The employees of IEX had risked their careers to attack the conflicts of interest in the stock market. They had refused the easy capital from the big Wall Street banks—to avoid conflicts of interest. To avoid conflicts of interest, the investors who had backed IEX had structured their investments so that they themselves did not personally profit from sending trades onto the exchange: Profits from their investment flowed through to the people whose money they managed. These investors had further insisted on having a stake of less than 5 percent in the exchange, to avoid having even the appearance of control over it. Before IEX launched, Brad had rebuffed an overture from IntercontinentalExchange (known as ICE), the new owners of the New York Stock Exchange, to buy IEX for hundreds of millions of dollars—and walked away from the chance to get rich quick. To align their interests with the broader market’s, IEX planned to lower their fees as their volumes rose—for everyone who used the exchange. And on the day IEX opened for trading, this manager at ING—who had earlier refused to meet with them so that they might explain the exchange to her—was spreading a rumor that IEX had a conflict of interest.**
But then all sorts of bizarre behavior had attended IEX’s arrival in the U.S. stock market. Ronan had gone to a private trade conference—no media, lots of Wall Street big shots. It was the first time he had been invited to the exclusive event, and he intended to lie low. He was outside in the hallway on his way to the bathroom when someone said, “You know, they’re in there talking about IEX.” Ronan returned to the conference room and listened to the heads of several big public U.S. stock exchanges on a panel. All agreed that IEX would only contribute to the biggest problem in the U.S. stock market: its fragmentation. The market already had thirteen public exchanges and forty-four private ones: Who needed another? When it came time for audience participation, Ronan found a microphone. “Hi, I’m Ronan, and I think I went to go take a piss at the wrong time,” he said, and then gave a little speech. “We’re not like you guys,” he concluded. “Or anyone else in the market. We’re an army of one.” He thought he was being calm and measured, but the crowd, by its standards, went wild—which is to say they actually clapped. “Jesus, I thought you were about to throw a punch,” some guy said afterward.
The stock exchanges didn’t like IEX for obvious reasons, the big Wall Street banks for less obvious ones. But the more the big banks sensed that Brad was being regarded by big investors as an arbiter of Wall Street behavior, the more carefully they confronted him. Instead of voicing their own objections to him directly, they would voice objections they claimed to have heard from other big banks. The guy from Deutsche Bank would say that the guy from Citigroup was upset that IEX was telling investors how to tell the banks to route to IEX—that sort of thing. “When I visited, they were all cordial,” said Brad. “It made me feel that the plan was to starve us out.” But without seeming to do so. The day before they’d opened for trading, a guy from Bank of America called Brad and said, Hey, buddy, what’s going on? I’d appreciate it if you’d say we’re being supportive. Bank of America had been the first to receive the documents they needed to connect to the exchange and, on opening day, were still dragging their feet in establishing a connection. Brad declined to help Bank of America out of its jam. “Shame is a huge tactic we have to deploy,” he said.
Nine weeks after IEX launched, it was already pretty clear that the banks were not following their customers’ instructions to send their orders to the new exchange. A few of the investors in the room knew this; the rest now learned. “When we told them we wanted to route to IEX,” one said, “they said, ‘Why would you want that? We can’t do that!’ The phrase ‘squealing pigs’ comes to mind.” After the first six weeks of IEX’s life, UBS, the big Swiss bank, inadvertently disclosed to one big investor that it hadn’t routed a single order onto IEX—despite explicit instructions from the investor to do so. Another big mutual fund manager estimated that, when he told the big banks to route to IEX, they had followed his instructions “at most ten percent of the time.” A fourth investor was told, by three different banks, that they didn’t want to connect to IEX because they didn’t want to pay the $300-a-month connection fee.
