Flash Boys: A Wall Street Revolt (4 page)

The RBC trading floor at One Liberty Plaza looked out on the holes once filled by the Twin Towers. When Brad arrived, the firm was still conducting air quality studies to determine if it was safe for its employees to breathe. In time they just sort of forgot about what had happened in this place; the hole in the ground became the view you looked at without ever seeing it.

For his first few years on Wall Street, Brad traded U.S. tech and energy stocks. He had some fairly abstruse ideas about how to create what he called “perfect markets,” and they worked so well that he was promoted to run the equity trading department, consisting of twenty or so traders. The RBC trading floor had what the staff liked to refer to as a “no-asshole rule”; if someone came in the door looking for a job and sounding like a typical Wall Street asshole, they wouldn’t hire him, no matter how much money he said he could make the firm. There was even an expression used to describe the culture: “RBC nice.” Although Brad found the expression embarrassingly Canadian, he, too, was RBC nice. The best way to manage people, he thought, was to convince them that you were good for their careers. He further believed that the only way to get people to believe that you were good for their careers was actually to be good for their careers. These thoughts came naturally to him: They just seemed obvious.

If there was a contradiction between who Brad Katsuyama was and what he did for a living, he didn’t see it. He assumed he could be a trader on Wall Street without its having the slightest effect on his habits, tastes, worldview, or character. And during his first few years on Wall Street he appeared to be correct. Just by being himself he became, on Wall Street, a great success. “His identity at RBC in New York was very simple,” says a former colleague. “Brad was the golden child. People thought he was going to end up running the bank.” For more or less his entire life, Brad Katsuyama had trusted the system; and the system, in return, trusted Brad Katsuyama. That left him especially unprepared for what the system was to do to him.

HIS TROUBLES BEGAN
at the end of 2006, after RBC paid $100 million for a U.S. electronic stock market trading firm called Carlin Financial. In what appeared to Brad to be undue haste, his bosses back in Canada bought Carlin without knowing much about either it or electronic trading. In what he thought to be typical Canadian fashion, they had been slow to react to a big change in the financial markets; but once they felt compelled to act, they’d panicked. “The bank’s run by these Canadian guys from Canada,” a former RBC director put it. “They don’t have the slightest idea of the ins and outs of Wall Street.”

In buying Carlin they received a crash course. In a stroke Brad found himself working side by side with a group of American traders who could not have been less suited to RBC’s culture. The first day after the merger, Brad got a call from a worried female employee, who whispered, “There is a guy in here with suspenders walking around with a baseball bat in his hands, taking swings.” That turned out to be Carlin’s CEO, Jeremy Frommer, who, whatever else he was, was not RBC nice. One of Frommer’s signature poses was feet up on his desk, baseball bat swinging wildly over his head while some poor shoeshine guy tried to polish his shoes. Another was to find a perch on the trading floor and muse in loud tones about who might get fired next. Returning to his alma mater, the University of Albany, to tell a group of business students the secret of his success, Frommer actually said, “It’s not just enough that I’m flying in first class. I have to know my friends are flying in coach.” “Jeremy was emotional, erratic, and loud—everything the Canadians were not,” says one former senior RBC executive. “To me, Toronto is like a foreign country,” said Frommer later. “The people there are not the same culture as us. They take a very cerebral approach to Wall Street. It was just such a different world. It was a hard adjustment for me. If you were a hitter, you couldn’t swing your dick around the way you could in the old days.”

