The publication of Michael Lewis’ Flash Boys has trained a new spotlight on one of the most controversial areas in today’s markets: high frequency trading. According to Michael Lewis, the high frequency trading firms, known as HFT, have essentially rigged the United States capital markets. Other experts argue that HFT adds liquidity, narrows spreads and aids in price discovery. Still others contend that the markets as a whole are structurally sound, but undermined by a few “bad apples”– elite HFT firms that benefit from special privileges and advantages not available even to middle-tier HFT firms. A good, if acrimonious, debate (and largely critical of Michael Lewis) presenting these different points of view can be found here.
Cutting through the debate is the fundamental question of whether the needs and practices of HFT firms have, in some fundamental sense, replaced the market itself, as the infamous May 6, 2010 “flash crash” — when the market lost 1000 points in a matter of minutes –appeared to illustrate.
But perhaps the most striking aspect of Flash Boys is that it seems to have almost overnight sparked an explosion in legal activity around HFT, even though the SEC and others have been been concerned about the impact of HFT on the market for years. Only a few weeks after the publication of Flash Boys, a class action lawsuit was filed in the Southern District of New York repeating Michael Lewis’ allegations verbatim. Not long afterwards, the unrelated Michael Lewis of tobacco class action fame spearheaded a separate action focussing on alleging “broken promises” by the stock market exchanges that systematically provide “stale” information to average investors. Suddenly, the pace of HFT litigation has accelerated. The Attorney General of the State of New York has brought a suit against Barclays alleging that it mislead institutional investors into believing its private “dark pool” was free of predatory HFT firms. Not to be outdone, the SEC finally announced its first successul action against an HFT firm accused of engaging in the time worn practice of “painting the tape” (manipulating the closing prices of stocks with massive late day trading volume). And in yet another class action, individuals investors are challenging the widespread practice engaged in by the online brokerages of selling their “order flow” to HFT firms who either “internalize” this flow or “front-run” it to the exchanges for a quick profit.
This flurry of activity in the six months following the publication of Flash Boys promises to be just the beginning of a wave of HFT litigation that will sweep through the highly fragmented US market — broken up into 11 separate exchanges and over 40 dark pools — in the coming months and years.