February 26, 2014

Unwired

It’s got to stop. Warren Buffett said so.

Until the Wall Street Journal’s Scott Patterson broke the story recently, most investor-relations professionals were unaware that Berkshire Hathaway unit Business Wire took fees from high-speed firms in trade for early delivery of news. It provoked outrage in circles including the office of the New York state attorney general.

I was quoted by Bloomberg’s Sam Mamudi in a related piece last Friday. What I thought was most important didn’t make the story. Sure, if something looks bad you should stop doing it, and I said so. In today’s parlance, the optics were bad.

“Quast,” you say. “They were selling our news to high-speed traders before it hit distribution channels.”

Half of every plane load today is in Group One because people get status for giving business to just one airline. It’s an early look.

“That’s flying. You don’t get in trouble for boarding early. You get locked in the poke for trading on things nobody else has got.”

That’s not true. Valuable information is the bedrock of capital-formation. Otherwise, the market would be one big index fund. And what Business Wire did wasn’t illegal.

“Are you defending it?” you say.

No. It’s bad form in an era where form, like optics, is more important than substance. But it’s like a police officer pulling somebody over for a bad taillight – which is not illegal but a safety hazard – and ignoring that the car is stolen.

Getting news early is a red herring. It shifts focus from the issue. If you’re a speed skater in the winter Olympics and you flinch, you scratch. The skaters have to restart the race. Same at the summer Olympics in sprints. Jump early and you can be disqualified.

But those are races. We’re treating the stock market like participants are racers.

The problem is the marketplace. Once upon a time there was a stock market. It was owned by brokers with books of business who pooled them to fashion a bazaar with critical mass. They agreed to a minimum commission – no undercutting on price (but you could charge more) – and to give each other preference (not force, choice).

It worked for a long time. Then brokers became complacent and investors began to sense they weren’t getting a good deal. So investors created their own market in 1969 to trade electronically and called it Institutional Networks. Today that’s Instinet, owned by Nomura.

Associated securities dealers started an automated-quotation system in 1971 and called it the NASDAQ. More competition.

In the 1980s, a new breed of competitor responded to persistent chatter that brokers were monopolizing markets. These outfits weren’t brokers at all but technology shops creating marketplaces that they called Electronic Communications Networks – ECNs. Island, Archipelago and others gobbled market-share.

And then the regulators said, “Okay. Everybody, out of the pool.”

Regulators decided it would be best if we had just one market. It took years and many rule-changes, the last big one Regulation National Market System, which we wrote about a few weeks ago.

The market we now have is a giant data network with nodes on it called displayed markets and dark pools. It’s built around a single price-point, the National Best Bid or Offer. The first trade to match the best of both sets the price for the whole market.

And this is why Business Wire was selling news early. It’s not the news that’s valuable. It’s setting the price. That’s what matters to fast traders – and any impetus will do. It devalues news to the worth of a split-second and 100 shares, the minimum bid.

Suppose there was one national price for spinach and you were forced to buy at that price? You walk in a grocery store and angle toward the spinach, and the price changes and suddenly it’s better at Safeway. So you head to Safeway and get there and the price – woops! Now it’s better at Kroger.

Then somebody would start selling early price information about spinach. And everybody would be outraged.

And it would miss the point. The problem isn’t Business Wire. It’s that markets are wired together around one price.

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