Flash Boys: A Wall Street Revolt
By Michael Lewis
W W Norton (2015)
Flash Boys is a true story about front running, the unethical practice of a stockbroker executing orders on a stock while taking advantage of advance knowledge of pending orders from elsewhere in the market.* From the bleak picture Lewis paints, it appears that investors – whether institutional or private – have virtually no way of protecting themselves against front running.
Like Lewis’s 2010 book The Big Short, Flash Boys reads just like a thriller, complete with exquisitely drawn heroes and villains. In this case, the heroes are crusading Canadian banker Brad Katsuyama and the assorted geeks and nerds who helped him start his own stock exchange. Katsuyama started IEX in 2013, after the Royal Bank of Canada and the Securities and Exchange Commission (SEC) refused to support his efforts to expose and end the practice of front running. By purposely slowing their transmission rates, IEX makes it impossible for high frequency traders to “front run” the trades occurring on the exchange. This has enabled Katsuyama to protect investors who use his exchange, while simultaneously collecting data on suspicious trades.
Flash Boys, a bestseller, originally came out in 2014. The 2015 edition includes an afterward in which Lewis describes being viciously attacked by the big Wall Street banks and brokers. He also enumerates a number of prosecutions of high frequency traders and brokerage firms (by the FBI, SEC and Financial Regulatory Authority) resulting from from the publicity Katsuyama’s work received from Flash Boys’ publication.
*The way this works in practice is you order 10,000 shares of a stock at a given price and a high frequency trader somewhere buys 10,000 shares at that price and resells them to you at a slightly higher price. Complex computer algorithms enable high frequency traders to exploit minute differences in transmission frequency to execute these secret trades – which usually take place in “dark pools” – private stock exchanges which keep no public record of their trades. All the major investment banks (Goldman Sachs, JP Morgan, Bank of America etc) have dark pools and high frequency traders pay for the privilege of trading in their dark pools.