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* The first round of investors included Greenlight Capital, Capital Group, Brandes Investment Partners, Senator Investment Group, Scoggin Capital Management, Belfer Management, Pershing Square, and Third Point Partners.
† In the interest of clarity, they’d hoped to preserve the full name, but they discovered a problem doing so when they set out to create an Internet address: investorsexchange.com. To avoid that confusion, they created another.
‡ The market order is the first and simplest type. Say, for instance, an investor wishes to buy 100 shares of Procter & Gamble. When he submits his order, the market for the shares in P&G is, say, 80–80.02. If he submits a market order, he will pay the offering price—in this case, $80.02 per share. But a market order comes with a risk: that the market will move between the time the order is submitted and the time it reaches the market. The flash crash was a dramatic illustration of that risk: Investors who submitted market orders wound up paying $100,000 a share for P&G and selling those same shares for a penny apiece. To control the risk of a market order, a second order type was invented, the limit order. The buyer of P&G shares might say, for instance: “I’ll buy a hundred shares, with a limit of eighty dollars and three cents a share.” By doing so, he will ensure that he does not pay $100,000 a share; but this may lead to a missed opportunity—he may not buy the shares at all, because he never gets the price he wanted. Another simple, and long-used, order type is “good ’til canceled.” The investor who says he wants to buy 100 shares of P&G at $80 a share, “good ’til canceled,” will never have to think about it again until he buys them, or does not.
§ The value of the microseconds saved by proximity to the exchanges explained why the exchanges expanded, bizarrely, after the people inside them had vanished. You might have thought that, when the whole of the stock market moved from a floor that needed to accommodate thousands of human traders into a single black box, the building that housed the exchange might shrink. Think again. The old New York Stock Exchange building on the corner of Wall and Broad streets was 46,000 square feet. The NYSE data center in Mahwah, which housed the exchange, was 400,000 square feet. Because the value of the space around the black box was so great, the exchanges expanded to enclose greater amounts of that space so that they might sell it. IEX could function happily inside a space roughly the size of a playhouse.
¶ In 2008, Citadel bought a stake in the online broker E*Trade, which was floundering in the credit crisis. The deal stipulated that E*Trade route some percentage of its customers’ orders to Citadel. At the same time, E*Trade created its own high-frequency trading division, eventually called G1 Execution Services, to exploit the value of those orders for itself. Citadel’s founder and CEO, Kenneth Griffin, pitched a fit, and called out E*Trade publicly for failing to execute its customers’ orders properly.
** Arnuk and Saluzzi, the principals of Themis Trading, have done more than anyone to explain and publicize the predation in the new stock market. They deserve more lines in this book than they receive but have written their own book on the subject, Broken Markets.
CHAPTER SEVEN
AN ARMY OF ONE
On the morning of September 11, 2001, Zoran Perkov took the subway from his home in Queens to Wall Street, as he did every day. As usual, he wore headphones and listened to music, and pretended that the other people on the train didn’t exist. The difference between that morning and all the others was that he was running late, and the people on the train were harder than usual to ignore. They were talking to each other. “Nobody talks to each other,” said Zoran. “It was a weird feeling, when you feel something is off.” He was twenty-six years old, tall and broad, with hooded eyes that saw everything in one shade of gray or another. Born in Croatia, into long lines of fishermen and stonemasons, he’d moved with his parents to the United States when he was a small child. He’d grown up in Queens, and he worked on a tech help desk for the cryptically named Wall Street Systems, at 30 Broad Street, immediately next door to the New York Stock Exchange. His job bored him. What precisely he did on Wall Street Systems’ tech help desk didn’t matter. He wouldn’t be doing it much longer. In the next few hours, he’d discover a reason for doing something else. This discovery—and the clear sense of purpose that came with it—would put him on a course to be of serious use to Brad Katsuyama.
