This spring, high-frequency traders were facing yet another assault on their livelihoods, and they needed to do something fast. For months their business had been under increasing pressure, much of it from within their own ranks. Profits were down dramatically as competitors piled into the market. They’d been blamed—unfairly, many of them believed—for the “flash crash” in 2010, when the stock market fell 600 points in less than five minutes after one trader’s mistaken order triggered a wave of automated selling. Now they confronted an even graver threat: the media blitz surrounding Michael Lewis’s Flash Boys. In the book, Lewis argues that high-frequency traders take advantage of other investors and that because of them the stock market is “rigged.”
The publicity rollout for the book was masterful. A segment aired on 60 Minutes, the same day an 11,000-word excerpt appeared on the cover of the New York Times Magazine. Author interviews with Jon Stewart and Charlie Rose quickly followed. There was wall-to-wall CNBC coverage, with Lewis filling the screen. At one point the author got into a near-brawl with a fellow panelist, prompting a new cascade of articles, which competed for attention with dozens of book reviews. Lewis’s surrogates, some of them characters in his book, had their own hectic schedule of media appearances. They were all broadcasting the same message: High-frequency traders were out of control and possibly about to bring down the global financial system. “High-frequency trading reminds me a little of the scam in Office Space,” said Senator Elizabeth Warren (D-Mass.) during one of the multiple congressional hearings that followed the book’s publication. “It also means a tilt in the playing field for those who don’t have the information or don’t have the access to the speed or who aren’t big enough to play in this game.”
High-frequency trading, or HFT, uses computer algorithms to execute huge numbers of trades at extremely fast speeds, sometimes in millionths of a second. Little money is made, on average, on each transaction—often only fractions of a cent—but the huge volume can generate significant profits. Computer-driven trades represent more than half of all stock transactions done in the U.S. and are credited with helping to lower the cost of buying and selling shares by helping to narrow the gap between bid and ask prices. Lewis and Warren charge that high-speed traders have an unfair advantage over other investors, because they can see other traders’ orders coming and adjust their own trades accordingly, putting in orders and canceling them in a flash. Lewis portrays them as parasitic middlemen being aided and abetted by crooked stock exchanges, which allow them to do this with impunity.
HFT firms feared the Flash Boys steamroller would shame regulators into a crackdown. Perhaps most important, the book might give trolling lawyers leads for private litigation that could cripple their businesses. While a trade organization, the Principal Traders Group at the Futures Industry Association, had existed since 2009 to work behind the scenes on policy issues, the industry didn’t seem to have a coordinated public response. Four HFT firms—Tower Research Capital, Hudson River Trading, Quantlab Financial, and Global Trading Systems—decided to form a group called Modern Markets Initiative to fight back. They needed a frontman, they decided. Someone who could be the approachable face of their complicated business and, ideally, help shape whatever direction all of this might take. They didn’t have to look for long.
In April, Bart Chilton ended his seven-year tenure as a commissioner of the Commodity Futures Trading Commission, the agency that regulates the options and futures markets. While he’d already accepted a job with the global law firm DLA Piper, he was “pleased and honored” that the MMI founders gave him a call—in fact, their business was the very kind DLA Piper hoped Chilton would build for the firm, where he serves as a policy adviser, offering his expertise to clients on regulation, the Dodd-Frank Act, and how things do or don’t get done in Congress. Still, as one of the industry’s most prominent critics—he once referred to high-speed traders as “cheetahs,” and not in a flattering sense—he appeared an odd choice.
“Even though they knew I had been pretty tough on them at times, they agreed they needed to be regulated and felt they were being unfairly taken advantage of with regards to the book,” Chilton says of MMI. “I’m a big Michael Lewis fan. That said, my favorite Lewis book was The Blind Side. I think that with regard to HFT, he had one hell of a blind side.”
Chilton’s “revolving door” move was immediately portrayed as the latest example of Washington-Wall Street codependence, in the tradition of Bob Rubin leaving the Clinton administration to rake in a fortune at Citigroup (C) and Timothy Geithner joining private equity firm Warburg Pincus after a tumultuous tour as Treasury secretary. Chilton took some heat, but he expected it. “You’d have to be an imbecile not to understand that it was going to come,” he says.
