Flash Boys: A Wall Street Revolt (7 page)

It had been hard to measure the cost of the new market structure. But now there was a tool for gauging not just how orders reached their destination but also how much money this new Wall Street intermediation machine was removing from the pockets of investors large and small: Thor. Brad explained to Mike Gitlin how his team had placed big trades to measure how much more cheaply they bought stock when they removed the ability of the machine to front-run them. For instance, they bought 10 million shares of Citigroup, then trading at roughly $4 per share, and saved $29,000—or less than a tenth of 1 percent of the total price. “That was the tax,” said Rob Park. It sounded small until you realized that the average daily volume in the U.S. stock market was $225 billion. The same tax rate applied to that sum came to more than $160 million a day. “It was so insidious because you couldn’t see it,” said Brad. “It happens on such a granular level that even if you tried to line it up and figure it out you wouldn’t be able to do it. People are getting screwed because they can’t imagine a microsecond.”

Thor showed you what happened when a Wall Street firm helped an investor to avoid paying the tax. The evidence was indirect but, to Gitlin’s mind, damning. The mere existence of Brad Katsuyama was totally shocking. “To have RBC have the foremost electronic trading expert in the world was a little strange,” said Gitlin. “You would not think that is where the world’s foremost electronic expert would reside.”

The discovery of Thor was not the end of a story; it was closer to a beginning. Brad and his team were building a mental picture of the financial markets after the crisis. The market was now a pure abstraction. It called to mind no obvious picture to replace the old one that people still carried around in their heads. The same old ticker tape ran across the bottom of television screens—even though it represented only a tiny fraction of the actual trading. Market experts still reported from the floor of the New York Stock Exchange, even though trading no longer happened there. For a market expert truly to get inside the New York Stock Exchange, he’d need to climb inside a tall black stack of computer servers locked inside a cage locked inside a fortress guarded by a small army of heavily armed men and touchy German shepherds in Mahwah, New Jersey. If he wanted an overview of the entire stock market—or even the trading in a single company like Intel—he’d need to inspect the computer printouts from twelve other public exchanges scattered across northern New Jersey, plus records of the private dealings that occurred inside the growing number of dark pools. If he tried to do this, he’d soon learn that there actually was no computer printout. At least no reliable one. No mental picture existed of the new financial market. There was only this yellowing photograph of a market now dead that served as a stand-in for the living.

Brad had no idea how dark and difficult the picture he’d create would become. All he knew for sure was that the stock market was no longer a market. It was a collection of small markets scattered across New Jersey and lower Manhattan. When bids and offers for shares sent to these places arrived at precisely the same moment, the markets acted as markets should. If they arrived even a millisecond apart, the market vanished, and all bets were off. Brad knew that he was being front-run—that some other trader was, in effect, noticing his demand for stock on one exchange and buying it on others in anticipation of selling it to him at a higher price. He’d identified a suspect: high-frequency traders. “I had a sense that the problems are being caused by this new participant in the market,” said Brad. “I just didn’t know how they were doing it.”

By late 2009 U.S. high-frequency trading firms were flying to Toronto with offers to pay Canadian banks to expose their customers to high-frequency traders. Earlier that year, one of RBC’s competitors, the Canadian Imperial Bank of Commerce (CIBC), had sublet its license on the Toronto Stock Exchange to several high-frequency trading firms and, within a few months, had seen its historically stable 6–7 percent share of Canadian stock market trading triple.
†
Senior managers at the Royal Bank of Canada were now arguing that the bank should create a Canadian dark pool, route their Canadian customers’ stock market orders into it, and then sell to high-frequency traders the right to operate inside the dark pool. Brad thought that it made a lot more sense for RBC simply to expose the new game for what it was, and perhaps establish themselves as the only broker on Wall Street not conspiring to screw investors. “The only card left to play was honesty,” as Rob Park put it.