With each mighty swing Jeremy Frommer scored a direct hit on Canadian sensibilities. The first Christmas after the two firms merged, he took it upon himself to organize the office party. The RBC Christmas party had always been a staid affair. Frommer rented out Marquee, the Manhattan nightclub. “RBC doesn’t do stuff at Marquee,” says one former RBC trader. “Everyone was like, ‘What the fuck is going on here?’ ” “I walked in and I didn’t know ninety percent of the people there,” says another. “It looked like we were in a Vegas hotel lobby bar. There were these girls walking around half-naked, selling cigars. I asked, ‘Who are all these people?’ ” Into this old-fashioned Canadian bank, heretofore immune from the usual Wall Street pathologies, Frommer imported a bunch of people who were not. “The women at Carlin had a different look than the women at RBC,” says another former RBC trader delicately. “You got the feeling they were hired because they were hot.” With Carlin also came a boiler room full of day traders, some of whom had rap sheets with various financial police, others of whom were about to wind up in jail for financial crimes.
*
“Carlin was what I always imagined a bucket shop was like,” says another former RBC trader. “There was a lot of the gold chains attire,” said another. It was as if a tribe of 1980s Wall Street alpha males had stumbled upon a time machine and, as a prank, identified the most mild-mannered, well-behaved province in Canada and teleported themselves into it. The RBC guys were at their desks at 6:30; the Carlin guys rolled in at 8:30 or so, looking distinctly unwell. The RBC guys were understated and polite; the Carlin guys were brash and loud. “They lied or exaggerated a lot about their relationships with accounts,” says a current RBC salesman. “They were like, ‘Yeah, I cover [hedge fund giant John] Paulson and we’re tight.’ And you’d call Paulson up and they’d barely heard of the guy.”

For reasons Brad did not fully grasp, RBC insisted that he move with his entire U.S. stock trading department from their offices near the World Trade Center site into Carlin’s building in Midtown. This bothered him a lot. He got the distinct impression that people in Canada had decided that electronic trading was the future, even if they didn’t understand why or even what it meant. Installed in Carlin’s offices, the RBC people were soon gathered to hear a state-of-the-financial-markets address given by Frommer. He stood in front of a flat panel computer monitor that hung on his wall. “He gets up and says the markets are now all about speed,” says Brad. “ ‘Trading is all about speed.’ And then he says, ‘I’m going to show you how fast our system is.’ He had this guy next to him with a computer keyboard. He said to him, ‘Enter an order!’ And the guy hit Enter. And the order appeared on the screen so everyone could see it. And Frommer goes, ‘See! See how fast that was!!!’ ” All the guy had done was type the name of a stock on a keyboard, and the name was displayed on the screen, the way a letter, once it has been typed, appears on a computer screen. “Then he goes, ‘Do it again!’ And the guy hits the Enter button on the keyboard again. And everyone nods. It was five in the afternoon. The market wasn’t open; nothing was happening. But he was like, ‘Oh my God, it’s happening in real time!’ And I was like, ‘I don’t fucking believe this.’ ” Brad thought:
The guy who just sold us our new electronic trading platform either does not know that his display of technical virtuosity is absurd, or, worse, he thinks we don’t know.

As it happened, at almost exactly the moment Jeremy Frommer fully entered Brad’s life, the U.S. stock market began to behave oddly. Before RBC acquired this supposedly state-of-the-art electronic trading firm, his computers worked. Now, suddenly, they didn’t. Until he was forced to use some of Carlin’s technology, he trusted his trading screens. When his trading screens showed 10,000 shares of Intel offered at $22 a share, it meant that he could buy 10,000 shares of Intel for $22 a share. He had only to push a button. By the spring of 2007, when his screens showed 10,000 shares of Intel offered at $22 and he pushed the button, the offers vanished. In his seven years as a trader he had always been able to look at the screens on his desk and
see
the stock market. Now the market as it appeared on his screens was an illusion.

This was a big problem. Brad’s main role as a trader was to sit between investors who wanted to buy and sell big amounts of stock and the public markets, where the volumes were smaller. Some investor might want to sell a 3-million-share block of Intel; the markets would only show demand for 1 million shares; Brad would buy the entire block, sell off a million shares of it instantly, and then work artfully over the next few hours to unload the other 2 million shares. If he didn’t know what the markets actually were, he couldn’t price the larger block. He had been supplying liquidity to the market; now, whatever was happening on his screens was reducing his willingness to do it. Unable to judge market risks, he was less happy to take them.

By June 2007 the problem had grown too big to ignore. An electronics company in Singapore called Flextronics announced its intention to buy a smaller rival, Solectron, for a bit less than $4 a share. A big investor called Brad and said he wanted to sell 5 million shares of Solectron. The public stock markets—the New York Stock Exchange (NYSE) and Nasdaq—showed the current market. Say it was 3.70–3.75, which is to say you could sell Solectron for $3.70 a share or buy it for $3.75. The problem was that, at those prices, only a million shares were bid for and offered. The big investor who wished to sell 5 million shares of Solectron called Brad because he wanted Brad to take the risk on the other 4 million shares. And so Brad bought the shares at $3.65, slightly below the price quoted in the public markets. But when he turned to the public markets—the markets on his trading screens—the share price instantly moved. Almost as if the market had read his mind. Instead of selling a million shares at $3.70, as he’d assumed he could do, he sold a few hundred thousand and trigged a minicollapse in the price of Solectron. It was as if someone knew what he was trying to do and was reacting to his desire to sell before he had fully expressed it. By the time he was done selling all 5 million shares, at prices far below $3.70, he had lost a small fortune.

