Flash Boys: A Wall Street Revolt (23 page)

“What if they [investors] send us their trade orders and we check them to see if they ever got here?” asked Rob Park sensibly.

“We can’t,” said Don. “It violates our confidentiality agreement with brokers.”

True. An investor might hand Bank of America an order and ask the Bank of America broker to route it to IEX. The investor might also ask that IEX be permitted to inform him of the outcome. And yet Bank of America might refuse, on principle, to allow IEX to inform the investor that they had followed his instructions—on the grounds that doing so would reveal Bank of America’s secrets!

“Why can’t we just publish what happened?” asked Ronan.

“It’s the banks’ information,” said Don.

“We can’t publish what happened to an investor’s trade because what happened to the investor is Goldman Sachs’s information?” Ronan was incredulous—but then he knew less about this than the others.

“Correct.”

“What can they do to us if we do it—shut us down?”

“Probably just a slap on the wrist the first time,” said Don.

Brad wondered aloud if it was possible to create a mechanism through which investors might be informed, in real time, where their brokers sent their stock market orders. “Like a security camera,” he said. “You don’t care if it’s even turned on. Just the fact that it’s there might alter behavior.”

“It’s a finger in the eye of the brokerage community,” said Don. He wore a t-shirt that said I Love Aquatic Life, and tossed a rugby ball to himself, but he didn’t feel as comfortable as he wished to appear. All these other guys had worked at big Wall Street banks; none of them had ever had to deal with those banks as a customer. They didn’t know their market power. As Don later put it, “The brokers, if they all decide to hate us, we’re fucked. End of story.” He didn’t put it so bluntly to the others, maybe because he sensed that they all knew it.

“It’s like saying, ‘I think people are stealing in this office,’ ” said Brad, with growing enthusiasm. “I can run in and run out and run in and run out and keep checking and try to catch someone. Or I can install a camera. It may be plugged in—or not. But there’s still this camera. And whoever is fucking stealing my coffee pots won’t know if it’s on.”

“We don’t really give a fuck if the investors use it,” added Ronan. “We just want the brokers scared they’ll check.”

Somewhere in the big room a phone rang, and the sound was as jolting as a car honking in a small town in the middle of the night. The room was an open pit, with no barriers between the people in it, but the young men inside it behaved as if they worked with walls around them. They were, all but one, young men. The exception, Tara McKee, had been a research associate at RBC until Brad found her, in 2009, and asked her to be his personal assistant. (“The first time I met him, I said, ‘I don’t care what I do—I just want to work for him.’ ”) She’d followed him out when he left the bank, even after he tried to talk her out of it, as he couldn’t pay her properly and didn’t think she could tolerate the risk. The cast of technologists Brad had assembled at this new place Tara found even more peculiar than the one he’d put together at RBC. “For geniuses, they are really dumb,” she said. “Some of them are really pampered: They can’t even put together a cardboard box. They don’t think you do something. They think you call somebody.”

They were also amazingly self-contained. This meeting concerned them all—compelling the big Wall Street banks’ cooperation might mean the difference between success and failure—but they all at least feigned indifference. The etiquette here was a kind of willed incuriosity—even about each other. “Communication with a lot of the guys is not that great,” said Brad. “It’s something we need to work on.” It was funny. To a man, they were puzzle solvers, and yet, to each other, they remained unsolved puzzles.

Schwall looked over the desks and shouted, “Whose phone is that?”

“Sorry,” someone said, and the ringing stopped.

“It’s a
nanny
,” said Don, of Brad’s security camera idea. “It’s demeaning. It could be a strain on the relationship.”

“When you get patted down in the airport, do you hate the people who pat you down?” asked Brad.

“I fuckin’ hate them,” said Don.

“I say, ‘I’m glad you’re checking my bags, because that means you’re checking other people’s,’ ” said Brad.

“The problem is that everyone is carrying marijuana through the checkpoint,” said Schwall.

“If anyone gets fucking angry it’s because they’re guilty,” said Brad hotly.

“I’m sorry,” said Don. “I’m fat and white and I’m not gonna bomb this airplane. I shouldn’t get extra swabbing.” He’d stopped tossing the rugby ball.

“Is there some use for this other than policing brokers?” asked Schwall. He was asking, “Can we police them without their realizing it?” The person among them most adept at uncovering the secrets of others believed it was possible for IEX to keep its own affairs secret.

“No,” said Brad.

“So it’s a nanny,” said Schwall with a sigh.

“
Broker Nanny
,” said Don. “It’s a great name. Shame we can’t patent it.”

The meeting went quiet. This was just one of a thousand arguments they’d had in designing the exchange. The group was roughly split—between people (Ronan and, to a lesser extent, Brad) who wanted to pick a fight with the biggest Wall Street banks, and people who thought it was insane to pick that fight (Don and, to a lesser extent, Schwall). Rob and Matt hadn’t yet come clean, but for different reasons. After his initial suggestion had been swatted away, Rob had gone silent. “Rob is farthest from the chaos,” said Brad. “He doesn’t meet with brokers. The solutions to the problems they [the Wall Street brokers] create are illogical because they solve a problem that is illogical.”

