Separate Trading Traffic into High and Low Speed Lanes
September 9, 2009
Professionals have always had an edge over the public in embracing new technologies, whether it was the old teletype ticker, the telephone, the compressed air driven wall boards, the private hoot and holler voice networks, the Quotron terminals, et al. The problem of unfair advantage is neither caused by new technologies nor its deployment.
The problem is trying to give the retail customer the same price as the wholesale customer, forcing the traders and market makers into a vast “underworld” of legitimate but dubious work-around techniques and private trading venues not accessible to the public.
This should not surprise Sens. Charles E. Schumer (D-N.Y.) and Ted Kaufman (D-Del.), who have been expressing outrage over the perceived unfair advantage of traders receiving better prices than the investing public because of a vastly speeded up market brought about by new technologies. As former Securities and Exchange Commission chairman Arthur Levitt, in an Op-Ed piece in the Wall Street Journal titled “Don't Set Speed Limits on Trading,” successfully argues high-frequency electronic trading gives investors both large and small a deeper pool of liquidity. And Chris Hynes and Donald Luskin, the founders of an early alternate trading market for institutional traders, Posit, argue that the practice of “flash trading” a stock you hold is equivalent to offering to sell your house to your neighbor before putting it up for sale in a public listing to everyone else.
This debate between politicians and practitioners is not new, although it has now been elevated by some solons now to a matter of the public interest, at a time when it is sport to vilify Wall Street.
In fact, Congressional hearings dealt with these issues, going into the Great Depression, after the Crash of 1929. That was an era of human give-and-take around negotiating prices, not computerized trading that now dominates price discovery. New rules of engagement resulted, formalized with the creation of the SEC and the promulgation of the Securities Acts of 1934 and 1940. These rules were updated during the first National Market System debate that began in the 60’s and resulted in the 1975 Securities Acts Amendments. That debate had two main focuses, the increased institutionalization of the markets and the increased availability of automation to assist in price discovery. The current debate began in the 1990’s and resulted in a second set of National Market System regulations, this time with a central focus on the use of automation in price discovery, so much so that it has almost overnight driven traditional stock exchange floors, with their human interaction, into extinction.
Within the debate was always the interest of regulators to maintain the same prices for retail customers that an institutional customer could obtain. This interest, however noble in intent, has had the unintended consequences of allowing traders and market makers a legal, structural advantage in price discovery that is now being elevated to high treason by politicians.
Wholesale and retail pricing is the mainstay of all commercial endeavors but not in regulated capital and contract markets. In commerce, if you can buy a dozen, you get a discount over buying just one. Not so in SEC and Commodity Futures Trading Commission regulated markets.
Before electronic trading, large orders, known as block orders, where “worked” across dealers’ trading desks and among specialists. When the pieces of the large orders where assembled they would be brought to the floor of an exchange where the buy and sell was posted as a completed “crossed” order, but only after the public orders available at that time in that particular trading market was filled at the same or better price than the block price. This satisfied the requirement that the retail customer present at the time was given the same price as the wholesale customer.
