An early appearance of a Terminator machine in American court history is the familiar case of Kaltko v. Briney. As you may recall from first year Con Law, this is the case where an enterprising couple from Iowa set up a trap to deter maim or kill trespassing thieves. When a would-be burglar triggered the trap, which was deliberately aimed “to hit the legs,” most of his leg was blown off. He sued for damages and eventually won at the Iowa Supreme Court.
Twenty-seven years later, the first movie in the Terminator series was released. The important similarity is not how John Connor also instructed his shotgun-wielding death machine to aim for the legs, but in a larger plot point: in the series, a worldwide nuclear apocalypse (“Judgement Day”) is initiated when an automated defense system, Skynet, interprets a command to take it offline for maintenance as an attack, and releases the American nuclear arsenal on Soviet Russia. The Soviets respond in kind and pretty much everyone gets vaporized. Obviously, there was some ret-conning in order for later sequels as the USSR no longer existed in 1997, the year of the apocalypse.
Some actors in the securities markets apparently have not heeded either the legal precedent of Kaltko nor the fictional cautionary tale of Terminator and have invested several billion dollars in high frequency trading supercomputers that buy and sale securities at a staggering pace—billions of transactions per second.
One result of this trend apparently has been the “Flash Crash” of 2010, wherein the Dow plunged by almost 1,000 points within a single day. Some investigations are still ongoing, but the SEC reporting so far has indicated that a single, massive sale of E-Mini contracts by a Kansas-based mutual fund sent the High Frequency Trading Algorithms into a tizzy, selling off enormous amounts of shares and driving their prices down rapidly. By the end of the day, buyers had snapped up the egregiously undervalued shares and the market closed just 3% down. A big sale by a mutual fund company isn’t quite the same as a nuclear attack, but the HFTAs—like Skynet—hadn’t been programmed to distinguish between a large transaction and an impending liquidity crisis.
If you were trying to liquidate part of your portfolio to, say, make a down-payment on your house or pay for your kid’s tuition bill, and your order happened to be executed during certain hours of the day, you might have been pretty disappointed—like the man whose investment wasn’t so much liquidated as vaporized when he lost $17,000 selling a blue chip stock.
The SEC’s stated mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The modern notion of market efficiency, an economic model that relies heavily on frictionless transactions, ironically emerged in the 1960s while at the same time capital markets were losing billions of dollars in what is known as the “Paper Crunch.” Securities transactions were so inefficient (all being done via delivery of physical certificates) that the backlog trades to linger before settlement for days and days at a time. Versions of the Efficient Market Hypothesis have been enshrined in the fraud-on-the-market doctrine which has been successfully invoked at the Supreme Court as recently as the summer of 2012 in the Erica P. John Fund v. Halliburton case.
But efficient market theories often depend on an asset pricing model, such as the Capital Asset Pricing Model (CAPM) or others, that assume a risk-averse, buy-and-hold investment outlook. Rates of return, or “future cash flows,” feature heavily in the models, but in the market today most of the trades are executed by computer programs that don’t plan on collecting any dividends.
On the Flash Crash of 2010:
On Asset Pricing Models:
SEC explains what it does: