Elevated Threat

by William Robson

  There have been plenty of previous ominous warnings of what could happen if the HFT machines and their computerized siblings were left unchecked by the regulators. There was the flash crash of 2010, Apple’s infamous one-day plunge, and, of course, the AP Hacking scandal that cost the DOW 113 points in mere minutes. Each event demonstrated what could happen if HFT trading ran amuck. All it took for the AP’s hacking scandal to send the DOW spiraling down was for a Syrian hacker team to take over the Associated Press’s Twitter feed and falsely claim that a bomb had gone off in the White House. Despite numerous calls by Congress to get regulations placed on the automated high volume trading platforms which are now ubiquitous in industry, and the inability for Congress to agree on anything coupled with the money the machines generated for Wall Street firms, guaranteed they would never be properly controlled.

  These HFT systems were all designed to make their firms and clients the most money available at the quickest possible speed. It never occurred to the regulators what could happen if a HFT system was built to intentionally lose money.

  June 5, 2015

  Chicago, Illinois

  The testing and certifications had been completed. There were only three days left before Monday’s first operational trades from Chicago’s newest and largest brokerage firm, GSX HVT Partner Group, would be commencing. Chicago is the third largest exchange outside of New York City and even there, no one had seen anything like GSX HVT’s massive trading capability. The GSX HVT team had spared no expense to be the fastest and most active high-frequency trader in Chicago’s history.

  Having a speed advantage with the stock and commodities markets is like being able to print money. Tiny fractions of a second can mean the difference between a push and making money on a trade. The brokerage firms located in Chicago are willing to pay hundreds of millions of dollars to speed up their communication with New York. When the GSX HVT Partner Group announced to its potential customers that they could guarantee them a 250 millisecond advantage, Chicago’s biggest financial players started signing up. All the brokerages were salivating at the thought of the money they would start to be making this Monday.

  The technology that the GSX HVT Partner Group utilized to increase the decision and trading speed came partially from its very high computing power with its efficient use of a new type of high-speed output ports. However, the bulk of the speed gain came from a newly developed fiber optic cable and the shorter route they were able to acquire to the exchanges in New York.

  The new hollow-core photonic crystal fiber optic cable could send a signal at 99.7% the speed of light, and the more direct route they were able to acquire between Chicago and New York had cut 97 miles off of the distance used by their nearest competitor. Negotiating the rights for the cable’s pathway had taken almost two years to complete along with untold amounts of graft to local politicians and land owners. But starting Monday, those millions spent to get it all in place would start to pale in comparison to the money that would be rolling in on every transaction their new masterpiece created.

  Some of the inner workings of the GSX HVT system were in many ways quite ordinary, at least to the handful of companies that produced such things. The exchange’s API’s had been established years ago and were in use by every other brokerage firm. Even the industry standard COTS operating system had only required minor modifications to enhance certain processes unique to GSX.

  But the “Kings Treasure” of the GSX HVT package of software was found in the SEDR module. The SEDR module was a 100% custom designed software package provided to the GSX HVT Partners by the AntiMay Corporation in Florida. SEDR included a completely new type of search engine that searched the world for pertinent information and then fed what it found to the decision engine. The decision engine consisted of a complicated algorithm that would decide what the information meant to the financial portfolios it controlled and it would then generate the trade requests that would bring the best return. The SEDR system was capable of collecting and processing Peta-bytes of information, and the system commands could be generated at speeds that even Cray supercomputers would be proud of.

  The GSX HVT system, using the SEDR engine, was capable of knowing if a finance minister in Abu Dhabi sold his gold and defected, or if a train full of potatoes had derailed in Iowa, and it would instantaneously adjust the firm’s portfolios. Money would be made for its owners when world events went well or badly. And money would be made when world events went badly, and money would be made even if nothing in the world changed.

  Unlike the commonly used hardware and the standard COTS Operating system that the GSX HVT system used, virtually every detail about the SEDR’s software was a mystery to everyone outside of the AntiMay Corporation. The SEDR engineers had only provided the GSX HVT testing team, and the federal regulators, a package of black box test programs to verify that the SEDR module would pass the required regulations. The GSX HVT owners were not happy with the secrecy that the SEDR management team insisted on, but when they saw the results from a private demonstration of the system, their concerns over security were quickly replaced with greed. Visions of the hundreds of millions of dollars that SEDR promised started dancing in the corporate big shots heads. Who needs to look at a bunch of code anyway?

  Even the government SEC certification watchdogs had to fight to get each and every bit of information from the AntiMay Corporation in Florida, and they were not happy about it. Still, the SEDR software did pass the government’s certification tests, and after endless lobbying by GSX HVT owners and all the Chicago politicians on their payroll, the government watchdogs were eventually convinced that SEDR had met all the federal standards and agreed to a license to execute a test run.