The subway car was a silent movie. Zoran watched the people in it talking to each other all the way to Wall Street. Ascending from the hole in the ground in front of Trinity Church and into the morning light, he noticed the necks tilted back and the eyes gazing upward. He, too, looked up, just as the second plane hit the South Tower. “You couldn’t see the plane,” he said. “You just saw this explosion.”
He took off his headphones and heard the sounds. “All around people crying, people screaming, people puking.” He saw people running up Broadway. He crossed the street and went to work. “Work isn’t work for me,” he said. “I got friends there. I went to find out what is going on.” Outside the front door, he spotted the same pretty woman with a cigarette he always saw on his way in. (“You know, the one hot chick in the building.”) She was smoking but also crying. He went upstairs, checked in with his friends, and called some guys he’d grown up with who worked on or around Wall Street. One of them worked in the Twin Towers—which tower Zoran couldn’t recall. A couple more worked in the buildings around the towers. He reached them and they agreed to use his office as their meeting point. When his friend from the Twin Tower arrived, he said that on his way out he’d heard the bodies hitting the ground.
The small group of five friends set out to escape. They discussed strategy. Zoran argued for walking out, up Broadway; the others voted to leave on the subway. “Democracy won,” said Zoran, and back down into the Wall Street station they went. It turned out that this was not an original idea. The crowds forced them apart; three of them squeezed into one car, while Zoran and another pushed into the next car. “It was such a mixed crowd,” said Zoran, “not your usual subway crowd.” There were all these Wall Street people: guys from the stock exchange in their colored jackets; people you just never saw there. The car lurched out of the station and into the dark tunnel, then stopped. “That’s when my ears popped,” said Zoran. “Like when you go swimming under water.”
The tunnel filled with smoke. Zoran had no idea what had happened—why his ears had popped, why the tunnel was full of smoke—but he noticed a guy trying to open a window, and he hollered at him to stop. Who gave you the authority? the guy screamed back at Zoran. “It’s smoke,” Zoran shouted. “Breathe it. Die. It’s that fucking simple.” The window stayed shut, but the car remained fractious and unsettled. The car holding his other friends was tranquil. People bent over, praying.
The conductor came on and announced that the train needed to return to the Wall Street station. To general concern, the guy who drove the train walked from the front car to the back car, did whatever needed to be done to allow the train to go the wrong way inside a tunnel, and jolted it back from whence it had come. But not completely: Only the front two cars gained access to the platform. The people in what was now the rear of the train needed to file out through the cars to reach the exit.
That’s when Zoran noticed the old man—his neighbor, in a crowd trying to form a line to exit the train. “He’s got a cane,” said Zoran. “He’s in an old suit—he’s gotten thinner and smaller, so it doesn’t fit him very well. I remember thinking: I should probably make sure this guy doesn’t get crushed. So I just kind of kept him in front of me. I felt responsible for him.” Half-guiding the old man, he nudged his way back up the steps of the subway station and onto Wall Street. Then everything went totally black. “We get to street level, and I had to realize it was street level,” said Zoran. “And I lost the old guy. From that moment I was just paying attention to everything around me.”
He now couldn’t see, but he could hear people shouting. “Over here! Over here!” he heard someone scream. He a
nd the friend who’d been in the subway car with him followed the sound of the voices, walking into what turned out to be the American Express building—though Zoran didn’t realize it until they’d been inside for a minute. What he noticed was the pregnant woman, sitting on the floor with her back against a wall. He went to her, made sure she wasn’t about to give birth, then gave her his phone, which still worked. The black air outside began to acquire a color. “For some reason everything had this beige-like tone,” he recalled. He could now see more or less where they were, and which direction was which. A cop inside the building said, “You need to stay in here.” Zoran grabbed his friend and left. They walked east and north until they arrived at some faceless apartment buildings on the Lower East Side. “It’s the projects,” said Zoran, “and people are coming out with cups of water and all of their cordless phones. To help. That’s when I started to cry.”
