Guest Post: R.T. Leuchtkafer shows how poorly informed the LewisFiction Blog Is
R.T. Leuchtkafer was sent the LewisFiction blog post titled http://lewisfiction.wordpress.com/2014/09/05/michael-lewis-in-the-dark-about-dark-pools/
He sent us an email with his responses to the incorrect points made in that post. We are including his response, unaltered, below.
FYI as a bit of background, post Flash Boys, a string of anonymous twitter accounts were set up attacking Michael Lewis and his claim that markets are rigged. We tend to not want to lend credibility to those Twitter Trolls, and their pro-status-quo anonymous blogs and propaganda. One of those trolls is the Twitter Account @LewisFiction, whose author also created a free blog (link above), to which RTL is responding.
FYI – for the record… Joe and I are not R.T. Leuchtkafer. In fact we were ourselves influenced by his SEC comment letters, which predate this whole debate.
RTL responses are in BOLD:
It would be funny if it weren’t so poorly informed. Let me go through the points.
8. ARE DARK POOLS DELAYING THE REPORTING OF TRADES?
On page 42 Michael Lewis writes: “Dark pools were another rogue spawn of the new financial marketplace. Private stock exchanges, run by the big brokers, they were not required to reveal to the public what happened inside them. They reported any trade they executed, but they did so with sufficient delay that it was impossible to know exactly what was happening in the broader market at the moment the trade occurred.
”This statement is factually inaccurate. Dark pools, like IEX, are registered with the SEC as Alternative Trading Systems (ATSs). Dark pools, like exchanges, are required to immediately report all transactions to FINRA for publication to the consolidated tape. Dark pools do not delay their transaction reports and Mr. Lewis provides no evidence or support of such devious behavior by the dark pool operators.
Lewisfiction is wrong, and bizarrely so. Dark pools are certainly required to report trades to “an effective transaction reporting plan,” which in practical effect means the FINRA print facility, which itself then reports those trades to the securities information processors (SIP). But exchanges are not required to report trades to FINRA. Exchanges report their trades directly to the SIP. This structural two-stage dark pool trade reporting process, dark pool to FINRA to SIP, introduces a delay exchange-reported trades don’t have.
9. DOES ANYONE KNOW WHAT HAPPENS IN A DARK POOL?
On Page 43, Michael Lewis writes: “Inside a dark pool, no one but the broker who ran it had any idea what was happening.”
This statement is factually inaccurate. Dark pools, like exchanges, are required to immediately report all transactions occurring in the dark pool. Transaction reports are instantaneously reported back to the two parties on the trade. Those transactions are also immediately published on the consolidated transaction reporting system for all to see. While dark pools do not reflect a quoted price, they are highly transparent in that they immediately publish trades to the customers trading in the pool and the public watching the public reporting feed.
Lewisfiction is wrong again, and bizarrely so. By law, dark pool “orders are not displayed to any person, other than employees of the alternative trading system.” Trades are reported to FINRA for reporting to the tape, but it is bizarrely ignorant to call these systems “highly transparent” when there is no pre-trade transparency in them whatsoever, by law. It’s in the name, after all: “dark,” which in English is quite nearly the exact opposite of “transparent.”
10. WHAT PERCENTAGE OF ORDERS ARE FILLED INSIDE THE DARK POOL?
On Page 86 Lewis writes: “A huge percentage of the customer orders sent into a dark pool were executed inside the pool.”
This statement is factually inaccurate. Dark pools make up approximately 12-13% of the overall market volume. The execution percentages of dark pools are largely driven by an investor’s selection of the various algorithms offered by the dark pool operator. Investors that choose “price sensitive” algorithms will have a routing bias that takes liquidity from the displayed markets and as a result, will have very low execution percentages in the dark pool. Investors that select “passive” algorithms will experience a relatively higher percentage of executions in the operator’s dark pool as a result of the algorithm attempting to “passively” engage the market to avoid market impact.
Lewisfiction is wrong again, here making a fundamental logical mistake. The fact that dark pools’ trade volume market share is 12-13% has absolutely nothing to do with the percent of its customer orders a firm might see filled in its dark pool.
11. ARE BANKS ABLE TO FILL ALL OF THEIR ORDERS INSIDE THEIR DARK POOL?
On Page 224: “A bank that controlled less than 10 percent of all U.S. stock market orders was somehow able to satisfy more than half of its customers’ orders without ever leaving its own dark pool.”
This statement is completely inaccurate. There are no banks in the U.S. that have ever claimed to be able to satisfy 50% of all of their customers’ orders exclusively on their dark pool. Dark pools only represent approximately 12-13% of overall market volumes in the U.S. No single dark pool could find enough liquidity on their own dark pool to satisfy 50% all of their customers’ orders. However, where a customer selects “passive routing” as one of its many choices of algorithms, the client’s order may experience a higher fill rate on the bank’s dark pool because the customer has requested that the order remain resting in the dark pool. Mr. Lewis is once again making up facts to fit his narrative.
Once again, Lewisfiction, reading comprehension is fundamental. None of your facts contradict what Lewis wrote, or are even relevant to it. His very point is that the bank’s natural liquidity pool was not substantial enough to satisfy its customer orders on its own, which could well imply some kind of shenanigans in play to achieve such high fill rates.