  The GSX HVT system with the SEDR module was approved by the feds for a two-month trial in April. During the extensive testing, it never failed a single test. Despite the secrecy, the GSX HVT system was given the green light by the feds to begin active trading on June 9, 2015. To the outside world, SEDR was just a big black box. A big black box that would soon make history.

  June 8, 2015

  Sammamish, Washington

  4 AM PST

  Terry was out of the house and heading for his office long before the sun was ready to light the way for him, even though by May in Sammamish the days are over fourteen hours long. Being a top-notch financial analyst and stock broker on the West Coast meant he had to keep in tune with the markets on the other coast mighty early. Doing so requires having a strong enough constitution to push yourself to reach for that first cup of Joe well before the neighbors have pulled their heads from their pillows. Despite welcoming the sun in this same way for nearly fifty years in the business, the early morning drives to the office still did not come any easier for Terry.

  There are not many businesses where the technology used to run them has changed as much as in the brokerage business. The majority of the brokers that began working in the business when Terry started had long given up the chase of keeping up with the relentless changes. Most of the old timers have long since retired on the half-percent commissions they had made on countless trades. But to Terry, the thrill of finding those hidden half-percents, which were just waiting for someone smart enough to find them, kept him in the chase. Retirement for Terry only meant taking off work a little early on Fridays so that he could hang out with his friends at the local casino. His retirement meant enjoying a sumptuous salmon fillet along with a glass of high-end 18-year-scotch. But come Monday, Terry’s fight with the sun to see who would get up the earliest would resume once again.

  It wasn’t until Terry was on his third cup of coffee that any hint of the surprises the day would bring began to appear on his radar. Unlike many of his peers, Terry had kept up with the technology trends in his business, and he utilized several automated programs to help him monitor the financial market for any unusual activity. When one of these watchdogs found something unusual, they would send him an email alert so he could investigate the issue. The first suc
h alert email Terry received was now warning him that the Vanguard 500 fund was starting to exhibit some strange volatility.

  Most of the time, these alerts were the result of some information that had become available to the various HFT systems that were not yet available to the public. The machines would trigger a mass movement of options based on the information causing a stock or index to fluctuate. There was no way to beat the machines speed on the initial movements, but the auto-generated email alerts of the changes at least gave Terry the ability to react to them before the less sophisticated brokers had a chance to. Terry liked to say that the HFT machines always left some crumbs behind for him to forage on.

  7:37 AM PST

  The Vanguard 500 fund had floated right between $147 and $150 for some weeks now, but even as Terry was still investigating the email about it, it suddenly dropped to $142, then to $140. One of the market’s most stable funds had experienced a 6.67% drop in value within minutes. Terry knew something big was happening, and quickly. He also knew he needed to get in front of it to protect his clients’ money.

  7:42 AM PST

  Before Terry had time to pinpoint what exactly had happened to the Vanguard 500, he received a second alert email. This time the warning was for the Fidelity Magellan fund. This fund had not ventured below $80 in the last quarter, and now it had fallen to $76 and was still diving. Terry couldn’t believe what he was seeing. He started checking other funds and found the same free fall was taking place everywhere he looked. The value of normally stable funds was disappearing before his eyes. Not only were the values dropping but the volume of the trades was staggering.

  The New York Stock Exchange one day volume record was set in Oct 2008 when 7,341,505,961 shares were traded. At the rate of the trades Terry was now seeing, he was sure that this long held record would pale by comparison. What was not as obvious was, what was driving this crazy volume and volatility?

  What Terry could not know, was that the GSX HVT system, supplied with a massive infusion of cash from the Agricultural Development Bank of China and Kala Naft Ltd in Canada, was busy manipulating the options in its control in such a way that they were guaranteed to lose money. Additionally, SEDR had a built-in understanding of the algorithms that were employed in the other HFT systems worldwide. By utilizing its own incredible computing power, transaction speed, and knowledge of how the other trading systems would react, SEDR had the ability to send out just exactly the right signals to the other logic engines, which would convince them the financial world was melting down around them. This in turn, would cause the other systems outside SEDR’s reach to make their own drastic portfolio changes, which in turn enticed the next downstream system to follow the game.

  As the prices continued to drop, the original mouse would just keep spinning its own wheel faster and faster, convincing the followers to do the same. Market values across-the-board would disappear quicker than the human overseers could adjust to the changes.

  To assist the GSX HVT drive the prices down, the SEDR creators had been busy over the last few months spamming out emails with attached zip files from someone named AntiMay. These spammed messages that AntiMay distributed, deposited remote BOT’s onto unsuspecting PC owners around the world. These BOT’s had the capability of sending “news” alerts to numerous websites. All of these dispersed surprise packages were now open and ready for business.

  At 7:45 a.m. the BOT’s started blasting websites with a litany of fake news reports. To assist in the subterfuge, the Associated Press and many of the major news networks were simultaneously hijacked by a team of AntiMay hackers. They were then forced to start reporting stories of gold mining accidents in South Africa, political unrest in Italy, massive earthquakes under Japanese nuclear facilities, a Prime Minister assassination in Britain, and on and on. In a matter of hours, real news, and fake news became indistinguishable to the HFT trading systems we have employed to manage our money.