Eventually they reached the FDR Drive and continued due north. That might have been the oddest feeling of the entire morning: that walk along a stretch of the FDR. They were alone. It was quiet. For an amazingly long time, the only human being they encountered was a half-dressed cop who roared past them on a motorbike toward the catastrophe. Then the papers began to flutter down from above. On them Zoran could read the address of the World Trade Center.
To say that Zoran found the whole experience exhilarating—well, that wouldn’t be quite right, though, as he told his story, he said that “somehow I feel guilty about telling it.” It was more that there hadn’t been even a moment when he had felt he didn’t know what he should do next. He’d been jarred into a new kind of awareness, and interest in the people around him, and he liked the feeling. His reactions had surprised him into an observation about himself. “I was impressed that I did not fall apart,” he said. “I didn’t use it as an excuse for anything. What it tells me is that I wasn’t afraid of those situations. I like being front and center. I like being in a drama.” He could even pinpoint the moment he realized he was better suited to a crisis than he expected himself to be. “It was when I realized I’ve started to give a shit about other people,” he said.
Two days later he returned to work, but he’d been biffed from an ill-defined career path onto another, clearer one. He wanted to be in a job that required him to perform in a crisis. If you worked on the technology end of Wall Street and were looking for pressure, you ran an electronic stock market. By early 2006, that’s what Zoran was doing—at Nasdaq. “They just sat me in front of four machines with buttons that could, like, destroy everything,” he said. “It was the best thing in the world. Every day was the Super Bowl. The value of what you were doing felt so high.” The feeling of the job was hard to get across to anyone who wasn’t a technologist, but there was definitely a feeling to it. “Put it this way,” said Zoran. “If I fuck up, I’m going to be in the news. I’m the only one who can break it, and if it breaks I’m the only one who can fix it.”
He’d learned this the hard way, of course. Not long after he started at Nasdaq, he’d broken one of the markets. (Nasdaq has owned several markets—Nasdaq OMX, Nasdaq BX, INET, PSX.) It happened when he was making changes to the system during trading hours. He entered a command, then heard the people around him panicking; but he failed to immediately connect one event to the other. A former Nasdaq colleague recalled the ensuing bedlam. “I remember seeing people running around and screaming while it was happening,” he said. Zoran looked up at the stock market on his computer screen: It was frozen. It took him a few seconds to realize that, even though the thing he’d been working on should have had no connection to the market in real time, he had somehow shut his entire market down. It took him another few seconds to see exactly how he had done it. Then he fixed it, and the market resumed trading. From start to finish the crisis had lasted twenty-two seconds. Twenty-two seconds, during which all trading had simply ceased. “I remember sitting there and thinking: I’m done,” said Zoran. “The CTO [chief technology officer] saved me. He said, ‘How can you get rid of a guy who makes a mistake, stops it, and fixes it?’ ”
Still, the event shaped him. “I said, ‘How do I never do that again?’ ” said Zoran. “I started really jumping into how to control large-scale complex systems. I became a student of complexity—defined as something you cannot predict. How do you have stability in a system that is by its nature unpredictable?” He read everything he could find on the subject. One of his favorite books was actually called Complexity, by M. Mitchell Waldrop. His favorite paper to pass out was “How Complex Systems Fail,” an eighteen-bullet-point summary by Richard I. Cook, now a professor of health care systems safety in Sweden. (Bullet Point #6: Catastrophe is always just around the corner.) “People think that complex is an advanced state of complicated,” said Zoran. “It’s not. A car key is simple. A car is complicated. A car in traffic is complex.”
