umarsaeed

Modern Day “Salami Slicing”

In Financial, Fresh on April 1, 2014 at 3:13 PM

My first introduction to “salami slicing” was in Superman 3. Richard Pryor, who played a quirky computer hacker that worked in the processing department of a bank, discovered that there were millions of transactions happening at the bank each day and that all of them required the bank to round amounts to the nearest penny. By accumulating these rounding increments into his own bank account, he became rich. Apparently, Wall Street has a similar scam and is doing this to all of us every day. 60 Minutes has a must-watch piece if you’re interested in how they skim money from your investments.

A couple of additional observations:

It’s interesting to think that even in the digital world, investing in physical networks and infrastructure yields a competitive advantage. We often think of information and intellectual property as intangible, ideas that are floating in the air that you must protect through copyright, patents or trademarks. We think of the services we use (email, cell phones, social media, etc.) as securing the information being transmitted. But all these digital bits floating around in the air come from somewhere and must stop off or be stored at physical servers. They must travel between cables, towers and satellites. The people that own the physical infrastructure have the tremendous power to control information. The question we must ask is, do they have the commensurate responsibility?

High-frequency trading appears to have no functional purpose to society or the effective operation of financial markets. You and I wouldn’t miss these firms if they never existed. Yet, these firms appear to have the ability to cause tremendous damage to our lives. There was the “flash crash” of 2010, which was a sign showing the world how disruptive these super-computers could be to financial markets. Now, it appears there’s a perfectly legal multi-billion dollar front-running operation in place. We are worse off because of their existence, whether we like it or not. The scam targets all investors, including our pension plans and mutual funds. In the 60 minutes piece, Brad Katsuyama, the trader that uncovered the scam while working for the Royal Bank of Canada, is now starting his own stock exchange where the machines that accept trade orders remove any speed advantage for the big players. If the exchange gets popular, it will mean the big investment firms that spent hundreds of millions of dollars on computers and infrastructure will have wasted a lot of money.

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