Flash Boys: A Wall Street Revolt

by Michael Lewis

  The chief obstacle to the FBI’s ability to extract his confession, oddly, wasn’t Serge’s willingness to provide it but its own agent’s ignorance of the behavior to which Serge was attempting to confess. “In the written statement he was making some very obvious mistakes, computer terms and so on,” recalled Serge. “I was saying, ‘You know, this is not correct.’ ” Serge patiently walked the agent through his actions. At 1:43 in the morning on July 4, after five hours of discussion, McSwain sent a giddy one-line email to the U.S. Attorney’s office: “Holy crap he signed a confession.”

  Two minutes later, he dispatched Serge to a cell in the Metropolitan Detention Center. The prosecutor, Assistant U.S. Attorney Joseph Facciponti, argued that Serge Aleynikov should be denied bail. The Russian computer programmer had in his possession computer code that could be used “to manipulate markets in unfair ways.” The confession Serge had signed, scarred by phrases crossed out and rewritten by the FBI agent, later would be presented by prosecutors to a jury as the work of a thief who was being cautious, even tricky, with his words. “That’s not what happened,” said Serge. “The document was being crafted by someone with no previous expertise in the matter.”

  Sergey Aleynikov’s signed confession was the last anyone heard from him, at least directly. He declined to speak to reporters or testify at his trial. He had a halting manner, a funny accent, a beard, and a physique that looked as if it had been painted by El Greco: In a lineup of people chosen randomly from the streets, he was the guy most likely to be identified as the Russian spy, or a character from the original episodes of Star Trek. In technical discussions he had a tendency to speak with extreme precision, which was great when he was dealing with fellow experts but mind-numbing to a lay audience. In the court of U.S. public opinion, he wasn’t well suited to defend himself, and so, on the advice of his attorney, he didn’t. He kept his long silence even after he was sentenced, without the possibility of parole, to eight years in a federal prison.

  CHAPTER SIX

  HOW TO TAKE BILLIONS FROM WALL STREET

  Ronan didn’t intend to tell his father exactly how much money he made, or anything else that sounded like boasting, but he wanted him to know he needn’t worry about his son any longer. For Christmas, in 2011, he’d fly back to Ireland, as he did every year, only this year he’d travel toward a conversation. He felt no particular attachment to the place. “I don’t belong there at all,” he said. “There’s fucking fat kids everywhere. When I was growing up there was no fat kids. It’s lost its charm.” He missed his family, nothing more. When he arrived at their house in the Dublin suburbs, his parents would be waiting with a list of their stuff that needed to be repaired or reprogrammed. After he’d rebooted their computer, or recaptured their satellite signal, he’d sit down with them and have this talk. “American parents get into their fucking kids’ business,” said Ronan. “In Ireland they don’t. They mind their own fucking business.” His father still had no clear idea what he did for a living, or, for that matter, why a big Wall Street bank would find him useful. “He didn’t think I was a fucking teller or something. But if I said to my dad, ‘I’m a trader,’ he’d say, ‘What the fuck do you know about trading?’ ” His life was his life, theirs was theirs. “My mom and dad, I know they love me. It’s just Irish love. And I just kinda wanted him to know I was legit in this business. It was semi to set him at ease. I didn’t want him to think I was putting the family in jeopardy.”

  Ireland’s economy had collapsed three years earlier, under the weight of a lot of American-style financial machinations and bad advice from American financiers. Many of Ronan’s childhood friends were still out of work. It didn’t seem like the best time to be taking a risk. Just days before Ronan was to fly back to Ireland, however, Brad Katsuyama had pulled him into a meeting with John Schwall and Rob Park. Brad had wanted to know, if he left RBC to create a new stock exchange, who might leave with him. They’d taken turns answering the same question: You in? On some level, Ronan could not believe what he was hearing as he listened to the sound of his own voice: He’d spent his entire career trying to get a job on Wall Street, and now that he finally had one, the guy who had given it to him was asking him to throw it away. On another level, the question answered itself. “Too much was riding on me,” he said. “And I felt like I owed Brad. He was the one who gave me a chance. I trusted him: He’s not a fucking idiot.”

