Exactly five years ago today, I published a New York Times op-ed with Michigan Senator Carl Levin that began with the following paragraph:
One year ago, the stock market took a brief and terrifying nose-dive. Almost a trillion dollars in wealth momentarily vanished. Shares in blue-chip companies were traded at absurdly low prices. High-frequency traders, who use computers to look for microscopic price differences in stocks on different exchanges and other trading venues, stopped trading, while others immediately sold whatever they bought, mainly to each other, in what has been called ‘hot potato’ trading.
From my seat at the time in the U.S. Senate, I was outraged and made specific recommendations to both the SEC and the CFTC. The country was coming out of the worst financial crisis since the Great Depression, a crisis caused in large measure by the notion that our markets functions best when there is little, or in some cases no, financial regulation. I knew then and now that this was wrong. The flash crash of May 6, 2010 simply offered even more evidence that we must have active and informed regulators overseeing our markets.
In the years before 2010, our equity markets had moved from analog to digital without any real monitoring of how that affected trading and market integrity. There had been no oversight as markets were increasingly taken over by high frequency traders. I am an engineer and a believer in technological progress, but the flash crash was a wake-up call. We needed to know a lot more about what HFT was doing to our markets.
But five years after Senator Levin and I called for action in our op-ed, not much has happened. One of the suggestions we mentioned in that op-ed—a proposal I outlined in a letter I sent to SEC Chair Mary Schapiro in 2010—was to create a Consolidated Audit Trail to monitor what was happening in our financial markets. Chairs of both the Securities Exchange Commission and Commodities Futures Trading Commission supported the idea and talked in 2010 about implementing a CAT within three years. The SEC recently announced a schedule that forecasts its completion at least another three years into the future.
The SEC did create new stock circuit breakers in 2010 that are designed to pause trading after a volatile price move. In 2010, after the flash crash, I said that circuit breakers were merely a Band-Aid and was proved right on August 24, 2015, when the market again went into free fall. According to a paper from Blackrock Asset Management, that day circuit breakers were tripped nearly 1,300 times, with minimal impact. Stocks such as GE (GE), J.P. Morgan (JPM), and Ford (F) traded down more than 20% and shares in private equity firm KKR (KKR-CO-L-P) declined more than 50%.
Temporary or not, flash crashes like the one that took place in August 2015 shake the confidence of individual investors who rely on the public markets to dictate the fundamental value of a company. So, what can we do while we wait for the SEC to get its act together and actually regulate HFT? There is one market-based response that can make a big difference. IEX has made a request to the SEC to be allowed to operate as a national securities exchange.
IEX CEO Brad Katsuyama rose to prominence in Michael Lewis’ bestseller Flash Boys, which exposed the conflicted relationships among HFT, stock exchanges, and big banks. In just two years, IEX has become one of the fastest-growing stock markets in the U.S. by applying technology in a way that protects investors from HFT, rather than exploiting them by facilitating it. Instead of selling hyper-fast access to data and trades, IEX has created a speed bump of 350 microseconds (millionths of a second) to all participants. A speed bump that small (roughly 1/1000th the speed of an eye blink) is irrelevant to a regular investor, but it seems to be a matter of life or death to HFT and the exchanges that sell them speed.
On April 8, 2016, the Canadian Securities Administrators (a collection of provincial regulators who have the same responsibility as the SEC) published new amendments to the rules governing the Canadian Stock Market and, specifically, the role of intentional delays and the definition of immediate. Simply put, the Canadians now permit a speed bump if it is “applied in the same way to all orders” and if it furthers “fair and orderly trading.” In one paragraph, our neighbors to the north paved the way for an IEX-like, investor-friendly market, the kind the SEC should quickly endorse.
The IEX proposal has initiated a full-scale battle on Wall Street, with market players picking sides. Hundreds of letters sent by mutual funds, pension funds, brokers, and members of the general public have spoken out in support of IEX. It is opposed, as you would expect, by some existing exchanges and the HFT community.
By slowing trading down to give long-term investors equal footing with HFTs, a market disruptor such as IEX could move us at least one step closer to preventing the next flash crash.
The SEC has postponed ruling on the IEX proposal two times. We have waited far too long. It is time for them to approve it.
Ted Kaufman is a former United States Senator and a member of the SEC Equity Market Structure Advisory Committee.
