As lawmakers and public servants come to grips with the revelations and allegations made in Michael Lewis “Flash Boys,” we appear to have enter the probes and lawsuits phase. In what is considered one of the largest legal actions against U.S. stock exchanges, the City of Providence, Rhode Island filed a class action lawsuit on behalf of all investors who purchased and/or sold stocks in the United States between April 18, 2009 and today.
It seems that Providence went too far by including equity finance exchange OneChicago in its legal action. After a discussion with the legal representatives behind the class action lawsuit, OneChicago was dismissed from the allegations. Traders spoke with David Downey, CEO of OneChicago, for his take on the dismissal and whether the industry should brace for more class actions.
Traders: The City of Providence dismissed OneChicago from its class action lawsuit. Could you give us some background on that situation?
David Downey, OneChicago: It was quite a shock to find that we were named as a defendant in that [class action lawsuit]. Its a very aggressive lawsuit that they filed. Its basically the entire U.S. equity market. Anybody who traded stocks presumably options during that time would be the class.
When I saw that we were lumped in there, I know exactly why they had lumped in all the other Section 6 exchanges. But they really didnt do their work because we have such a different type of an exchange.
Traders: How does OneChicago differ from other exchanges?
Downey: Were notice registered, number one. Were the only exchanges that are duly registered with the CFTC and the SEC. Were a designated contract market. That means our main regulator is the CFTC. Were notice registered at the Security Exchange under Section 6 and 6(g), not 6(b). A lot of the responsibilities that they listed out there was not actually the summary responsibilities of the 6(g) notice registered exchange has.
Number two, one of the issues in the lawsuit was that they were sending the order flow back and forth between them, and they were charging payment, make or take rules and payment for order flow rules. None of those exchanges connect to OneChicago. We dont send any order flow to anybody and they dont send any order flow to us. We dont have a fungible product with their products. All the prime brokers that they mentioned, none of them have ever sent a customer order to OneChicago because our product competes with the way they make money from their customers. Theyre loathe to even let their customers know we exist.
Thirdly, none of the high-frequency traders have ever connected to OneChicago.
Traders: How did OneChicago resolve this legal issue?
Downey: I contacted the plaintiff attorney and suggested that they potentially had made an error. They were kind enough to call me back. We talked rationally about the issue, and I explained to them that I understood what they were trying to achieve. Shooting deer with buckshot sometimes catches the unlucky rabbit like we are. At that point, I said, listen, we dont belong in this. Id like you to dismiss this against us. It was very easy. We didnt even have to hire an attorney to do this.
Traders: They mistakenly thought you traded with HFT firms?
Downey: None of those participants play with us. We are very different. Even though we look like a stock, the product is actually just a financing tool. Its a way for people to refinance their positions at a better rate.
Traders: How does your business work?
Downey: Think of it like this: people who own houses have mortgages. If theyre mortgaged at 8 percent, theyll be crazy not to refinance at 4 percent. Someone whos paying 6 percent for a margin loan should really refinance their position. They can do that with the future they get in their risk profile. Its exactly the same but they can try and turn that 6 percent margin loan into 50 basis points or half of 1 percent interest rate charged to carry that position over time.
Thats the nature of the product. It had nothing to do with trading. It has everything to do with carrying positions.
Traders: Do you think were going to see more lawsuits like this? Do you think that once one attorney general is looking into high-frequency trading, were going to see more AGs emerge with lawsuits?
Downey: Just reading the newspaper, watching 60 Minutes, listening to the regulators all come out and say were going to investigate this type of activity. Having every exchange lumped together as a defendant, all the major prime brokers lumped together as a defendant, having the high-frequency traders. Of course, I believe that there are going to be other lawsuits.
If you read that lawsuit, they cite that book several times. This is why theyre getting their facts from this book. The last time I saw it, I thought I never heard of Michael Lewis in any industry conference explaining how this business works. I know hes been in the business but hes more of a writer. Some of the stuff he wrote was absolutely spot on but some of it was a stretch.
When I looked at the lawsuit, some of that stuff is a stretch. I dont agree with all the stuff that they say. They just throw in as much as they can. Its a sensationalistic approach to the marketplace.
This interview was edited and condensed for clarity.