12. WHAT IS THE TIME A TRADE IS EXECUTED IN A DARK POOL?
On Page 86, Mr. Lewis writes: “And because the dark pool was not required to say exactly when it had executed a trade…”
Yes, hard to believe but this statement is also absolutely incorrect.All executions in a dark pool or elsewhere in the market are required to be immediately reported to the public. In addition, customers receive real-time and post-trade execution reports. The time of execution is provided to investors on the investors’ execution reports. This is information that the broker is actually required to provide under SEC Rule 10b-10.
13. ARE BANKS DIRECTING ORDERS OUT OF DARK POOLS FOR KICKBACKS?
On Page 182, Michael Lewis writes: “If the bank was unable to execute a stock market order in its own dark pool, the bank directed that order first to the exchange that paid the biggest kickback for it—when the kickback was simply the bait for some flash trap.”
Once again, Mr. Lewis proves that he spent no time researching this industry. All routing brokers are subject to the routing requirements under Regulation NMS (ironically, the rule that Mr. Lewis claims is the problem). What Mr. Lewis fails to realize (or explain) is that routing brokers must send their orders to the exchange displaying the “best price” in the market and cannot select a different exchange absent the best price.
And again, as so often before, Lewisfiction, comprehension is fundamental. Brokers are required to send their orders to the best price only if the order is marketable. If it isn’t marketable, it can go anywhere, and as research from Robert Battalio at Notre Dame has shown, these orders quite often go to the venue offering the biggest kickbacks.
14. DARK POOLS DON’T RECORD THEIR TRADES.
On Page 219, Michael Lewis writes: “Sixty percent of the time that this feeding frenzy occurs on a public stock exchange, no trade is recorded. The frenzy comes in response to a trade that has occurred in some dark pool. The dark pools are not required to report their trades in real time; and so, on the official tape, the frenzy appears unprovoked. It isn’t.”
First, Mr. Lewis references “sixty percent of the time” with no support or data to validate this claim. Second, regardless of that claim, his statement that “dark pools are not required to report their trade in real time” is absolutely false. I know I’ve already covered this but I want to be totally clear, the US trade reporting rules require exchanges and ATSs (dark pools) to report trades in real time. FINRA rules require transactions to be reported “as soon as practicable” which has been interpreted to mean in real-time for an automated platform. Mr. Lewis again fabricates information that is totally inaccurate but conveniently supports his desired fictional story.
I know I’ve already covered this but I want to be totally clear, Lewisfiction, dark pool trades have a two-step reporting process, from dark pool to FINRA to SIP, that introduces a permanent structural delay. Given the latencies in this two-step, it is not at all unusual for the exchange markets to react to a dark pool print before that print ever hits the tape.
15. WHAT PERCENTAGE OF THE STOCK MARKET TRADES OCCUR IN DARK POOLS?
On Page 113, Mr. Lewis writes: “By the middle of 2011, roughly 30 percent of all stock market trades occurred off the public exchanges, most of them in dark pools.”
I’ve included a chart below from Rosenblatt Securities, which shows Dark Pool volumes in 2011 barely reached 13% of the total market. 13% versus 30% is quite a large difference and represents yet another huge error in the book. Mr. Lewis does a great job of painting a fictional picture of a corrupt Wall Street which will no doubt result in an intriguing Hollywood movie…yet we should recognize it for what it is…FICTION!
The “roughly 30 percent” that Mr. Lewis references includes block trades and retail trades executed in the over-the-counter market. Not only does Mr. Lewis have problems with his math (“most of them in dark pools”), but a simple review of the data in 2011 shows that the public exchanges’ volumes were growing in market share in 2011 (see chart below).
By this point I’m convinced Lewisfiction is not a native English speaker. Yes, Michael Lewis wrote “roughly 30 percent of all stock market trades occurred off the public exchanges,” and that’s true; whether Reg ATS dark pools were 13% of the market is completely irrelevant to what he wrote. And while Lewis says “most” trades were in dark pools, why assume his usage here is narrowly limited to Reg ATS facilities?
16. HOW MUCH OF BANKS TRADING OCCURS IN DARK POOLS?
On Page 224: “Collectively, the banks had managed to move 38 percent of the entire U.S. stock market now traded inside their dark pools—and this is how they had done it.”
This statement is completely inaccurate. As reported now by FINRA and as reported previously by Tabb Group and Rosenblatt, the dark pools are only approximately 13% of the U.S. market. They were never 38% of the U.S. market. Trading in the over-the-counter market (off exchange) is approximately 38% to 40% of the U.S. market. Mr. Lewis uses this statistic to grossly misrepresent the dark pool market share in the U.S.
Again, Lewisfiction, his point is that nearly 40 percent of the entire U.S. stock market is off-exchange, and that’s a fact. That volume is in Reg ATS facilities and OTC market maker books, and many of these are run by banks. The language may not be as precise as you prefer it to be, but Lewisfiction your own language is itself spectacularly imprecise, complete with whoppers like the claim that exchanges have to report their trades to FINRA (which will surprise not only the exchanges but FINRA). Why do you look at the tick in Michael Lewis’s eye and not notice the flash crash in your own eye?