  By the end of 2011, there was something else on Ronan’s mind, too. He’d now seen Wall Street from the inside. It wasn’t as persuasive to him as he had expected it to be. “It’s like if I stay here I’ll become full of shit,” he said.

  They were all very much in; what they were in for was less clear. Until they found someone willing to pay for the building of a new stock exchange, they couldn’t very well quit their jobs to do it. Ronan’s commitment to Brad was less a promise of immediate action than a promissory note to be cashed at some point in the indefinite future. But they did have a goal: to restore fairness to the U.S. stock market—for the first time in Wall Street history, perhaps, to institutionalize fairness. And they had a rough idea: to deploy Thor as the backbone of a strange new kind of stock exchange, to which brokers could send stock market orders so that Thor might route them to all the other exchanges. And yet none of them, least of all Ronan, believed that Thor alone could change the stock market, mainly because they doubted that the big brokerage firms would hand over their most valuable commodity (their customers’ stock market orders) to any third party to execute. They also suspected that other forms of unfairness plagued the market, problems that Thor didn’t begin to address. “I give what we have right now a ten percent chance of working,” Ronan told his colleagues. “But with the four of us I give us a seventy percent chance of figuring it out.”

  After he left Brad’s office, Ronan realized that the talk he wanted to have with his father had changed: He needed his father’s advice. He’d already taken one big risk, when he had quit a telecom job in which he’d made nearly half a million a year for a Wall Street job that paid him a third of that. It had panned out: RBC had just handed him a bonus of nearly a million bucks and was asking him if he would like to run the more lucrative half of their stock market trading operation. (“They told me I could name my price.”) As his plane dipped toward the Irish coast, he wanted to know if he was out of his mind to quit his $910,000-a-year job for one that paid $2,000 a month—money that would quite possibly be paid to him out of funds he himself invested in the new company. His father might not care to know the details, but he’d grasp the gist of his predicament. “I wanted to ask him: ‘Is there a time when you stop rolling the dice?’ I didn’t know if RBC was that time.” But when he finally sat his father down, Ronan realized he couldn’t explain even the gist of his predicament unless he confessed the size of his bonus. “When I was telling him I’d made nine hundred and ten thousand dollars he about had a fucking heart attack,” said Ronan. “I mean, he doubled over in his chair.”

  At length his father recovered, then looked up at his son and said, “You know what, Ro, your risks seem to have paid off so far. Why the fuck not?”

  Ronan landed back in New York on Tuesday, January 3, 2012, turned on his BlackBerry, and watched the new messages flood in. The first was from Brad, announcing his resignation from the Royal Bank of Canada. As Ronan later recalled the moment, “The next ten messages said, ‘Holy shit, Brad Katsuyama just fucking resigned.’ ” Ronan knew that RBC’s bosses up in Canada had been refusing, artfully, to deal with Brad’s insistence that it would be better for all concerned if he not only quit the bank to pursue an idea he had conceived while working for the bank but also took several of the bank’s most valuable employees with him. The bosses in Canada clearly didn’t like the sound of any part of this. They assumed that if they stalled for time, Brad would come to his senses. What kind of Wall Street trader quits a secure $2-million-plus-a-year job to start a risky business—a business for which he doesn’t have even the financ
ial backing?

  At baggage claim, Ronan reached Brad by phone. “I just wanted to ask him: ‘What the fuck is going on?’ ” Brad told him, in surprisingly few words: He was tired of all these supposedly important people who ran this supposedly important bank nodding politely when he tried to speak to them about something that was far, far more important than any one person or any one bank. “They were thinking he’d never do it,” said Ronan. “And he was like, ‘Oh yeah, motherfucker?’ And he did it!” When Ronan rang off, he thought: Well, he’s pushed me all in.

