Flash Boys: A Wall Street Revolt

by Michael Lewis

  To put it another way: The process that ended with Serge Aleynikov sitting inside two holding facilities that housed dangerous offenders and then a federal prison may have started with the concern of some Goldman Sachs manager with his bonus. “Who is going to pull the fire alarm before they smell the fire?” asked the juror who had advanced this last theory. “It’s always the people who are politically motivated.” As he left dinner with Serge Aleynikov and walked down Wall Street, he thought about it some more. “I’m actually nauseous,” he said. “It makes me sick.”

  THE MYSTERY THE jury of Sergey Aleynikov’s peers had more trouble solving was Serge himself. He appeared, and perhaps even was, completely at peace with the world. Had you lined up the people at those two Wall Street dinners and asked the American public to vote for the man who had just lost his marriage, his home, his job, his life savings, and his reputation, Serge would have come dead last. At one point, one of the people at the table stopped the conversation about computer code and asked, “Why aren’t you angry?” Serge just smiled back at him. “No, really,” said the juror. “How do you stay so calm? I’d be fucking going crazy.” Serge smiled again. “But what does craziness give you?” he said. “What does negative demeanor give you as a person? It doesn’t give you anything. You know that something happened. Your life happened to go in that particular route. If you know that you’re innocent, know it. But at the same time you know you are in trouble and this is how it’s going to be.” To which he added, “To some extent I’m glad this happened to me. I think it strengthened my understanding of what living is all about.” At the end of his trial, when the original jury returned with its guilty verdict, Serge had turned to his lawyer, Kevin Marino, and said, “You know, it did not turn out the way we had hoped. But I have to say, it was a pretty good experience.” It was as if he were standing outside himself and taking in the situation as an observer. “I’ve never seen anything like it,” said Marino.

  In the comfort of the Wall Street cornucopia, that notion—that the hellish experience he’d been through had actually been good for him—was too weird to pursue, and the jurors had quickly returned to discussing computer code and high-frequency trading. But Serge actually believed what he had said. Before his arrest—before he lost much of what he thought important in his life—he went through his days and nights in a certain state of mind: a bit self-absorbed, prone to anxiety and worry about his status in the world. “When I was arrested, I couldn’t sleep,” he said. “When I saw articles in the newspaper, I would tremble at the fear of losing my reputation. Now I just smile. I no longer panic. Or have panic ideas that something could go wrong.” By the time he was first sent to jail, his wife had left him, taking their three young daughters with her. He had no money and no one to turn to. “He didn’t have very close friends,” his fellow Russian émigré Masha Leder recalled. “He never did. He’s not a people person. He didn’t even have anyone to be power of attorney.” Out of a sense of Russian solidarity, and out of pity, she took the job—which meant, among other things, frequent trips to visit Serge in prison. “Every time I would come to visit him in jail, I would leave energized by him,” she said. “He radiated so much energy and positive emotions that it was like therapy for me to visit him. His eyes opened to how the world really is. And he started talking to people. For the first time! He would say: People in jail have the best stories. He could have considered himself a tragedy. And he didn’t.”

  By far the most difficult part of his experience was explaining what had happened to his children. When he was arrested, his daughters were five, three, and almost one. “I tried to put it in the most simple terms they would understand,” said Serge. “But the bottom line was I was apologizing for the fact that this had happened.” In jail he was allowed three hundred minutes a month on the phone—and for a long time the kids, when he called them, didn’t pick up on the other end.

  The holding facility in which Serge spent his first four months was violent, and essentially nonverbal, but he didn’t find it hard to stay out of trouble there. He even found people he could talk to, and enjoy talking to. When they moved him to the minimum-security prison at Fort Dix, in New Jersey, he was still in a room crammed with hundreds of other roommates, but he now had space to work. He remained in some physical distress, mainly because he refused to eat meat. “His body, he had really bad times there,” said Masha Leder. “He lived on beans and rice. He was always hungry. I’d buy him these yogurts and he would gulp them down one after another.” His mind still worked fine, though, and a lifetime of programming in cube farms had left him with the ability to focus in prison conditions. A few months into Serge’s jail term, Masha Leder received a thick envelope from him. It contained roughly a hundred pages covered on both sides in Serge’s meticulous eight-point script. It was computer code—a solution to some high-frequency trading problem. Serge feared that if the prison guards found it, they wouldn’t understand it, decide that it was suspicious, and confiscate it.

  A year after he’d been sent away, the appeal of Serge Aleynikov was finally heard, by the Second Circuit Court of Appeals. The judgment was swift, unlike anything his lawyer, Kevin Marino, had seen in his career. Marino was by then working gratis for a client who was dead broke. The very day he made his argument, the judges ordered Serge released, on the grounds that the laws he stood accused of breaking did not actually apply to his case. At six in the morning on February 17, 2012, Serge received an email from Kevin Marino saying that he was to be freed.

