I am always intrigued by the odd similarities of seemingly unrelated but contemporaneous newsworthy events. In Wednesday’s Wall Street Journal, there was a brief news item that a large financial institution may have a problem with “La Cucaracha.” The item explains the so-called “cockroach theory of investing”: a company discloses one piece of bad news, which is often followed by additional pieces of bad news, “just as the discovery of one cockroach usually means others are nearby.”
This week, stories about high-frequency traders are dominating the financial media. Michael Lewis, author of Liar’s Poker, The Blind Side and Moneyball, appeared on a recent episode of 60 Minutes to promote his new book, Flash Boys: A Wall Street Revolt. Mr. Lewis argues that the stock markets are “rigged” in favor of high-frequency traders who use dedicated data cables and specialized algorithms to trade milliseconds ahead of the rest of the market.
Concerned that Mr. Lewis may have spotted a cockroach, the FBI, the SEC, the CFTC, the New York Attorney General, and other regulatory and self-regulatory authorities suspect that there may be others. Each reportedly has launched investigations of high-speed traders. The FBI, in particular, is trying to determine whether high-speed traders are trading on material non-public information in fast-moving markets before such information becomes available to other market participants.
On Tuesday, SEC Chair Mary Jo White asked a US House of Representatives subcommittee for additional funding to support her agency’s oversight of high-speed computerized trading and rapidly changing markets in general.
On Wednesday, the Wall Street Journal also reported that Virtu Financial Inc., a New York-based high-speed trading firm, has decided to delay the start of its roadshow in connection with its planned IPO, presumably due to the growing media and regulatory clamor about the role of high-frequency trading in the markets.
Of course, it is entirely possible that an isolated cockroach sighting does not signify a plague-like infestation. There are very strong arguments suggesting that high-frequency traders provide liquidity to the markets and more efficient and equitable pricing than would be possible without such professional traders. This, in turn, actually aids smaller market participants, including retail investors. To mix metaphors, anybody who has ever boarded a commercial airplane understands that those who are able and willing to pay for first-class seats get priority boarding and disembarkation privileges as well as other perks. Minor and reasonable jealousies aside, is anybody truly offended that certain professionals enjoy a several millisecond advantage for their capital outlay?
Mr. Lewis has become an adept writer and his books make for an interesting and enjoyable read. But, at the end of the day, the question is whether the existence of institutional investors who are willing and able to pay millions of dollars to computer technicians, puzzle solvers and data transmission experts, and millions more for dedicated data licenses and computer trading algorithms for the ability to trade a few microseconds ahead of other investors creates a fundamental unfairness in the markets and an un-level playing field. Mr. Lewis’ outrage likely will help him sell books. Unfortunately, it also likely will contribute further to the erosion of trust in the markets and will force multiple regulators to spend enormous resources in their quest to find and eradicate additional cockroaches. Sometimes the ramifications of the solution are, indeed, worse than the problem.