Flash Boys: A Wall Street Revolt

by Michael Lewis

The other banks all grasped the point of the line but were given pause by the contract Spread required them to sign. This contract prohibited anyone who leased the line from allowing others to use it. Any big bank that leased a place on the line could use it for its own proprietary trading but was forbidden from sharing it with its brokerage customers. To Spread this seemed an obvious restriction: The line was more valuable the fewer people that had access to it. The whole point of the line was to create inside the public markets a private space, accessible only to those willing to pay the tens of millions of dollars in entry fees. “Credit Suisse was outraged,” says a Spread employee who negotiated with the big Wall Street banks. “They said, ‘You’re enabling people to screw their customers.’ ” The employee tried to argue that this was not true—that it was more complicated than that—but in the end Credit Suisse refused to sign the contract. Morgan Stanley, on the other hand, came back to Spread and said, We need you to change the language. “We say, ‘But you’re okay with the restrictions?’ And they say, ‘Absolutely, this is totally about optics.’ We had to wordsmith it so they had plausible deniability.”

Of all the big Wall Street banks, Goldman Sachs was the easiest to deal with. “Goldman had no problem signing it,” the Spread employee said.

Dark pools were another rogue spawn of the new financial marketplace. Private stock exchanges, run by the big brokers, they were not required to reveal to the public what happened inside them. They reported any trade they executed, but they did so with sufficient delay that it was impossible to know exactly what was happening in the broader market at the moment the trade occurred.

If, say, Fidelity wanted to sell a million shares of Microsoft Corp.—so the argument ran—they were better off putting them into a dark pool run by, say, Credit Suisse than going directly to the public exchanges. On the public exchanges, everyone would notice a big seller had entered the market, and the market price of Microsoft would plunge.

they’d save all sorts of money in fees they paid to the public exchanges—by putting together buyers and sellers of the same stocks who came to RBC at the same time. If RBC had some investor who wanted to buy a million shares of Microsoft, and another who wanted to sell a million shares of Microsoft, they could simply pair them off in the dark pool rather than pay Nasdaq or the New York Stock Exchange to do it. In theory this made sense; in practice, not so much. “The problem,” said Brad, “was RBC was two percent of the market. I asked how often we were likely to have buyers and sellers to cross. No one had done the analysis.” The analysis, once finished, showed that RBC, if it opened a dark pool and routed all its clients’ orders into it first, would save about $200,000 a year in exchange fees.

condemning the stock exchanges for allowing “sophisticated high-frequency traders to gain access to trading information before it is sent out widely to other traders. For a fee, the exchange will ‘flash’ information about buy and sell orders for just a few fractions of a second before the information is made publicly available.” That was the first time that Brad had heard the term “flash orders.” To the growing list of mental questions, he added another: Why would stock exchanges have allowed flash trading in the first place?

Someone out there was using the fact that stock market orders arrived at different times at different exchanges to front-run orders from one market to another.

The online broker TD Ameritrade, for example, was paid hundreds of millions of dollars each year to send orders to high-frequency trading firms, including one called Citadel, which executed a large number of orders on TD Ameritrade’s behalf. Why were these companies willing to pay so much to see the flow? No one could say with certainty.

“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.”

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.