  A few months later, Marino noticed that the government had failed to return Serge’s passport. Marino called and asked for it back. The passport never arrived; instead Serge, now staying with friends in New Jersey, was arrested again and taken to jail. Once again, he had no idea what he was being arrested for, but this time neither did the police. The New Jersey cops who picked him up didn’t know the charges, only that he should be held without bail, as he was deemed a flight risk. His lawyer was just as perplexed. “When I got the call,” said Marino, “I thought it might have something to do with Serge’s child support.” It didn’t. A few days later, Manhattan district attorney Cyrus Vance sent out a press release to announce that the State of New York was charging Serge Aleynikov with “accessing and duplicating a complex proprietary and highly confidential computer source code owned by Goldman Sachs.” The press release went on to say that “[t]his code is so highly confidential that it is known in the industry as the firm’s ‘secret sauce,’ ” and thanked Goldman Sachs for its cooperation. The prosecutor assigned to the case, Joanne Li, claimed that Serge was a flight risk and needed to be re-jailed immediately—which was strange, because Serge had gone to and returned from Russia between the time of his first arrest and his first jailing. (It was Li who soon fled the case—to a job at Citigroup.)

  Marino recognized the phrase “secret sauce.” It hadn’t come from “the industry” but from his opening statement in Serge’s first trial, when he mocked the prosecutors for treating Goldman’s code as if it were some “secret sauce.” Otherwise Serge’s re-arrest made no sense to him. To avoid double jeopardy, the Manhattan DA’s office had found new crimes with which to charge Serge for the same actions. But the sentencing guidelines for the new crimes meant that, even if he was convicted, it was very likely he wouldn’t have to return to jail. He’d already served time, for crimes the court ultimately determined he had not committed. Marino called Vance’s office. “They told me that they didn’t need him to be punished anymore, but they need him to be held accountable,” said Marino. “They want him to plead guilty and let him go on time served. I told them in the politest terms possible that they can go fuck themselves. They ruined his life.”

  Oddly enough, they hadn’t. “Inside of me I was completely witnessing,” said Serge, about the night of his re-arrest. “There was no fear, no panic, no negativity.” His children had reattached themselves to him, and he had a new world of people to whom he felt close. He thought he was living his life as wel
l as it had ever been lived. He’d even started a memoir, to explain what had happened to anyone who might be interested. He began:

  If the incarceration experience doesn’t break your spirit, it changes you in a way that you lose many fears. You begin to realize that your life is not ruled by your ego and ambition and that it can end any day at any time. So why worry? You learn that just like on the street, there is life in prison, and random people get there based on the jeopardy of the system. The prisons are filled by people who crossed the law, as well as by those who were incidentally and circumstantially picked and crushed by somebody else’s agenda. On the other hand, as a vivid benefit, you become very much independent of material property and learn to appreciate very simple pleasures in life such as the sunlight and morning breeze.

  EPILOGUE

  RIDING THE WALL STREET TRAIL

  For at least a few members of the Women’s Adventure Club of Centre County, Pennsylvania, the weather was never much of an issue. The Women’s Adventure Club had been created by Lisa Wandel, an administrator at Penn State University, after she realized that many women were afraid to hike alone in the woods. The club now had more than seven hundred members, and its sense of adventure had expanded far beyond a walk in the woods. Between them the four women who met me on their bicycles beside the Pennsylvania road had: learned the flying trapeze, swum the Chesapeake Bay, and won silver at the downhill mountain biking world championships; they had finished a road bike race called the Gran Fondo “Masochistic Metric,” a footrace called the Tough Mudder, and three separate twenty-four-hour-long mountain bike races; they had graduated from race car driving school and made thirteen Polar Bear Plunges in some local river in the dead of winter. After studying the Women’s Adventure Club’s website, Ronan had said, “It’s a bunch of lunatic women who meet up and do dangerous shit; I got to get my wife into it.”

  In the bleak January light we pedaled onto Route 45 out of Boalsburg, Pennsylvania, heading east, along what was once the route for the stagecoach that ran from Philadelphia to Erie. It was nine in the morning, and still below freezing, with a stiff breeze lowering the windchill to eleven degrees. The views were of farms and fallow brown fields, and the road was empty except for the occasional pickup truck, roaring past us with real anger. “They hate bikers,” explained one of the women adventurers mildly. “They try to see how close they can get.”

  The women rode this stretch of road every so often, and had noticed when the fiber-optic line was being laid beside it, back in 2010. From time to time one of the road’s two lanes was closed by the line’s construction crews. You’d see these motley queues of bikes, cars, pickup trucks, Amish horse-drawn carts, and farm equipment waiting for the tail end of the oncoming traffic. The crews trenched the ground between the paved road and the farms, making it difficult for the Amish in their wagons to get back to their homes—sometimes you’d see these Amish kids, the girls in their pretty purple dresses, hopping off the wagon and leaping over the trench. The members of the Women’s Adventure Club had been told by a local government official that the fiber-optic line was a government project to provide high-speed Internet access to local colleges. Hearing that it was actually a private project to provide a 3-millisecond edge to high-frequency traders, they had some new questions about it. “How does a private line get access to a public right-of-way?” asked one. “I’m really curious to know that.”