Of all the banks that dragged their feet after their customers asked them to send their stock market orders to IEX, Goldman Sachs had offered the best excuse: They were afraid to tell their computer system to do anything it hadn’t done before. In August 2013, the Goldman automated trading system generated a bunch of crazy and embarrassing trades that lost Goldman hundreds of millions of dollars (until the public exchanges agreed, amazingly, to cancel them). Goldman wanted to avoid giving new instructions to its trading machines until it figured out why they had ceased to follow the old ones. There was something about the way Goldman had treated Brad when he visited their offices—listening to what he had to say, bouncing him up the chain of command rather than out the door—that led him to believe their excuse. He sensed that they were taking him seriously. After his first meeting with their stock market people, for instance, Goldman’s analysts had told the firm’s clients that they should be more wary of investing in Nasdaq Inc.
The other banks—Morgan Stanley and J.P. Morgan were the exceptions—were mostly passive-aggressive, but there were occasions when they became simply aggressive. Employees of Credit Suisse spread rumors that IEX wasn’t actually independent but owned by the Royal Bank of Canada—and so just a tool of a big bank. One night, in a Manhattan bar, an IEX employee bumped into a senior manager at Credit Suisse. “After you guys fail, come to me and I’ll give you a job,” he said. “Wait, no, everyone hates your fucking guts, so I won’t.” In the middle of their first day of trading, one of IEX’s employees got a call from a senior executive of Bank of America, who said that one of his colleagues had “ties to the Irish Mafia,” and “you don’t want to piss those guys off.” The IEX employee went to Brad, who just said, “He’s full of shit.” The IEX employee was less sure, and followed the call with a text.
IEX employee: Should I be concerned?
Bank of America employee: Yes.
IEX employee: Are you serious?
Bank of America employee: Jk [Just kidding].
IEX employee: Haven’t noticed any Irish guys following me.
Bank of America employee: Be careful next time you get in your car.
IEX employee: Good thing I don’t own a car.
Bank of America employee: Well, maybe your gf’s car.
Brad also heard what the big Wall Street banks were already saying to investors to dissuade them from sending orders to IEX: It’s too slow. For years, the banks had been selling the speed and aggression of their trading algos, along with the idea that, for an investor, slower always meant worse. They seemed to have persuaded themselves that the new speed of the markets actually helped their clients. They’d even dreamed up a technical-sounding name for an absence of speed: “duration risk.” (“If you make it sound official, people will believe that it’s something you really need to care about,” Brad explained.) The 350-microsecond delay IEX had introduced to foil the stock market predator was roughly one-thousandth of the blink of an eye. But investors for years had been led to believe that one-thousandth of the blink of an eye might matter to them, and that it was extremely important for their orders to move as fast and aggressively as possible. Guerrilla! Raider! This emphasis on speed was absurd: No matter how fast the investor moved, he would never outrun the high-frequency traders. Speeding up his stock market order merely reduced the time it took for him to arrive in HFT’s various traps. “But how do you prove that a millisecond is irrelevant?” Brad asked.
He threw the problem to the Puzzle Masters. The team had expanded to include Larry Yu, whom Brad thought of as the guy with the box of Rubik’s cubes under his desk. (The standard 3x3-inch cube he could solve in under thirty seconds, and so he kept it oiled with WD-40 to make it spin faster. His cube box held more challenging ones: a 4x4-incher, a 5x5-incher, a giant irregularly shaped one, and so on.) Yu generat
ed two charts, which Brad projected onto the screen for the investors.
To see anything in the stock market, you have to stop trying to see it with your eyes and instead attempt to imagine it as it might appear to a computer, if a computer had eyes. The first chart showed the investors how trading on all public U.S. stock exchanges in the most actively traded stock of a single company (Bank of America Corp) appeared to the human eye over a period of ten minutes, in one-second increments. The activity appears constant, even frantic. In virtually every second, something occurs: a trade or, more commonly, a new buy or sell order. The second chart illustrated the same activity on all public U.S. stock exchanges as it appeared to a computer, over the course of a single second, in millisecond increments. All the market activity within a single second was so concentrated—within a mere 1.78 milliseconds—that on the graph it resembled an obelisk rising from a desert. In 98.22 percent of all milliseconds, nothing at all happened in the U.S. stock market. To a computer, the market in even the world’s most actively traded stock was an uneventful, almost sleepy place. “Yes, your eyeballs think the markets are going fast,” Brad said. “They aren’t really going that fast.” The likelihood an investor would miss out on something important in a third of a millisecond was close to zero, even in the world’s most actively traded stock. “I knew it was bullshit to worry about milliseconds,” said Brad, “because if milliseconds were relevant, every investor would be in New Jersey.”
