The scheme, run by a number of Wall Street insiders, involves the use of computers that buy and trade securities hundreds of times quicker than a blink of an eye. The process, called high-frequency trading, is so fast and so complex that no single human can follow or even comprehend it. The whole thing is done by computers using formulas that try to take advantage of milliseconds in order to buy securities as low as possible and sell them as high as possible. Banks and brokerage houses have spent billions setting up these systems.
According to Lewis, the rigging takes place with a practice called front running. When a small investor puts in an order for, say, a number of shares of Microsoft, the high-frequency trading system buys the shares in front of the person making the buy order, driving the price up, and then sells them at the slightly inflated price. In effect the Wall Street front runner is able to skim a small amount of money from what the investor would ordinarily make, pocketing the difference. Multiply this by hundreds of thousands or even millions of orders and the front runner can make a tidy sum, at the expense of the small investor.
Most forms of front running are illegal, but due to a quirk in the law, the use of these computer systems makes this version legal.
Until governments and legislators can figure out how to close this particular loophole, a group at the Royal Bank of Canada has figured out a way to do an end run around the front loaders. It involves staggering orders across various exchanges so that they arrive at the same time, cutting out the high-frequency traders. Since then a group has developed their own stock exchange, called the IEX, that uses a 60 kilometer fiber optic cable strung between the high-frequency traders’ computers and their own systems. The effect will be to cause the front runners’ orders to be processed the same as anyone else’s, thus ending the practice. While the new exchange has made its share of enemies, it has also garnered a lot of support from companies like Goldman Sachs which are keen to restore transparency and trust to the securities markets.