Brad argued to his bosses that he should be permitted to launch what amounted to a public information campaign. He wanted to go out and explain, to anyone with money to invest in the United States stock markets, that they were now the prey. He wanted to tell them about this new weapon they might use to defend themselves from the predator. But the market was already pressuring him to say nothing at all. He was in a race to win a debate in front of RBC’s top management about how to respond to the newly automated stock markets. All he had going for him was his weird discovery, which proved . . . what, exactly? That the stock market now behaved strangely, except when it didn’t? The RBC executives who wanted to join forces with high-frequency traders knew as little about high-frequency trading as he did. “I needed someone from the industry to verify that what I was saying was real,” said Brad. He needed, specifically, someone from deep inside the world of high-frequency trading. He’d spent the better part of a year cold-calling strangers in search of an HFT strategist willing to defect. He now suspected that every human being who knew how high-frequency traders made money was making too much money doing it to stop and explain what was going on. He needed to find another way in.

_____________

*
In the room was, among other people, Zvi Goffer, who was later sentenced to ten years in jail for orchestrating an insider trading ring in his prior job, with the Galleon Group.

†
The rules of the Canadian stock market are different from the rules of the U.S. stock market. One rule in Canada that does not exist in the United States is “broker priority.” The idea is to enable brokerage firms that have both sides of a trade to pair off buyers and sellers without the interference of other buyers and sellers. For example, imagine that CIBC (representing some investor) has a standing order to buy shares in Company X at $20 a share, but that it is not alone, and several other banks also have standing orders for Company X’s shares at $20. If CIBC then enters the market with an order from another CIBC customer to sell shares in Company X at $20, the CIBC buyer has priority on the trade and is the first to have his order filled. By allowing high-frequency traders to operate with CIBC’s license, CIBC was, in effect, creating lots of collisions between its own customers and the HFT firms.

CHAPTER THREE

RONAN’S PROBLEM

P
art of Ronan’s problem was that he didn’t look like a Wall Street trader. He had pale skin and narrow, stooped shoulders, and the uneasy caution of a man who has survived one potato famine and is expecting another. He also lacked the Wall Street trader’s ability to bury his self-doubt, and to seem more important and knowledgeable than he actually was. He was wiry and wary, like a mongoose. And yet from the moment he caught his first glimpse of a Wall Street trading floor, in his early twenties, Ronan Ryan badly wanted to work on Wall Street—and couldn’t understand why he didn’t belong. “It’s hard not to get enamored of being one of these Wall Street guys who people are scared of and make all this money,” he said. But it was hard to imagine anyone being scared of Ronan.

The other part of Ronan’s problem was his inability or unwillingness to disguise his modest origins. Born and raised in Dublin, he’d moved to America in 1990, when he was sixteen. The Irish government had sent his father to New York to talk American companies into moving to Ireland for the tax benefits, but few imagined that they would do so. Ireland was poor and dreary (“kind of like a shithole, to be honest”). His father, who was not made of money, had spent every last penny he had to rent a house in Greenwich, Connecticut, so that Ronan might attend the Greenwich public high school and see what life was like on the “right side of the tracks.” “I couldn’t believe it,” says Ronan. “The kids had their own cars at sixteen! Kids would complain they had to ride on a school bus. I’d say, ‘This fucking thing actually takes you to school! And it’s free! I used to walk three miles.’ It’s hard not to love America.” When Ronan was twenty-two, his father was recalled to Ireland; Ronan stayed behind. He didn’t think of Ireland as a place anyone would ever go back to if given the choice, and he’d now embraced his idea of the American Dream—Greenwich, Connecticut, version. The year before, through an Irish guy his father had met, he’d landed a summer internship in the back office at Chemical Bank and had been promised a place in the management training program.

Then they canceled the training program; the Irish guy vanished. Graduating from Fairfield University in 1996, he sent letters to all the Wall Street banks but received just one false flicker of interest, from what, even to his untrained eyes, was a vaguely criminal, pump-and-dump penny stock brokerage firm. “It’s not as easy as you think to get a job on Wall Street,” he said. “I didn’t know anyone. My family had no contacts whatsoever. We knew no one.”

Eventually he gave up trying. He met another Irish guy who happened to work in the New York office of MCI Communications, the big telecom company. “He gave me a job strictly because I was Irish,” said Ronan. “I guess he had a few charity cases a year. I was one of them.” For no particular reason other than that no one else would hire him, he went to work in the telecom industry.

