Doyle Lonnegan (Robert Shaw) looks up from his room service breakfast at Kelly (Robert Redford) to announce he knows how the con works: “You’re past-posted.” This is the point in the movie The Sting when Henry Gondorf (Paul Newman) and Kelly/Redford set the hook to reel in their big fish for their big sting. Lonnegan thinks he knows how Gondorf’s illegal gambling parlour in Chicago is able to know the results for horse races around the country before they are made public. In betting parlance, this insider knowledge is called past-posting because the bet is made after the post call for the beginning of a race (past the post). Today there are claims that so-called flash trading on stock markets is something like old-fashioned past-posting at the racetrack.
In the classic Newman-Redford film, the past-posting does not require a great deal of speed in communication—after all the movie is set in the year 1936. Results from horse tracks around the country then were sent over Western Union telegraph and re-distributed through the media of the day. Roy Alston’s character in The Sting pores quickly over ticker tape of various racetrack reports and finds results that will fit the needs for the conning of the New York gangster, played by Shaw. He tips off Lonnegan (Shaw) waiting by a pay phone booth in a nearby drug store. Lonnegan then makes the bets at Gondorf’s establishment. The con required a time lag of up to 5 or 10 minutes in order to work. But in contemporary high speed stock trading speeds of microseconds (millionths of a second) or even nanoseconds (billionths of a second) allegedly can make all the difference.
A recent book by Michael Lewis, called Flash Boys: A Wall Street Revolt, spotlights the practice of flash trading, or ultra high speed stock trading. Lewis is perhaps best known for his books The Blind Side and Moneyball, both of which were made into popular movies. Lewis focuses on the processes of Brad Katsuyama, a trader for the Royal Bank of Canada who discovers that suddenly his computer seems to play tricks on him as he tries to execute large trades. He sees the buy and sell prices for his stock, but when he clicks on “buy” everything immediately changes—the price he thought he was getting has vanished. Lewis’ story also begins with the engineering of a long distance cable running from the south side of Chicago to northern New Jersey, laid at great expense to avoid almost all turns and changes in elevation (very tricky through Pennsylvania). Katsuyama also finds that large stock traders, such as those working in the major banks, will pay high prices to locate their computers as close as physically possible to those of the various stock exchanges (mostly housed in northern New Jersey). Lewis, through Katsuyama’s investigations, uncovers how the “flash traders” are able to take advantage of microseconds to “run ahead” of trades as they occur to snap up and re-sell the target stocks before the initial trades themselves can be completed, thereby running up profits. Lewis also discusses the use of “dark pools” by some of the largest investment banks in which they can execute trades “out of sight” of the public markets, as if they were happening in a dark pool.
The machinations are too complex to describe in a brief blog entry, but are explained in more detail in Lewis’ book and other recent business articles and posts, as in the Wall Street Journal. On April 17, for example, the Journal featured a report on subpoenas sent to some of the firms engaged in high frequency stock trading (Wall Street Journal, April 17, 2014, p. C2). The subpoenas issued from the office of the Attorney General of New York focused on the practice known as “latency arbitrage,” in which the high-speed firms take advantage of the delays, or latencies, in the communication among various parts of the trading network. As the Journal points out, those high speed traders “can detect trades before other investors can see them and take advantage of the information,” even though latencies are measured in microseconds (millionths of a second). In earlier probes the Commodities Futures Trading Commission was investigating whether similar high-speed tactics amounted to insider trading “by taking advantage of fast moving market information unavailable to other traders” (same Journal article). An article on April 30 in the same paper reported that the Securities and Exchange Commission (the SEC) was also initiating investigations of high-speed firms taking advantage of timing differences in the availability of stock-trading information. This article even references Michael Lewis’ book as one motivation for the concern (“White Says SEC is ‘Quite Focused’ on High-Speed Trading,” Wall Street Journal, April 30, 2014, p. C3; also see Wall Street Journal, May 2, 2014, p. C1: “NYSE Settles Charges Its Safeguards Fell Short”).
Lewis explains that Katsuyama and the team of expert programmers he enlisted were motivated by a concern for fairness, particularly in that private investors and people who depend upon the success of pension funds were being ripped off by the use of flash trading, dark pools, and latency arbitrage. The interesting point in the view of CEPA is that Katsuyama’s team and Lewis are trying to communicate to the public and policy-makers about a highly complex, technical issue with potentially significant financial impact on ordinary individuals. At the moment, the legal question is not settled, as the SEC chair in the April 30 Journal article notes that high speed traders may be operating within regulations. Is high speed trading a “Sting” or not? More analysis seems to be coming. People like Lewis and Brad Katsuyama have at least brought attention to the issue.
William W. Neher
Bill Neher is professor emeritus of communication studies at Butler University, where he taught for 42 years. Over those years he has served as Dean of the University College, Director of the Honors Program, Head of the Department of Communication Studies, the Chair of the faculty governance, and most recently as the first Dean (Interim) for the new College of Communication begun in June 2010. He is the author of several books dealing with organizational and professional communication, ethics, and African studies, plus several public speaking and communication text books.
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