  BRAD GOT TO work around 6:30 every morning. That first morning after the Christmas break, he went to his immediate superior and told him that he was done. Then he went to his desk and wrote one email to Ronan, Rob Park, and John Schwall, and another to three senior guys in Canada. Five minutes later his phone rang. It was Canada, outraged. What the hell are you doing? asked the senior manager on the other end of the line. You can’t do this. To which Brad said: I just did.

  He left the bank with nothing—no paper, no code, no certainty that anyone would actually follow him out, and not even, as it turned out, a clear idea for a business. Like everyone else in the stock market, Brad had received a jolt when he read that a Goldman Sachs high-frequency programmer had gone to jail for mailing himself computer code. Goldman’s sensitivity confirmed his suspicion that, around 2009, the big Wall Street banks, previously distracted by the financial crisis, had finally woken up to the value of the customer orders inside their own dark pools. They were using fear and intimidation to control the technologists who, ultimately, could exploit that value; and the culture of finance suddenly was becoming more closed and secretive—which was saying something. The people who now did what Ronan had once done for the big banks and HFT firms, for instance, would not be allowed to see and hear all that Ronan had been allowed to see and hear. And the banks were now using the legal system to make it harder for their more technical employees to leave. “I said to Rob, ‘No fucking around,’ ” recalled Brad. “He said, ‘Don’t worry. There’s nothing I’d want to take from here anyway.’ ”

  They’d be starting fresh. They could use the insights about the stock market gained from Thor, but Thor itself belonged to the Royal Bank of Canada. Their main advantage—their only sustainable advantage—was that investors trusted them. The investors on the receiving end of Wall Street’s sales pitches were not, by nature, trusting; or, if they were trusting by nature, their natures were reshaped by their environment. People on Wall Street were simply paid too much to lie and dissemble and obfuscate, and so every trusting feeling in the financial markets simply had to be followed by a trailing doubt. Something about Brad had led investors to lower their guard and to trust him. Whatever that was, it was sufficiently powerful that a group of people who ran some of the world’s biggest mutual funds and hedge funds, and who controlled roughly one third of the entire United States stock market, petitioned his superiors at RBC, after he had quit, to allow him to leave, so that he might restore trust to the financial markets on a grander scale.

  And yet—even as he walked away from millions of Wall Street dollars—some of these very people raised questions about his motives. He needed $10 million or so to hire the people who could help him to design his new stock market, and to write the computer code that would be the basis for that market. He’d hoped—assumed, even—that these big investors would supply him with the capital to build the new stock exchange, but eight of every ten pitch meetings began with some version of the same question: “Why are you doing this? Why are you attacking a system that has made you rich and will make you even richer if you just go along with it?” As one investor put it, behind Brad’s back, “I have a question about Brad: Have you figured out why he’s playing Robin Hood?”

  Brad’s first answer to that question was the thing he’d told himself: The stock market had become grotesquely unjust, and badly needed to be changed, and he’d come to see that, if he didn’t do it, no one else would. “That didn’t sit well,” he recalled. “They’d just say, ‘That sounds like complete bullshit.’ The first couple of times it happened, it really bothered me.” Then he got over it. If this new stock exchange flourished, its founders stood to make money—maybe a lot of money. He wasn’t a monk; he simply didn’t feel any need to make great sums of money. But he noticed, weirdly, that when he stressed how much money he himself might make from the new stock exchange, potential investors in his new business warmed to him—and so he started to stress how much money he might make. “We had a saying that seemed to appease everyone when they asked why we are doing this,” he said. “We are long-term greedy. That worked very well. . . . It always got a better response out of them than my first answer.”