Matt Trudeau, also quiet, often tended to step back and observe. “I’ve always felt a little outside the groups of people I hung around with,” he said. He was a natural conciliator as well. He may have quit his job on principle, but he didn’t enjoy conflict, even the internal kind. “I might not be jaded enough,” Matt now said carefully. “But let’s say we launch and we’re wildly successful and we never have to roll this out.”

That thought was dead on arrival: No one believed they would be wildly successful the moment they launched—least of all Matt. He knew firsthand what happened when a new exchange opened: nothing. Chi-X Canada was now a huge success—20 percent of the Canadian market—but in its first month it had traded 700 shares total. Entire days passed without a single trade on that exchange; and the next few months weren’t much better. And that was what success looked like. IEX didn’t have the luxury of going months without activity. Their new stock exchange didn’t need to be an instant sensation, but it had to host enough trading to illustrate the positive effects of honesty. They needed to be able to prove to investors that an explicitly fair exchange yielded better outcomes for investors than all the other exchanges. To prove the case, they needed data; to generate that data, they needed trades. If the big Wall Street banks colluded to keep trades off IEX, the new exchange would be stillborn. And they all knew it.

“They’re gonna be pissed,” said Schwall finally.

“We’re in a fight,” said Brad. “If every client felt like their instructions were being followed, we wouldn’t be having this discussion. It’s not about IEX wanting to go punch some broker in the face for no reason. It’s not about saying, ‘Who is our enemy?’ It’s about saying who we are aligned with. We’re aligned with the investor.”

“They’re still gonna be pissed,” said Schwall.

“Are we really in the police business?” asked Don.

“Maybe we don’t have to have it at all,” added Schwall. “Maybe we just have to create the illusion we have it. We talk to the buy side about having it, and they whisper to their brokers—that might be enough.”

“But they’ll all know,” said Don. “They know we have to keep the brokers’ junk private. And the broker has to keep the clients’ junk private. And the client can’t opt out.”

Brad offered one last idea: a chat room in which investors could converse with their brokers as the trade was happening. “Or they can always get their broker on the phone and say, ‘Tell me what the fuck is going on,’ ” he said. “It’s always been a solution.”

“They’ve never done it,” said Ronan.

“They’ve never been motivated to do it,” said Matt. True: Investors had never been given a compelling reason to favor one stock exchange over another.

“You get Danny Moses in a chat room with Goldman,” said Brad, referring to the head trader at Seawolf. “He’ll ask them.”

“But Danny’s a bit argy-bargy,” said Ronan.

“
Argy-bargy,
I like that,” said Don.

Ronan had been teaching Don Irish epithets, one at a time. “You got
wanker
.
Tosser
. Now you got
argy-bargy
,” said Ronan.

“You do nothing, and everyone does what they want,” said Brad. “You do something and you can influence behavior. But, by creating the tool, do we incentivize behavior we want to eliminate? By shining the light, do we create a gray zone, just outside the light? Is it like Reg NMS, where you create the very thing you’re trying to get rid of?”

“Shining a light creates shadows,” said Don. “If you try to create this bright line, you are going to create gray zones on either side.”

“If we sincerely believe it creates too many blind spots, we might not want to do it,” said Brad.

“If we bill it as a nanny and she’s drunk on the couch, are we gonna look like assholes?” added Don. “Better not to have a nanny at all. Just leave the kids home alone.”

“If you can think of any other possible use for this fucker, that would help,” said Schwall, who clung to his hope that they might disguise their actions. That they might be secret cops.

“I’m less bullish on this than I was before,” said Brad. “I’ll be honest. Because a drunk nanny might not be better than no nanny at all.”

“How drunk can a nanny get?” asked Ronan idly.

Brad tossed the marker back into the whiteboard bin. “You can see why the client has been left in the dust,” he said. “The system is designed to leave the client in the dust.” Then he turned to Don. “At Nasdaq did they talk about this?”

“No,” said Don, leaning back against the window.

For a moment, Brad looked at Don, and at the view that he only partly concealed. In that moment, he might as well have been, not on the inside of his new exchange looking out, but on the outside looking in. How did they seem to others? To the people
out there
? Out there, where the twin symbols of American capitalism once loomed, reduced in a few hours to a blizzard of office memos and a ruin. Out there, where idealism was either a ruse or a species of stupidity, and where the people who badly needed them to succeed hadn’t the faintest idea of their existence. But out there a lot of things happened. People built new towers to replace the old ones. People found strength they didn’t know they had. And people were already coming to their aid, and bracing for the war. Out there, anything was possible.

_____________

*
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
.