The first big job they gave him was to make sure that the eight thousand new pagers MCI had sold to a big Wall Street firm were well received. As he was told, “People are really sensitive about their pagers.” Ronan traveled in the back of a repair truck in the summer heat to some office building to deliver the new pagers. He set up his little table at the back of the truck and unpacked the crates and waited for the Wall Street people to come and get their new pagers. An hour into it he was sweating and huffing inside the truck while a line of people waited for their pagers, and a crowd had formed, of guys to whom he’d already given the pagers: pager protestors. “These new pagers
suck
!” and “I hate this fucking pager!” they screamed, as he tried to pass out even more pagers. As he dealt with the revolt, one of the Wall Street firms’ secretaries called him about her boss’s new pager. She was so despondent about the thing that Ronan thought he could hear her crying. “She keeps saying over and over, ‘It’s too big! It’s going to really hurt him! It’s too big! It’s going to really hurt him!’ ” Ronan was now totally confused: How could a pager inflict harm on a grown man? It was a tiny box, an inch by an inch and a half. “Then she tells me he’s a midget, and it would dig into his side when he bent over,” said Ronan. “And that he wasn’t like a normal-sized midget. He was a
really
small dude. And I’m thinking, but I don’t say it because I don’t want her to think I’m a dick,
Why don’t you just strap it onto his back, like a backpack?
”

At that moment, and others like it, many things crossed Ronan’s mind that he did not say. Sizing pagers to little Wall Street people, and being hollered at by big Wall Street people who didn’t like their new gadgets, was not what he’d imagined doing with his life. He was upset he hadn’t found a path onto Wall Street. He decided to make the best of it.

That turned out to be the view that MCI offered him of the entire U.S. telecom system. Ronan had always been handy, but he’d never actually studied anything practical. He knew next to nothing about technology. Now he started to learn all about it. “It’s pretty captivating, when you take the nerdiness out of it, how this shit works,” he said. How a copper circuit conveyed information, compared to a glass fiber. How a switch made by Cisco compared to a switch made by Juniper. Which hardware companies made the fastest computer equipment, and which buildings in which cities contained floors that could withstand the weight of that equipment—old manufacturing buildings were best. He also learned how information actually traveled from one place to another—which was usually not in a straight line run by a single telecom carrier but in a convoluted path run by several. “When you make a call to New York from Florida, you have no idea how many pieces of equipment you have to go through for that call to happen. You probably just think it’s fucking like two cans and a piece of string. But it’s not.” A circuit that connected New York City to Florida would have Verizon on the New York end, BellSouth on the Florida end, and MCI in the middle; it would zigzag from population center to population center; once it got there it would wind in all sorts of crazy ways through skyscrapers and city streets. To sound knowing, telecom people liked to say that the fiber routes ran through “the NFL cities.”

That was another thing Ronan learned: A lot of people in and around the telecom industry were more knowing than knowledgeable. The people at MCI who sold the technology often didn’t actually understand it and yet were paid far better than people, like him, who simply fixed problems. Or, as he put it, “I’m making thirty-five and they’re making a buck twenty and they’re fucking idiots.” He got himself moved to sales and became a leading salesperson. A few years into the job, he was lured from MCI by Qwest Communications; three years later, he was lured from Qwest by another big telecom carrier, Level 3. He was now making good money—a couple of hundred grand a year. By 2005, he also couldn’t help but notice, his clients were more likely than ever to be big Wall Street banks. He spent entire weeks inside Goldman Sachs and Lehman Brothers and Deutsche Bank, figuring out the best routes to run fiber and the best machines to hook that fiber up to. He hadn’t lost his original ambition. At some point on every Wall Street job he had, he’d nose around for a job opening. “I’m thinking: I’m meeting so many people. Why can’t I get a job at one of these places?” Actually, the big banks offered him jobs all the time, but the jobs were never finance jobs. They offered him tech jobs—working in some remote site with computer hardware and fiber-optic cable. There was a vividly clear class distinction between tech guys and finance guys. The finance guys saw the tech guys as faceless help and were unable to think of them as anything else. “They always said the same thing to me: ‘You’re a boxes and lines guy,’ ” he said.