Flash Boys: A Wall Street Revolt

by Michael Lewis

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  * 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

  Part 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.

  Then, in 2005, BT Radianz called. Radianz was born of 9/11, after the attacks on the World Trade Center knocked out big pieces of Wall Street’s communication system. The company promised to build for big Wall Street banks a system less vulnerable to outside attack than the existing system. Ronan’s job was to sell the financial world on the idea of subcontracting their information networks to Radianz. In particular, he was meant to sell the banks on “co-locating” their computers in Radianz’s data center in Nutley, New Jersey. But not long after he started his job at Radianz, Ronan had a different sort of inquiry, from a hedge fund based in Kansas City. The caller said he worked at a stock market trading firm called Bountiful Trust, and that he had heard Ronan was expert at moving financial data from one place to another. Bountiful Trust had a problem: In making trades between Kansas City and New York, it took them too long to determine what happened to their orders—that is, what stocks they had bought and sold. They also noticed that, increasingly, when they placed their orders, the market was vanishing on them, just as it was vanishing on Brad Katsuyama. “He says, ‘My latency time is forty-three milliseconds,’ ” recalls Ronan. “And I said, ‘What the hell is a millisecond?’ ”

  Latency was simply the time between the moment a signal was sent and when it was received. There were several factors that determined the latency of a stock market trading system: the boxes, the logic, and the lines. The boxes were the machinery the signals passed through on their way from Point A to Point B: the computer servers and signal amplifiers and switches. The logic was the software, the code instructions that operated the boxes. Ronan didn’t know much about software, except that, more and more, it seemed to be written by Russian guys who barely spoke English. The lines were the glass fiber-optic cables that carried the information from one box to another. The single biggest determinant of speed was the length of the fiber, or the distance the signal needed to travel to get from Point A to Point B. Ronan didn’t know what a millisecond was, but he understood the problem with this Kansas City hedge fund: It was in Kansas City. Light in a vacuum traveled at 186,000 miles per second, or, put another way, 186 miles a millisecond. Light inside of fiber bounced off the walls and so traveled at only about two-thirds of its theoretical speed. But it was still fast. The biggest enemy of the speed of a signal was the distance the signal needed to travel. “Physics is physics—this is what the traders didn’t understand,” said Ronan.

  The whole reason Bountiful Trust had set up shop in Kansas City was that its founders believed that it no longer mattered where they were physically located. That Wall Street was no longer a place. They were wrong. Wall Street was, once again, a place. It wasn’t actually on Wall Street now. It was in New Jersey. Ronan moved the computers from Kansas City to Radianz’s data center in Nutley and reduced the time it took them to find out what they had bought and sold from 43 milliseconds to 3.8 milliseconds.

  From that moment the demand on Wall Street for Ronan’s services intensified. Not just from banks and well-known high-frequency trading firms but also from prop shops (proprietary trading firms) no one had ever heard of, with just a few guys in them. All wanted to be able to trade faster than the others. To be faster they needed to find shorter routes for their signals to travel; to be faster they needed the newest hardware, stripped down to its essentials; to be faster they also needed to reduce the physical distance between their computers and the computers inside the various stock exchanges. Ronan knew how to solve all of these problems. But as all his new customers housed their computers inside the Radianz data center in Nutley, this was a tricky business. Ronan says, “One day a trader calls and asks, ‘Where am I in the room?’ I’m thinking, In the room? What do you mean ‘in the room’? What the guy meant, it turned out, was in the room.” He was willing to pay to move his computer that sent orders into the stock market as close as possible to the pipe that exited the building in Nutley—so that he would have a slight jump on the other computers in the room. Another trader then called Ronan to say that he had noticed that his fiber-optic cable was a few yards longer than it needed to be. Instead of having it wind around the outside of the room with everyone else’s cable—which helped to reduce the heat in the room—the trader wanted his cable to hew a straight line right across the middle of the room.

  It was only a matter of time before the stock exchanges figured out that, if people were willing to spend hundreds of thousands of dollars to move their machines around inside some remote data center just so they might be a tiny bit closer to the stock exchange, they’d pay millions to be inside the stock exchange itself. Ronan followed them there. He came up with an idea: sell proximity to Wall Street as a service. Call it “proximity services.” “We tried to trademark proximity, but you can’t because it’s a word,” he said. What he wanted to call proximity soon became known as “co-location,” and Ronan became the world’s authority on the subject. When they ran out of ways to reduce the length of their cable, they began to focus on the devices on either end of the cable. Data switches, for instance. The difference between fast data switches and slow ones was measured in microseconds (millionths of a second), but microseconds were now critical. “One guy says to me, ‘It doesn’t matter if I’m one second slower or one microsecond; either way I come in second place.’ ” The switching times fell from 150 microseconds to 1.2 microseconds per trade. “And then,” says Ronan, “they started to ask, ‘What kind of glass are you using?’ ” All optical fibers were not created equal; some kinds of glass conveyed light signals more efficiently than others. And Ronan thought: Never before in human history have people gone to so much trouble and spent so much money to gain so little speed. “People were measuring the length of their cables to the foot inside the exchanges. People were buying these servers and chucking them out six months later. For microseconds.”