A stock market was a complex system. One definition of a complex system was a place where, as Zoran put it, “Shit will break and there is nothing you can do about it.” The person whose job it was to make sure shit didn’t break ran two kinds of career risks: the risk of shit breaking that was within his control, and the risk of shit breaking over which he had no control. Zoran continued to run one of the Nasdaq markets. Eventually, the company handed him bigger markets to run; and the risk of running them grew. By the end of 2011, he was overseeing all of Nasdaq’s market running. (Head of Global Operations, he was called.) He had spent the better part of six years adding complexity to those markets, for reasons he did not always understand. The business people would just decide to make some change, which it was his job to implement. “The Post-Only order type was the first thing that got me,” said Zoran, of the order designed to be executed only if the trader received a kickback from the exchange. “What the fuck is the point of a Post-Only order?” He was somehow expected to cope with the demands made on Nasdaq’s markets by Nasdaq’s biggest customers (high-frequency traders) and, at the same time, keep those markets safe and stable. It was as if a pit crew had been asked to strip down the race car, rip out the seat harnesses, and do whatever else they might to make the car go faster than it ever had before—and at the same time reduce the likelihood that the driver would die. Only in this case, if the driver was killed, blame for his death would be assigned, arbitrarily, to one member of the pit crew. Him.
This state of affairs led to a certain skittishness in the pit crew. It wasn’t just that the high-frequency traders were demanding changes to the market that would benefit only them: The mere act of changing the system increased the risks to everyone who depended on it. Adding code and features to a trading system was like adding traffic to a highway: You couldn’t predict the consequences of what you had done; all you knew was that you had made the situation more difficult to understand. “No one is trying to control what they don’t know,” said Zoran. “And what they don’t know is growing.” He thought of himself as good in a crisis, but he didn’t see the point of manufacturing crises so that he might demonstrate his virtuosity. He was also far less suited to managing a bunch of market runners than he was to running a market himself. He had no gift for corporate politics. Every day, he liked his job less and less—until, in March 2012, he was fired, whereupon he got a phone call from Don Bollerman. Don wanted Zoran to run the market for IEX. “I’m not going to pitch you just now, mainly because we have no money and we don’t even know what we’re going to do,” said Don. “But I may pitch you later.” Don knew that Zoran had been a casualty of an office political battle, and, more to the point, that he was maybe the best exchange runner he’d ever seen. “He has all the qualities,” said Don. “Poise under pressure. The ability to understand a complex and vast system. And be able to think into it—imagine into it—accurately. To diagnose and foresee problems.”
It was a little unsettling that the geeks who now ran the financial markets were also expected to have the nerves of a test pilot. But by the time Don approached Zoran, it had grown clear that the investing
public had lost faith in the U.S. stock market. Since the flash crash back in May 2010, the S&P index had risen by 65 percent, and yet trading volume was down 50 percent: For the first time in history, investors’ desire to trade had not risen with market prices. Before the flash crash, 67 percent of U.S. households owned stocks; by the end of 2013, only 52 percent did: The fantastic post-crisis bull market was noteworthy for how many Americans elected not to participate in it. It wasn’t hard to see why their confidence in financial markets had collapsed. As the U.S. stock market had grown less comprehensible, it had also become more sensationally erratic. It wasn’t just market prices that were unpredictable but the market itself—and the uncertainty it created was bound to extend, sooner or later, to the many foreign stock markets, bond markets, options markets, and currency markets that had aped the U.S stock market’s structure.
In March 2012 the BATS exchange had to pull its own initial public offering because of “technical errors.” The next month, the New York Stock Exchange canceled a bunch of trades by mistake because of a “technical glitch.” In May, Nasdaq bungled the initial public offering of shares in Facebook Inc. because, in essence, some investors who submitted orders to buy those shares changed their minds before the price was agreed upon—and certain Nasdaq computers couldn’t deal with the faster speeds at which other Nasdaq computers allowed the investors to change their minds. In August 2012, the computers of the big HFT firm Knight Capital went berserk and made stock market trades that cost Knight $440 million and triggered the company’s fire sale. In November, the NYSE suffered what was termed a “matching engine outage” and was forced to halt trading in 216 stocks. Three weeks later, a Nasdaq employee clicked the wrong icon on his computer screen and stopped the public offering of shares in a company called WhiteHorse Finance. In early January 2013, BATS announced that, because of some unspecified computer error, it had, since 2008, inadvertently allowed trades to occur, illegally, at prices worse (for the investor) than the National Best Bid and Offer.
Flash Boys: A Wall Street Revolt Page 19