  WE’RE IN A transition here. That’s what the Goldman Sachs people said when you asked them, in so many words, how they could have gone from bringing the wrath of U.S. prosecutors down upon Serge Aleynikov for emailing their high-frequency trading computer code to himself, to helping Brad Katsuyama change the U.S. stock market in ways that would render Goldman’s high-frequency trading computer code worthless.

  There was a connection between Serge Aleynikov and Goldman’s behavior on December 19, 2013. The trial and the publicity that attended it caused a lot of people to think more rigorously about the value of Goldman Sachs’s high-frequency trading code. High-frequency trading had a winner-take-all aspect: The fastest predator took home the fattest prey. By 2013 the people charged with determining Goldman’s stock market strategy had concluded that Goldman wasn’t very good at this new game, and that Goldman was unlikely ever to be very good at it. The high-frequency traders would always be faster than Goldman Sachs—or any other big Wall Street bank. The people who ran Goldman Sachs’s stock market department had come to understand that what Serge had taken wasn’t worth stealing—at least not by anyone whose chief need was speed.

  The trouble for any big Wall Street bank wasn’t simply that a big bureaucracy was ill-suited to keeping pace with rapid technological change, but that the usual competitive advantages of a big Wall Street bank were of little use in high-frequency trading. A big Wall Street bank’s biggest advantage was its access to vast amounts of cheap risk capital and, with that, its ability to survive the ups and downs of a risky business. That meant little when the business wasn’t risky and didn’t require much capital. High-frequency traders went home every night with no position in the stock market. They traded in the market the way card counters in a casino played blackjack: They played only when they had an edge. That’s why they were able to trade for five years without losing money on a single day.

  A big Wall Street bank really had only one advantage in an ever-faster financial market: first shot at its own customers’ stock market trades. So long as the customers remained inside the dark pool, and in the dark, the bank might profit at their expense. But even here the bank would never do the job as efficiently or thoroughly as a really good HFT. It was hard to resist the pressure to hand the prey over to the more skilled predator, to ensure that the kill was done quickly and discreetly, and then, after the kill, to join in the feast as a kind of junior partner—though more junior than partner. In the dark pool arbitrage IEX had witnessed, for instance, HFT captured about 85 percent of the gains, leaving the bank with just 15 percent.

  The new structure of the U.S. stock market had removed the big Wall Street banks from their historic, lucrative role as intermediary. At the same time it created, for any big bank, some unpleasant risks: that the customer would somehow figure out what was happening to his stock market orders. And that the technology might somehow go wrong. If the markets collapsed, or if another flash crash occurred, the high-frequency traders would not take 85 percent of the blame, or bear 85 percent of the costs of the inevitable lawsuits. The banks would bear the lion’s share of the blame and the costs. The relationship of the big Wall Street banks to the high-frequency traders, when you thought about it, was a bit like the relationship of the entire society to the big Wall Street banks. When things went well, the HFT guys took most of the gains; when things went badly, the HFT guys vanished and the banks took the losses.

  Goldman had figured all of this out—probably before the other big Wall Street banks, to judge from its treatment of IEX. By December 19, 2013, the people newly installed on top of Goldman Sachs’s stock market operations, Ron Morgan and Brian Levine, wanted to change the way the market worked. They were obviously sincere. They truly believed that the market at the heart of the world’s largest economy had grown too complex, and was likely to experience some catastrophic failure. But they also were trying to put an end to a game they could never win—or control. And so they’d flipped a switch, and sent lots of their customers’ stock market orders to IEX. When they did this they started a process that, if allowed to play out, would take billions from Wall Street and return it to investors. It would also create fairness.

  A big Wall Street bank was a complex environment. There were people inside Goldman Sachs less than pleased by what Levine and Morgan had done. And after December 19 the firm had retreated, just a little bit. It was hard even for Brad Katsuyama to know why. Was it changing its collective mind? Had it underestimated the cost of being the first mover? Was it too much to ask Goldman Sachs to look up from short-term profit and study the landscape down
the road? It was possible that even Goldman Sachs did not know the answers to those questions. Whatever the answers, something Brian Levine had said still made a lot of sense. “There will be a lot of resistance,” he’d said. “There will be a lot of resistance. Because a tremendous infrastructure has been built up around this.”

  It’s worth performing a Goldman Sachs–like cost-benefit analysis of this infrastructure, from the point of view of the economy it is meant to serve. The benefit: Stock market prices adjust to new information a few milliseconds faster than they otherwise might. The costs make for a longer list. One obvious cost is the instability introduced into the system when its primary goal is no longer stability but speed. Another is the incalculable billions collected by financial intermediaries. That money is a tax on investment, paid for by the economy; and the more that productive enterprise must pay for capital, the less productive enterprise there will be. Another cost, harder to measure, was the influence all this money exerted, not just on the political process but on people’s decisions about what to do with their lives. The more money to be made gaming the financial markets, the more people would decide they were put on earth to game the financial markets—and create romantic narratives to explain to themselves why a life spent gaming the financial markets is a purposeful life. And then there is maybe the greatest cost of all: Once very smart people are paid huge sums of money to exploit the flaws in the financial system, they have the spectacularly destructive incentive to screw the system up further, or to remain silent as they watch it being screwed up by others.