  He didn’t know how much money high-frequency traders were making, but he could guess from how much they were spending. From the end of 2005 to the end of 2008, Radianz alone billed them nearly $80 million—just for setting up their computers near the stock exchange matching engines. And Radianz was hardly the only one billing them. Seeing that the fiber routes between the New Jersey exchanges were often less than ideal, Ronan prodded a company called Hudson Fiber into finding straighter ones. Hudson Fiber was now doing a land-office business digging trenches in places that would give Tony Soprano pause. Ronan could also guess how much money high-frequency traders were making by the trouble they took to conceal how they made it. One HFT firm he set up inside one of the stock exchanges insisted that he wrap their new computer servers in wire gauze—to prevent anyone from seeing their blinking lights or improvements in their hardware. Another HFT firm secured the computer cage nearest the exchange’s matching engine—the computer code that, in effect, was now the stock market. Formerly owned by Toys “R” Us (the computers probably ran the toy store’s website), the cage was emblazoned with store logos. The HFT firm insisted on leaving the Toys “R” Us logos in place so that no one would know they had improved their position, in relation to the matching engine, by several feet. “They were all paranoid,” said Ronan. “But they were right to be. If you know how to pickpocket someone and you were the pickpocketer, you would do the same thing. You’d see someone find a new switch that was three microseconds faster, and in two weeks everyone in the data center would have the same switch.”

  By the end of 2007 Ronan was making hundr
eds of thousands of dollars a year building systems to make stock market trades faster. He was struck, over and over again, by how little the traders he helped understood of the technology they were using. “They’d say, ‘Aha! I saw it—it’s so fast!’ And I’d say, ‘Look, I’m happy you like our product. But there’s no fucking way you saw anything.’ And they’re like, ‘I saw it!’ And I’m like, ‘It’s three milliseconds—it’s fifty times faster than the blink of an eye.’ ” He was also keenly aware that he had only the faintest idea of the reason for this incredible new lust for speed. He heard a lot of loose talk about “arbitrage,” but what, exactly, was being arbitraged, and why did it need to be done so fast? “I felt like the getaway driver,” he said. “Each time, it was like, ‘Drive faster! Drive faster!’ Then it was like, ‘Get rid of the airbags!’ Then it was, ‘Get rid of the fucking seats!’ Towards the end I’m like, ‘Excuse me, sirs, but what are you doing in the bank?’ ” He had a sense of the technological aptitude of the various players. The two biggest high-frequency trading firms, Citadel and Getco, were easily the smartest. Some of the prop shops were smart, too. The big banks, at least for now, were all slow.

  Beyond that, he didn’t even really know much about his clients. The big banks—Goldman Sachs, Credit Suisse—everyone had heard of. Others—Citadel, Getco—were famous on a small scale. He learned that some of these firms were hedge funds, which meant that they took money from outside investors. But most of them were prop shops, trading only their own founders’ money. A huge number of the firms he dealt with—Hudson River Trading, Eagle Seven, Simplex Investments, Evolution Financial Technologies, Cooperfund, DRW—no one had ever heard of, and the firms obviously intended to keep it that way. The prop shops were especially strange, because they were both transient and prosperous. “They’d be just five guys in a room. All of them geeks. The leader of each five-man pack is just an arrogant version of that geek. A fucking arrogant version of that.” One day a prop shop was trading; the next, it had closed, and all the people in it had moved to work for some big Wall Street bank. One group of guys Ronan saw over and over: four Russian, one Chinese. The arrogant Russian guy who was clearly their leader was named Vladimir. Vladimir and his boys ping-ponged from prop shop to big bank and back to prop shop, writing the computer code that made the actual stock market trading decisions. Ronan watched them meet with one of the most senior guys at a big Wall Street bank that hoped to employ them—and the Wall Street big shot sucked up to them. “He walks into the meeting and says, ‘I’m always the most important man in the room, but in this case Vladimir is.’ ” Ronan knew that these roving bands of geeks felt nothing but condescension toward the less technical guys who ran the big Wall Street firms. “I was listening to them talk about some calculation they had been asked to make, and Vladimir goes, ‘Ho, ho, ho. That’s what Americans call math.’ He said it like moth. That’s what Americans call moth. I thought, I’m fucking Irish, but fuck you guys. This country gave you a shot.”