“What’s the spike represent?” asked one of the investors, pointing to the obelisk.
“That’s one of your orders touching down,” said Brad.
A few investors shifted in their seats. It was growing clear to them, if it wasn’t already so, that, if the stock market was the party, they were the punch bowl. They were unlikely to miss any action as the result of a delay of one-third of a millisecond. They were the reason for all the action! “Every time a trade happens at the exchange, it creates a signal,” said Brad. “In the fifty milliseconds running up to it—total silence. Then there is an event. Then there is this massive reaction. Then a reaction to that reaction. The HFT algos on the other side are predicting what you’ll do next based on what you just did.” The activity peaked roughly 350 microseconds after an investor’s order triggered the feeding frenzy, or the time it took for HFT to send its orders from the stock exchange on which the investor had touched down to all of the others. “Your eye will never pick up what is really happening,” said Brad. “You don’t see shit. Even if you’re a fucking cyborg you don’t see it. But if there was no value to reacting, why would anyone react at all?” The arrival of the prey awakened the predator, who deployed his strategies—rebate arbitrage, latency arbitrage, slow market arbitrage. Brad didn’t need to dwell on these; he’d already walked each of the investors through his earlier discoveries. It was his new findings that he wanted them to focus on.††
On IEX’s opening day—when it had traded just half a million shares—the flow of orders through its computers had been too rapid for the human eye to make sense of it. Brad had spent the first week or so glued to his terminal, trying to see whatever he could see. Even that first week, he was trying to make sense of lines scrolling down his computer screen at a rate of fifty per second. It felt like speed-reading War and Peace in under a minute. All he could see was that a shocking number of the orders being sent by the Wall Street banks to IEX came in small 100-share lots. The HFT guys used 100-share lots as bait on the exchanges, to tease information out of the market while taking as little risk as possible. But these weren’t HFT orders; these were from the big banks. At the end of one day, he asked for a count of one bank’s orders: 87 percent of them were in these tiny 100-share lots. Why?
The week after Brad had quit his job at the Royal Bank of Canada, his doctor noted that his blood pressure had collapsed to virtually normal levels, and he’d cut his medication in half. Now, in response to this new situation he couldn’t make sense of, Brad had migraines, and his blood pressure was again spiking. “I’m straining to see patterns,” he said. “The patterns are being shown to me, but my eyes can’t pick them up.”
One afternoon, an IEX employee named Josh Blackburn overheard Brad mention his problem. Josh was quiet—not just reserved, but intensely so—and didn’t say anything at first. But he thought he knew how to solve the problem. With pictures.
Josh, like Zoran, traced his career back to September 11, 2001. He’d just started college when a friend messaged him to turn on the TV, and he’d watched the Twin Towers collapse. “When that happened it was kind of a what can I do moment?” A couple of months later, he’d gone to the local air force recruiting center and attempted to enlist. They’d told him to wait until the end of his freshman year. At the end of the school year he’d returned. The air force sent him to Qatar, where a colonel figured out that he had a special talent for writing computer code; one thing led to another, and two years later he was in Baghdad. There he created a system for getting messages to all remote units, and another system for creating a Google-like map, before the existence of Google maps. From Baghdad he’d gone to Afghanistan, where he wound up being in charge of taking the data from all the branches of the U.S. military across all battlefields and turning it into a single picture the generals could use to make decisions. “It told them everything that was going on, real-time, on a twenty-foot wall map,” Josh said. “You could see trends. You could see origins of rocket attacks. You could see patterns in when they occurred—the attacks on [U.S. Army base] Camp Victory would come after afternoon prayer. You could see what the projections were [of where and when the attacks might occur] and how they compared to where attacks actually happened.” The trick was not simply to write the code that turned information into pictures but to find the best pictures to draw—shapes and colors that led the mind to meaning. “Once you got all that stuff together and showed it in the best way possible, you could find patterns,” Josh said.