For the first few months he kept a relatively low profile, but on Oct. 8, he and MMI released what they describe as “Principles for Effective Modern Markets,” a snapshot of what they stand for as part of their campaign to preempt the multiple different regulatory and congressional bodies that are pushing for new restrictions on HFT. The same day the guidelines were released, Chilton appeared on Bloomberg TV to promote them.
“I’m really thankful that the Modern Markets Initiative guys are, I think, the white hats in this space,” Chilton said, flashing a grin at the camera. “They are actually calling for regulation. They’re calling for simple markets, no special access, no hidden speeds, etc. And responsible regulation. And those are things that I did call for as a commissioner.” Although he describes himself as an adviser and not a lobbyist, he went on to say, “The Modern Markets guys are all down with ensuring that we have high integrity in these markets, that everyone’s playing by the rules. And that’s why I’m really pleased to be working with them.”
Chilton’s DLA Piper office is a modern, all-glass affair in central Washington. On a September afternoon he’s sitting behind a glossy oval desk with a red lava lamp on it, its cream-colored orbs undulate from one end to the other. Chilton’s long, white-steel hair flutters in the breeze of a nearby fan, and the lamp’s pinkish light gives him the rosy cast of a romance novel cover model. On the bookshelf behind him is a reader’s guide to Beltway striving: This Town, the recent excavation of political media culture by Mark Leibovich; The Audacity of Hope, President Obama’s memoir; a golf manual; and, most appropriate of all, Dark Pools by Scott Patterson, about the private electronic markets that allow transactions to be done anonymously by high-speed traders.
When Chilton decided it was time to leave government, he’d been in public service for 30 years, ever since he graduated from Purdue University in Indiana, where he grew up. He worked as a legislative director for three different congressmen, as deputy chief of staff for the secretary of Agriculture under President Clinton, and as an adviser to Tom Daschle when he was Senate majority leader. He was nominated to the CFTC by President Bush in 2007 and renominated by Obama in 2009.
At the CFTC, Chilton demonstrated an intuitive sense for personal branding, sporting cowboy boots, flashy suits, and shirts with monogrammed cuffs. Then there was the hair—almost anyone who caught sight of him was shocked that someone with such a flamboyant mane would spend his days studying policy papers on derivatives. (“The bar is pretty low on being colorful as a regulator,” he says.) He gave speeches relentlessly, sprinkling them with goofy jokes and pop culture references (Saturday Night Live, Tom Petty, and the Dixie Chicks included) that made headlines. He used money budgeted for a policy staffer to hire someone to help with communications, selling his editorials to newspapers and pitching him to cable news shows. He also built a reputation as an independent thinker who cared about the interests of smaller investors, often pushing for rules that Wall Street banks fought. On the subject of HFT, he took the stance that the practice was here to stay, and the best approach would be to figure out how to live with the computer traders by reining them in in a smart way. But he made clear that they needed reining in.
In July 2011, Chilton gave his now-famous “cheetahs” speech to the American Soybean Association Legislative Forum. “This new species of trader, due to the advent of high-speed computing technology and sensitive algorithmic programs, races in and out of markets trying to scoop up micro dollars in milliseconds,” he said. “Not only are cheetahs new, but this highly sophisticated trading strategy is new, too.” He went on to say that the cheetahs had contributed to the flash crash on May 6, 2010, as well as other mini-crashes and price swings since. “If markets are going to be efficient and effective and less volatile, we need to cage the cheetahs,” he said. “I’m not saying they should be extinct, and overly burdensome regulations shouldn’t endanger them as a species, but they need to be confined. After all, financial markets impact all of us in one way or another.”
He then outlined what he meant: Regulators should impose testing of algorithms before they’re let loose on the market; HFT firms should be accredited somehow; there should be “kill switches” to shut programs down if they start to malfunction, as well as accountability for those who cause problems. He strongly urged regulators to do more to keep up with changing technology. Many HFT executives were annoyed by his characterization of them as something out of the animal kingdom, but Chilton says they get along fine. “We reached an accommodation, the group of HFTs that I’m working with, in that they agree with everything I’ve been saying.” (None of MMI’s members were willing to talk about their relationship with Chilton.)
