T. Rowe Price fears high-frequency computer trading

Along with Europe's financial crisis, Middle East unrest and sluggish U.S. growth, mutual-fund seller T. Rowe Price has identified a 2012 economic risk you probably haven't thought about.

Every day, Wall Street firms armed with secret software bombard stock exchanges with thousands of electronic orders. Shares are bought and sold in milliseconds.

The firms have zero interest in investing for the long term — or more than an eye blink, for that matter. Their computers seek trading irregularities to generate profit of a fraction of a penny per share. Even the identities of the companies they buy are often irrelevant.

Last year such "high-frequency" orders accounted for more than half the volume on U.S. stock exchanges, according to the TABB Group, a New York research firm.

The folks at T. Rowe Price, who try to find good companies for ordinary investors to own for months or years, don't like what they see. Rapid trading is responsible for much of the crazy stock market gyration the past couple of years, they suspect. They worry that more is to come.

"We've gotten a little anxious when you hear that, on a given day, high-frequency traders of all types … make up 60, 70, 80 percent of what's trading," Andy Brooks, head of U.S. stock trading at the firm, said in an interview. "The public's confidence in pricing and markets, and getting a fair deal and earning a fair return, has been challenged. And these guys — the more aggressive high-frequency traders — undermine confidence. And that's bad for everybody."

Baltimore-based T. Rowe Price, with its focus on small investors, is one of the few financial companies to break the industry's code of silence on criticizing rapid traders.

Former Delaware Sen. Ted Kaufman, a Democrat, likens the boom in high-frequency trading, with its novelty, complexity and opacity, to the bubble in mortgage bonds a few years ago. We know how that turned out.

"We had a lot of change, we had a lot of money, we had no transparency, and it almost destroyed the financial system of the world," Kaufman said in a telephone interview. "I cannot stress enough how worried I am, how concerned I am about what's happening to our markets."

Computer stock sales have been around since the 1980s. But the new transactions surpass traditional program trading in speed, frequency, volume and intent. Often they occur not in traditional exchanges, such as the New York Stock Exchange or Nasdaq, but in smaller, less-regulated forums or privately run "dark pools."

The idea is not to own a piece of corporate America. It's to flood the system with orders that are quickly reversed — or never fulfilled. Like a shill working for an auctioneer, quickly canceled offers to buy or sell create a bogus impression of demand. A study published last fall by researchers at the University of Mississippi found such "quote stuffing" to be "pervasive" among U.S. stock exchanges.

"We know that some high-frequency trading strategies have cancellation rates in the 95 percent range," Brooks said. "So that means that 95 percent of the time that you say you want to buy 100 shares of IBM, you don't really buy it. And that begs the question: Why have you said you want to buy? Are you trying to influence someone to do something else? And is that manipulative?"

High-frequency trading, which took off about five years ago, seems to be enormously lucrative. Two years ago, court testimony relating to an ownership dispute over rapid-trading software revealed that Citadel Investment reaped $1 billion in high-frequency profits in 2008, according to The Wall Street Journal.

Dozens of firms do it. Every dollar they make comes from somebody else — often from companies such as T. Rowe Price and small investors.

"It's making us pay up," said Clive Williams, head of global stock trading for T. Rowe Price. "It's not good for our business."

As usual, the people who are supposed to regulate this stuff are outgunned, outmanned and besieged by lobbyists who claim high-frequency traders add liquidity and choice to the system. Kaufman, an early critic of high-frequency trading, left the Senate in 2010.

After the May 2010 "flash crash," in which the Dow plunged more than 600 points in five minutes and high-frequency traders were found to be a factor, the Securities and Exchange Commission approved "circuit breakers" designed to halt rapid stock-price changes.

But the agency is taking its time in ordering a centralized database that would let regulators see what rapid traders are really up to. Brooks believes the SEC should consider charging fees to traders who cancel unfulfilled orders — an idea that's even further from realization. T. Rowe Price suggests that regulators experiment with other rule changes to gauge how pointless trading could be reduced without harming liquidity.

Adam Sussman, director of research for the TABB Group, notes that retail firms such as T. Rowe Price don't object to all high-frequency traders, just the most aggressive ones.

That's true, as confirmed by Brooks. But all high-frequency trades are symptomatic of a larger, corrosive bug that infects much of the U.S. economy and politics as well. It's about short-term gain at the expense of long-term prosperity. Investors see it, and they're getting fed up.

Williams talks about listening to phone calls from customers at T. Rowe Price's complex in Owings Mills: "These guys have been 10 years in the market. But they've not really got much return. But they've had huge volatility. 'Enough! Enough!' [they say] — 'I'll just take the money and put it under the bed.'"


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