Revisiting ‘Flash Boys’12.06.2017 By John D'Antona
The Holy Bible. To Kill a Mockingbird. The Grapes of Wrath. These are some of humankind’s greatest works of writing.
And then there is The Wealth of Nations, The General Theory of Employment, Interest and Money and Liar’s Poker, some of Wall Street’s most revered manuals. And then there is Flash Boys: A Wall Street Revolt by Michael Lewis. The 179-page tome published in March 2014, was profiled in a 60 Minutes news story that was the talk of Wall Street the following morning. It shook the high-speed trading community to its very core.
Not even author Michael Lewis envisioned the effects his book would have. In a Vanity Fair article where he himself admits to spending several years trying to understand the machinations of the equities market, he profiled “an obscure 35-year-old trader at the Royal Bank of Canada named Brad Katsuyama,” and others too. “They were all well-regarded professionals in the U.S. stock market. The situation was that they no longer understood that market. And their ignorance was forgivable. It would have been difficult to find anyone, circa 2009, able to give you an honest account of the inner workings of the American stock market—by then fully automated, spectacularly fragmented, and complicated beyond belief by possibly well-intentioned regulators and less well-intentioned insiders. That the American stock market had become a mystery struck me as interesting. How does that happen? And who benefits?”
Flash Boys documents and chronicles Katsuyama and his colleagues as they eventually figured out that market complexity, though it may have arisen innocently enough, served the interest of financial intermediaries rather than the investors and corporations the market is meant to serve. “It had enabled a massive amount of predatory trading and had institutionalized a systemic and totally unnecessary unfairness in the market and, in the bargain, rendered it less stable and more prone to flash crashes and outages and other unhappy events.”
Having understood the problems, Katsuyama and his colleagues had set out not to exploit them but to repair them. “That, too, I thought was interesting: some people on Wall Street wanted to fix something, even if it meant less money for Wall Street, and for them personally.”
Some thought the book was nothing more as an advertisement for Katsuyama and his at the time nascent ATS, IEX, which would eventually become a public stock exchange. Others saw it as an expose’ into the greed of Wall Street and its collective contempt for Main Street. Some saw it as an attack on the newest electronic traders – the high-frequency trader – who were out to undermine all of the finance world by executing hundreds of tiny trades by flooding the exchanges with millions of simultaneous orders and cancellations.
David Weisberger, founder of CoinRoutes, told Traders Magazine that he felt ‘Flash Boys’ was a poorly researched, over sensationalized book with enough facts sprinkled in to make it believable by a generation of traders that had been disenfranchised by technology.
Lewis “did not talk to any of the leading operators of smart order routers such as myself at Lava/Citi, Joe Wald at Knight/Edge Trade, Jose Marques at Pathfinder at Credit Suisse or he would have found out that parallel routing that didn’t create gaps was important in situations where clients wanted to buy or sell a high percentage of the displayed quantity.”
Weisberger continued that the work was sensationalized, because, despite not one corroborating piece of evidence or any data to support it, his claims about retail investors being disadvantaged were false.
And what about the ‘sprinkled facts’?
“Because it was true that poorly built routers would have leaked information, but the real problem was (and is) sequential routing that looks for low cost venues which leak a lot of information and often results in quotes fading away,” Weisberger said. “This is notable because no speed bump less than milliseconds would do a thing to help with that.”
Weisberger doesn’t pull any punches. But he did admit the tome did illuminate a business that was only known to Main Street courtesy of Oliver Stone and 20th Century Fox back in 1987.
“Flash Boys, faults aside, did bring needed scrutiny on practices of brokers and exchanges,” he began. “It made market structure interesting to many people, which had the effect of stimulating a lot of productive dialogue. It also, ironically, helped blunt the force of public opinion against dark pools since IEX, who became public heroes as a result of the book, started as a dark pool and still is mostly a dark pool. Finally, it must also be said that, while Flash Boys did increase scrutiny on market structure, it also provided a ready excuse for poor performance to active managers which never bothered to invest in quantitative technology or market structure research in the first place.”
“One thing I think we all can agree on is that Michael Lewis is an excellent author,” began Joe Saluzzi, partner and co-founder at Themis Trading. “Michael has a unique talent of taking a very complicated financial subject and breaking it down into a narrative which a reader without a financial background can understand. He did that with “The Big Short” and he did that again with “Flash Boys.” While I personally prefer “Broken Markets” written by Sal Arnuk and myself, I thought “Flash Boys” did a great job exposing the problems associated with our modern equity market structure.”
Saluzzi told Traders Magazine that while IEX and Brad Katsuyama were the primary subjects of the novel, there was the bigger takeaway in that the stock exchanges’ business model – for profit via data sales – was finally exposed.
“While folks who study equity market structure knew for years that the exchanges were in the business of selling market data, most average investors had no idea that exchanges were making millions of dollars by doing things like renting out rack space in their colocation centers to give high frequency traders a speed edge,” Saluzzi said.
So, if ‘Flash Boys’ was the revelation the marketplace was waiting for, Saluzzi was overjoyed, as he too was happy to see Main Street finally see how Wall Street worked.
“As Judge Brandeis once said, “Sunlight is the best disinfectant.“ The public and policy makers needed to know how the stock market really operates,” Saluzzi said. “While we at Themis Trading have been screaming from the rooftop for years now to get this message out, it took a book by Michael Lewis to finally get the attention of the average investor and some policy makers. This extra attention has forced regulators to step up their game and the result has been that the exchanges have started to clean up their act.”
Saluzzi pointed to the fact that for years Nasdaq allowed post-only orders to leak information about hidden orders. This practice finally stopped this year. “Would they have done that without the extra regulatory attention since “Flash Boys” was published?” Saluzzi thinks not.
Looking back, Saluzzi said he and his firm felt vindicated by ‘Flash Boys” as it had reiterated many points his own firm had been saying for years but with little attention outside Wall Street.
“Our goal has always been to deliver the best execution possible for our institutional clients and along the way we kept uncovering conflicts of interest with the modern equity market structure. ‘Flash Boys’ was able to expose some of these issues to a much larger audience,” Saluzzi said.
A lack of volume growth and existential questions are big-picture concerns.
OMS-EMS integration, transparency, and research integration are predicted.
Some market participants would say it has felt more like 100 years.
Innovation and regulation have redefined financial technology.
FactSet executives opine on what has changed -- and what has stayed the same.