at Reuters have aggressively covered the topic ever since we broke the news that Sergey Aleynikov was criminally charged with trying to steal some of the top secret compute code to Goldman Sachs’ proprietary HFT program.

But it was the Times story that got Schumer’s attention and I’m glad it did. After all, a few days earlier I wrote a column calling on the SEC to begin an investigation into allegations that this type of automated, lightening fast trading could play havoc with the markets.

Yet this is what troubles me about Schumer’s request: it focused almost exclusively on the issue of so-called flash trades. Schumer’s letter to the SEC didn’t touch on potentially bigger issues like the possibility of a few HFT players coming to dominate trading.

The letter also didn’t focus on the potential for a rogue mathematical formula manipulating trading in a stock or a commodity. Nor did Schumer address the issue of a misfiring algo accidentally sparking a massive market sell-off in a stock.

Now flash trading, a process during which the stock exchanges give HFT players a millisecond sneak peak at potential customer orders, is troublesome. The exchanges say this is necessary for HFT market participants to provide the best prices for other trades. But cynics say it’s either a form of frontrunning or an unfair advantage for the HFT crowd.

My hunch is that flash trading is probably unfair and unnecessary. But I didn’t mention the issue in my column calling on the SEC to investigate HFT because I’m not sure how big an issue it really is.

I mean Wall Street firms almost always have a built in trading edge. And flash trading seems just like another systematic advantage for the big guys.

But in the long run, even something as bad as frontrunning–if that is indeed what flash trading is–pales compared to the potential for HFT to play havoc with the trading in particular stocks and commodities.

Again, I’m not sure if that really could happen. Some suggest the potential exists. But supporters of HFT say such fears are overblown. The SEC, however, needs to determine the answer to this question before a problem arises down the road.

And the potential of any one player, whether it be Goldman, Citadel or GETCO, dominating the market through HFT also seems far more worrisome than flash trading. It’s too soon to start talking about anti-trust issues with regards to HFT. But if a handful of Wall Street firms and hedge funds eventually come to dominate HFT, that could mean just a few select players will dictate the pace of daily trading in stocks and commodities.

That’s real scary stuff and that’s what I’d like the SEC to be looking into now.

UPDATE: For more on flash orders, here are two detailed stories from Traders Magazine, which  outlined the issue and the controversy long before Schumer got on the case.

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