  He spent six months running around New York faking greed he didn’t really feel, to put money people at ease. It was maddening: He couldn’t get the people who should give him money to do so, and he couldn’t take the money from the people who wanted to give it to him. Just about all of the big Wall Street banks either asked him outright if they might buy a stake in his exchange or wanted at least to be considered as possible investors. But if he took their money, his stock exchange would lose both its independence and its credibility with investors. His friends and family in Toronto also all wanted to invest in his new company. They presented a different issue. Two hours after Brad had let them know, via email, that he was pounding the pavement to raise money for a new stock market, they ponied up, collectively, $1.5 million. Some of these people could afford to take risks with their money, but some had no more than a few thousand dollars in savings. Before he allowed them to invest, Brad insisted that they send him bank statements to prove that they could afford to lose whatever they invested. “Your brother has never failed at anything he has ever done,” one old friend wrote to Brad’s older brother, Craig, to explain why the new business wasn’t at all risky, and to ask him to intercede on his behalf and overrule Brad’s decision not to take his money.

  What he needed was for the big stock market investors who had said they wanted him to quit RBC to fix the stock market—that is, the mutual funds, pension funds, and hedge funds—to put their money where their mouth was. They offered all sorts of excuses why they couldn’t help: They weren’t designed to invest in start-ups; the investment managers thought it was a great idea, but the compliance arm simply wasn’t equipped to evaluate Brad; and so on. “The amount of money we were asking for was so small that it was too much of a pain in the ass for them to figure out how to give it to us,” said Brad. They all wanted him to build his exchange; they all hoped to benefit from that exchange; but they all also assumed that someone else would supply the capital to do it. Many had good excuses—it was indeed outside the mission of a giant pension fund to invest in start-ups. Still, it was disappointing. “They’re like one of those fucking friends who say he’ll back you up in a fight and they don’t do anything,” said Ronan, after one long and frustrating day of begging for capital. “You’re on the ground, bloody, and only then do they jump in and throw a punch.”

  Some of them were like that; but not all of them. The giant mutual fund manager Capital Group pledged to invest—on the condition that they weren’t the lone investor but part of a consortium; so did another, Brandes Investment Partners. And there were several that voiced a sound objection: The business Brad was pitching to them was a foggy proposition—a stock exchange that existed mainly to route their stock market orders to all the other exchanges. How would that work? Thor had worked great, but why did Brad imagine that the predators who operated with such abandon on America’s public and private exchanges would not adapt to it? And why did he think Wall Street’s biggest banks would subcontract the routing of their stock market orders to his new exchange? Because it was “fair”? The banks’ salesmen ran around every day selling the banks’ own routers. They weren’t going to turn on a dime and say, “Oh yeah, we’ve been paid huge sums of money to sell you out to high-frequency traders, but now we’re going to give a
ll the stock market orders to Brad, so we can’t sell you out any longer.”

  Brad didn’t fully understand the enterprise he needed to create until the market forced him to, by not giving him the capital for the enterprise he thought he wanted to create. Fuller understanding arrived in August 2012, in a meeting with David Einhorn, who ran the hedge fund Greenlight Capital. After listening to Brad’s pitch, Einhorn asked him a simple question: Why aren’t we all just picking the same exchange? Why didn’t investors organize themselves to sponsor a single stock exchange entrusted with guarding their interests and protecting them from Wall Street predators? There’d never been any collective pressure brought by investors on the big banks to route their stock market orders to any one exchange, but that was only because there was no good reason to prefer one exchange over another: The fifty or so places on which stocks were traded were all designed by financial intermediaries, for financial intermediaries. “It was so obvious it was almost embarrassing,” said Brad. “That should have been our pitch: not that we should route the orders using Thor but [that] we should create the one place investors would choose to go.” That is, they shouldn’t simply seek to defend investors on the existing stock exchanges. They should seek to put all the other exchanges out of business.

  By mid-December he’d sewn up $9.4 million from nine different big money managers.* Six months later he’d raise $15 million from four new investors. The money Brad needed that he didn’t get he kicked in himself: By January 1, 2013, he’d put his life savings on the line.