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Computers, Lawyers, and The Limits of Expertise

04/24/2013

At 1:07 PM on April 23rd, the respected Associated Press announced on their Twitter account that there were explosions at the White House and the President was injured.  Within three minutes, the Dow lost 143 points but then recovered — leaving a bad case of whiplash.  No harm, no foul — right?

What happened is that some group of sick hackers (who have identified themselves as Syrians?) hacked into the AP’s Twitter account and sent out a fake tweet.  Ha, Ha!

It’s not funny!  It is not a victimless crime.  There were investors who were selling and received less than a fair price, and there were investors who were buying and paid less than a fair price.  People with Stop-Loss orders got sold-out needlessly, possibly with tax consequences.

Two things bother me about this story.  First, hackers are hard to catch but are under-punished when caught.  Second, this incident illustrates the market’s vulnerability to algorithmic trading by computers.  When you saw the tweet, how long did it take you to think “What, this can’t be?  How can I check this?  If true, what are the consequences?”  In that short time, the high-frequency trading computers who read ALL news feeds, including tweets, saw the words “explosions” and “White House” in the same message and immediately sold stocks, avoiding the loss in nano-seconds,while humans were still scratching their heads.

Certainly, this is not in the same league as the Flash Crash on May 6, 2010, when the Dow dropped almost a thousand points (9%) within minutes.  That was a failure of technology.  This time, technology performed exactly as expected.  The point is:  whether computers work as expected or not, the average investor is at a disadvantage.

Computerization of the stock exchanges has clearly been beneficial to the average investor, by increasing liquidity and reducing costs.  But, the technical complexity has over-whelmed the lawyers who run the S.E.C., who simply have not idea how to regulate something they don’t understand.  In the meantime, the high-frequency computerized traders have the advantage . . . and we have the lawyers.

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