The job was hard to do, but, as it turned out, harder to stop doing. When his first tour of duty was up, Josh reenlisted, and when that tour ended, he re-upped again. When his third tour was over, he saw the war winding down and his usefulness diminish. “You find it very difficult to come home from,” said Josh. “Because you see the impact of your work. After that, I couldn’t find any passion in anything I did, any meaning.” Coming home, he looked for a place to deploy his skill—and a friend in finance told him about an opening in a new high-frequency trading firm. “In the war, you’re trying to use the picture you create to take advantage of the enemy,” said Josh. “In this case, you’re trying to take advantage of the market.” He worked for the HFT firm for six weeks before it failed, but he found the job unsatisfying.
He’d come to IEX in the usual way: John Schwall had found him while trolling on LinkedIn and asked him to come for an interview. At that point, Josh was being inundated with offers from other high-frequency trading firms. “There was a lot of ‘we are elite,’ ” he said. “They kept hitting the elite thing.” He didn’t care all that much about being elite; he just wanted his work to mean something. “I came in for an interview on Friday. Saturday they made me an offer. Brad said, we’re going to change the way things work. But I didn’t really know what Brad was talking about.” Since joining, he’d been quiet and had put himself where he liked to be, in the background. “I just try to take in what people are saying, and listen to what everyone is complaining about,” he said. “I wish this or I wish that, and then bring it together and find the solution.”
Brad knew little of Josh’s past—only that whatever Josh had done for the U.S. military sounded like the sort of thing he couldn’t talk about. “All I knew was that he was in a trailer in Afghanistan, working with generals,” said Brad. “When I tell him my problem—that I couldn’t see the data—he just says, ‘Hit Refresh.’ ”
Quietly, Josh had gone off and created for Brad pictures of the activity on IEX. Brad hit Refresh; the screen was now organized in different shapes and co
lors. The strange 100-lot trades were suddenly bunched together and highlighted in useful ways: He could see patterns. And in the patterns he could see predatory activity neither he nor the investors had yet imagined.
These new pictures showed him how the big Wall Street banks typically handled investors’ stock market orders. Here’s how it worked: Say you are a big investor—a mutual fund or a pension fund—and you have decided to make a big investment in Procter & Gamble. You are acting on behalf of a lot of ordinary Americans who have given you their savings to manage. You call some broker—Bank of America, say—and tell them you’d like to buy 100,000 shares of Procter & Gamble. P&G’s shares are trading at, say, 82.95–82.97, with 1,000 shares listed on each side. You tell the big Wall Street bank you are willing to pay up to, say, $82.97 a share. From that point on, you basically have no clue how your order—and the information it contains—is treated. Now Brad saw: The first thing the broker did was to ping IEX with an order to buy 100 shares, to see if IEX had a seller. This made total sense: You didn’t want to reveal you had a big buyer until you found a seller. What made a lot less sense was what many of the brokers did after they discovered the seller. They avoided him.
Say, for example, that IEX actually had a seller waiting on it—a seller of 100,000 shares at $82.96. Instead of coming in and trying to buy a much bigger chunk of P&G, the big bank just kept pinging IEX with tiny 100-share orders—or the bank vanished entirely. If the bank had simply sent IEX an order to buy 100,000 shares of P&G at $82.97, the investor would have purchased all the shares he wanted without driving up the price. Instead, the bank had pinged away and—by revealing its insistent, noisy demand—goosed up the price of P&G’s stock, at the expense of the investor whose interests the bank was meant to represent. Adding to the injury, the bank typically wound up with only a fraction of the stock its customer wanted to buy. “It opened up this whole new realm of activity that was crazy to me,” Brad told his audience. It was as if the big Wall Street banks were looking to see if IEX had a big seller to avoid trading with him. “I thought, Why the hell would anyone do this? All you do is increase the chances that an HFT will pick up your signal.”
Flash Boys: A Wall Street Revolt Page 21
