In this exclusive interview, previous high frequency trader turned whistleblower, Dave Lauer, discusses the ins-and-outs of HFT on Financial Sense Newshour, including how it is used to takedown stocks through naked short selling, the conflicts of interest with regulators, exchanges, and large firms, and numerous other issues now facing investors in our brave new world of electronic trading. In the end, Lauer concludes that there’s no room for short-term traders anymore—we are just too outmatched by high-speed technology and computation. His advice: Focus on long-term value.
Let’s talk about your role as a technology consultant and how the market is structured, because it seems like it’s Wall Street versus Main Street where the little investor really can’t have any confidence in the market when these big high frequency trading firms can go in and use manipulative techniques to alter the outcome in the markets.
"It’s hard to have any confidence and I understand it having seen it from the other side. One of the main problems is...the police aren’t on the beat, the regulators aren’t able to keep up technologically. I’ve spent a lot of time talking to regulators and Congress about what I think needs to be done for them to, not compete with high frequency and their technology skills, but at least be there and be able to monitor what’s going on. And I know they don’t have those capabilities and, until they do…until they have the ability to monitor and enforce existing regulation and stop relying on individual exchanges to do surveillance and, again, nothing happens on a single exchange basis from the perspective of a high frequency trader—it’s 13 exchanges and many dark pools, and that’s how they see the world and that’s how regulators need to see the world as well."
It seems that one way to limit market manipulation through high frequency trading would be through re-implementing the uptick rule. Why don’t regulators do this?
"It’s a good question and I advocated for a reinstatement of the uptick rule in my testimony to the Senate Banking Committee. I think it’s an important structural element that tends to slow things down. Anything that tends to slow things down is met with extreme resources on the other side of the issue. I think one of the major problems is that the buy-side and the average retail investor don’t really have anyone fighting for them. The industry—Wall Street, high frequency—has legions of lobbyists pouring hundreds of millions of dollars into lobbying and you tend to see the results of that. You tend to see the results of extremely watered down Dodd-Frank rules; you tend to see the fight against simple things like the uptick rule, like trying to combat and enforce rules against naked short-selling. I think it’s a very difficult position that regulators are in but they tend to really just hear one side of every argument because that’s the side with the most resources."
We did a study and looked at 30 or 40 of some of the largest junior resource stocks and in every single case there were large instances where the stock was taken down more than 10% by high frequency trading. In several instances there were takedowns with naked short selling by high frequency traders of even 30% or more in a 2-minute period. When complaining about it, the regulators said “It’s just HFT, get used to it.”
"That’s the problem, the regulators have become convinced by the HFT firms and their lobby that the markets are so much better than they were and one thing you alluded to in an earlier question is the conflation of volume and liquidity. It’s a very nuanced point but one that seems to be missed by many people, especially looking at these issues, is that volume is not equal to liquidity. And if you need any evidence of that, the Flash Crash was one of the highest volume events in history and certainly one of the most illiquid. I think when regulators look at the market and they see volumes high and they see high frequency saying, “Look how tight these spread are,” they say, “Well, everything’s good. Everything’s fine.” And you can see even the fail-to-deliver lists that get smaller and smaller. That doesn’t mean there isn’t naked short-selling going on, especially from a high frequency perspective, if you’re flat at the end of every day it almost doesn’t matter what you did within that day. You’re sort of responsible for making sure that you’re doing your checks properly and your prime broker and you are responsible for making sure that everything is coordinated but we all know that there’s illicit stuff that happens in terms of the relationship between prime brokers and their biggest customers. So, all these things are happening but it’s easy for the regulators to point at things they’ve been told or things that are positive and look away from the negative, especially when you consider that they’re extremely under-resourced and they have a very difficult time managing these new markets, managing this electronic environment. So, I do believe personally—and this tends to run counter to a lot of the people on this side of the issue—I believe the regulators are trying their best but they’re overwhelmed both by a lack of resources, a lack of understanding of technology, and every time they try to do something they are confronted overwhelmingly by lobbying and litigative resources. So they’re taken to court and the burden of proof is so overwhelmingly high that it tends to be that they just would rather stay out than have to deal with it."
To hear the remainder of this interview or any of our other expert interviews from top financial thinkers, CLICK HERE to subscribe.
For a list of previous podcasts and guests, CLICK HERE to see our archive.