Some of you may have read Michael Lewis’ newest book Flash Boys – we devoured it shortly after it was published in April. Others may have watched as Lewis was interviewed on 60 Minutes and other media outlets as part of the “book launch” and still others may be waiting for the inevitable movie. Very briefly, the book outlines a scheme to rig the markets by companies most have never heard of using technology and “dark pools” to wring small gains out of many of the stock trades that occur in the US each day.
“investors are systematically disadvantaged”1
Likely as a result of the media attention to this issue, a US Senate subcommittee heard testimony on June 17th from among others, the main protagonist in Flash Boys and a professor from the University of Notre Dame under the title “Conflicts of Interest in the U.S. Equity Markets” 2.
Is this something you should be worried about and is there something we should be doing about it?
We view this trading exploitation that is occurring akin to bandits copying the master key to a city’s parking meters and while not emptying them, opening each one and taking out a quarter every day. Although a minor infraction, it should be stopped.
While the book doesn’t improve an already-tarnished image of Wall Street following the Financial Crisis, we don’t believe the markets are broken or “rigged” but we do believe they are not as fair as they should be. We take precautions when we trade your funds to avoid being targeted and have been discussing the issue with our service providers (Schwab and fund companies) to determine what they are doing to limit your exposure to this activity.
“Equity trading and market structure are constantly evolving,” says John Romiza, head of international trading at Dimensional Fund Advisors [DFA]. “In the past decade, everything has become more complex and faster. As a whole, that has been a good thing for investors who have been able to keep up with the pace of development, like Dimensional.”
Trading costs are now a fraction of what they were 20 years ago mostly due to developments in technology and decimalization. So overall, your costs as an investor have come down significantly. However, there will always be bandits looking to exploit the system. In line with the testimony and closing remarks from the Senate panel hearing, we would like to see the regulators requiring more detailed and standardized disclosure from firms that trade on our markets so that the exploitation can be addressed.
We hope you take comfort knowing that we are aware of the issue and doing what we can to protect you from the outlaws. Please feel free to call and discuss with any of us.
1 Quote from Bradley Katsuyama, President and CEO of IEX Group during panel Q&A session.
2 Testimony of Bradley Katsuyama, and Robert Battalio, Professor of Finance, Mendoza College of Business, University of Notre Dame and others; Senators on Panel: Carl Levin, D-MI, John McCain, R-AZ and Ron Johnson, R-WI .