  Large corporate and private investors were now catching onto the market wind up, and brokers from every corner of the nation were sending in sell orders faster than they could type. The mouse wheel started by SEDR just kept spinning faster.

  When Walter Cronkite told us, “And that’s the way it is,” that was the way it was. Since there were few contrary views, our perception of the world around us, and the reality of the world around us, were one in the same. In today’s world, thanks to social media and 24-hour news, we have acquired the ability to access real-time information from anywhere in the world. But our internal filters, which should be able to separate facts from hearsay, have not kept up. For many people, the perception of the world provided by social media still equates to reality.

  To the trading algorithms in the HFT machines, perception is whatever the news stream says it is, real or not. But unlike humans, they have the power to create a new reality out of that perception by instantly moving vast amounts of money. Thus, if someone were able to control the perception of what these machines see, a dismal form of reality for the investors would follow. SEDR was doing it all at record speeds.

  11:15 AM PST

  The talking heads from all the major network news organizations began breaking into regularly scheduled programs with a breathtaking story of the unprecedented volatility that was occurring in the Chicago and New York trading centers. They all started running video of floor traders frantically running around, waving their hands in a frenzy of undecipherable gestures. Stock values from the start of the day were superimposed over current prices. Red-ink charts were everywhere. When the general public got wind of what was going on, the phone lines to their brokers were jammed.

  The search engines in the HFT computers, scanning the news for information, parsed this new information from the networks as red-flag indicators, such as, unprecedented events and high volatility, which started kicking off another round of algorithm-based trades. The mouse wheel was now in hyperspace.

  11:27 AM PST

  Terry was running out of space on his head for more grey hairs, but now with one hand on his computer making trades and the other holding his now perpetually ringing phone, he knew that new ones would be finding a way to appear. When his computer screen flashed a message directly from the SEC, he had to get his glasses to make sure he was seeing what he thought he was.

  “All trading has been temporarily halted today at 2:24 p.m. EST due to system communication’s problems. Floor trading and all crossing sessions are not expected to resume until 8:00 a.m. Wednesday, June 8.”

  Even with a mind like a steel trap, when it came to the market, Terry could only remember seeing one similar message like this back in June 2005. That closure of the market was for just a few minutes at the very end of the trading day, certainly not for 45 hours like this one.

  Terry slumped back in his chair and briefly toyed with the idea of closing shop and heading off to the casino and putting the craziness of this day behind him. But one look at the incoming phone calls queuing up told him all he needed to know what the rest of his afternoon and evening would be like. Terry learned long ago that the only thing worse to a client than having their health turn bad was when they lost their money. He knew he had a lot of explaining to do to his clients, even if he didn’t really know what he was going to say.

  5:00 PM EST – Washington, DC

  The public was in a panic by the time the President’s speech began. The monitory news from all available sources was packed with doom and gloom. Somehow, the President needed to bring back some semblance of order. The Federal Reserve Chairman was with the President in an attempt to explain what had happened.

  First the President, and then the Federal Reserve Chairman tried their best to reassure the public. The two presented a polished oratory on exactly what had happened, and how the system that caused the improper manipulation of the markets had been shut down. Their stoic body language and the confidence of their words would make for a good case study in a debate class. Unfortunately, there were not any words they could pro
vide that would bring relief for the 300 million Americans listening. Nothing could relieve the angst that losing money can bring.

  After the speech had ended, the 24-hour news machine got under way fanning the flames of discontent. Each commentator had a theory for the cause of the financial meltdown. Not surprisingly, the meltdown was caused by the poor stewardship of whichever political party had different views than theirs. Surprisingly, few commentators spoke about how the crash had actually been originated by the SEDR HFT. The result of this constant chatter from the endless news was that the confidence in our financial system by the public continued to be eroded with each new report.

  By the time the authorities were able to provide credible assurances to the public that the day’s events were now understood to be a bizarre form of cyber-attack on our financial system, and that the source of the illegitimate news stories had been terminated, the damage from the day’s events had already been turned into reality. Pensioners had seen their retirement accounts dismantled in one crazy day. Corporate losses were incalculable, both from the actual valuation of the dollar loss and from the public’s confidence of the market they would need in order to recover from those losses. Everyone expected that when the market reopened on Wednesday, personal portfolios would be converted to cash instruments or closed as fast as the orders could be taken. This action would continue to spiral the market down. Private individuals were expected to be leaving the market in record numbers. The only thing not affected by the mayhem would be the algorithms in the brokerage firm’s HFT portals. They would again be hard at work, calculating how to respond to Monday’s data when they went active again on Wednesday.

  Overnight, the Asian and European markets both opened to their largest one-day drop in history. The mouse wheel kept spinning, even after SEDR was shut down.