In the summer of 2013, months after he’d indicated through back channels that he wanted to be renominated to the CFTC for another term, he started to suspect the administration didn’t want him back. Then someone told him his chances weren’t looking good, which burned. Chilton realized he had to find something else to do. “If they wanted a consumer advocate who speaks their mind and tries to be on the right side of things,” he says, “they lost it in me.”
“I’m not going to feel bad in my heart about what I’m doing now”
He considered various job offers. “I had this idea about trying to explain what we had done at the agency and work with others around the world, sort of continue what I had been doing,” Chilton says. “What I really couldn’t figure out was where I’d do that. Would I go to a think tank? Frankly, a law firm was not my first thought.”
As for his current role, “I spent 30 years being underpaid,” he says. “I served our country all these years. I believe what I did is genuinely as important as what a doctor or a member of our military or the clergy does. Nobody’s going to take it away from me, and I’m not going to feel bad in my heart about what I’m doing now.”
It’s hard to argue with the principles Chilton and MMI released. For one thing, they’re rather vague. MMI supports “fair and equal access” to markets, “transparency,” “stability,” “simplicity,” and “sound regulation,” and mentions Chilton’s kill switches. Not everyone was impressed. “I could go to a health food store and read something like that on a bulletin board,” says Andrei Kirilenko, a finance professor at MIT’s Sloan School of Management. “Simplicity, integrity, wholesomeness—it’s, ‘Don’t touch our business model at all, we are wholesome.’”
“What the industry would like is nothing at all. But what they can agree on is the idea of best practices,” says Ben Van Vliet, a finance professor at the Illinois Institute of Technology who specializes in markets and HFT. “The problem is that they are aspirational. They represent the highest level of behavior that we would all hope to attain—we can try, but none of us are going to do it. So in that respect, best practices have little bite to them.” He adds, though, that such a process is always going to take time, and the principles are a good starting point.
Two months after Flash Boys hit, New York Attorney General Eric Schneiderman made life even more difficult for the HFTs by filing a lawsuit against Barclays (BCS) accusing the U.K. bank of fraud in the way it operated its dark pool, Liquidity Cross, or LX. The suit claims the bank hid from other investors that a large proportion of high-frequency traders were using the dark pool, and says the bank offered unfair advantages to electronic traders to entice them to use it.
Although the suit is not about HFT firms so much as Barclays’s alleged bad behavior, the case managed to reinforce the industry’s negative image. At one point the suit argued that computer traders’ faster access to data in the dark pool gave them the ability to see the slower traders’ orders and take advantage of them. “Barclays itself commonly labeled these types of high-frequency strategies as ‘toxic,’ ‘predatory,’ or ‘aggressive,’ ” it reads. According to Bloomberg News, Schneiderman sent subpoenas to at least three high-frequency trading firms: Chopper Trading, Jump Trading, and Tower Research Capital, the latter being a founding MMI member. Barclays, saying it doesn’t believe the suit is justified, has filed a motion to have it dismissed.
No one in the industry who was contacted was willing to speak publicly about the case or the subpoenas. “I can’t comment on it. I can’t go near it,” says Bill Harts, MMI’s chief executive officer. As for Flash Boys, their other pain point, he says, “I had a hard time finding the book in my bookstore until I realized I had to look in the nonfiction section.” Making multiple references to Flash Boys, the city of Providence, which manages pensions for city employees and retirees, filed a class action in April against every stock exchange it could think of, as well as brokerage and HFT firms. The suit accuses them of defrauding all public investors who traded U.S. stocks since April 18, 2009.
If the HFT guys weren’t prepared to take their medicine, Chilton says, he wouldn’t have been able to work with them. “I wouldn’t feel good in my heart. Not worth it. You gotta go to sleep at night,” he says. “Certainly not going to jeopardize what I’ve been doing for 30 years.” About that cheetahs comment: “People look at it as negative, and certainly I meant it as such in most cases,” he says, sliding the lava lamp to one side, out of his field of vision. “But there are complimentary things tied with cheetahs. They’re elegant, they’re superspeedy, they’re skilled at what they do.”