This made no sense to him. He understood how he might move the price of an infrequently traded stock simply by satisfying the demand for the highest bidder. But in the case of Solectron, the stock of a company about to be taken over at a known price by another company was trading heavily. There should be plenty of supply and demand in a very narrow price range; it just shouldn’t move very much. The buyers in the market shouldn’t vanish the moment he sought to sell. At that point he did what most people do when they don’t understand why their computer isn’t working the way it’s supposed to: He called tech support. “If your keyboard didn’t work, these were the guys who would come up and replace it.” Like tech support everywhere, their first assumption was that Brad didn’t know what he was doing. “ ‘User error’ was the thing they’d throw at you. They just thought of us traders as a bunch of dumb jocks.” He explained to them that all he was doing was hitting the Enter key on his keyboard: It was hard to screw that up.

Once it was clear that the problem was more complicated than user error, the troubleshooting was bumped to a higher level. “They started to send me product people, the people who had bought and installed the systems, and they at least sort of sounded like technologists.” He explained that the market on his screens used to be a fair representation of the actual stock market but that now it was not. In return he received mainly blank stares. “It wound up being me talking to someone and them looking, like, befuddled.” Finally he complained so loudly that they sent him the developers, the guys who had come to RBC in the Carlin acquisition. “We would hear how they had this roomful of Indians and Chinese guys. Rarely would you see them on the trading floor. They were called “the Golden Goose.” The bank did not want the Golden Goose distracted, and, when the geese arrived, they had the air of people on leave from some critical mission. They, too, explained to Brad that he, and not his machine, was the problem. “They told me it was because I was in New York and the markets were in New Jersey and my market data was slow. Then they said that it was all caused by the fact that there are thousands of people trading in the market. They’d say, ‘You aren’t the only one trying to do what you’re trying to do. There’s other events. There’s news.’ ”

If that was the case, he asked them, why did the market in any given stock dry up
only
when he was trying to trade in it? To make his point, he asked the developers to stand behind him and watch while he traded. “I’d say, ‘Watch closely. I am about to buy one hundred thousand shares of AMD. I am willing to pay forty-eight dollars a share. There are currently one hundred thousand shares of AMD being offered at forty-eight dollars a share—ten thousand on BATS, thirty-five thousand on the New York Stock Exchange, thirty thousand on Nasdaq, and twenty-five thousand on Direct Edge.’ You could see it all on the screens. We’d all sit there and stare at the screen and I’d have my finger over the Enter button. I’d count out loud to five . . .

“ ‘One . . .

“ ‘Two. . . . See, nothing’s happened.

“ ‘Three. . . . Offers are still there at forty-eight . . .

“ ‘Four. . . . Still no movement.

“ ‘Five.’ Then I’d hit the Enter button and—boom!—all hell would break loose. The offerings would all disappear, and the stock would pop higher.”

At which point he turned to the guys standing behind him and said, “You see, I’m the event. I
am
the news.”

To that the developers had no response. “They were kind of like, ‘Ohhh, yeah. Let me look into that.’ Then they’d disappear and never come back.” He called a few times, but “when I realized they really had no shot at solving the problem, I just left them alone.”

Brad suspected that the culprit was the technology from Carlin that RBC had more or less bolted onto the side of his trading machines. “As the market problem got worse,” he said, “I started to just assume my real problem was with how bad their technology was.” A pattern was established: The moment he attempted to react to the market on his screens, the market moved. And it wasn’t just him: The exact same thing was happening to all of the RBC stock market traders who worked for him. In addition, for reasons he couldn’t fathom, the fees that RBC was paying to stock exchanges were suddenly skyrocketing. At the end of 2007 Brad conducted a study to compare what had happened on his trading books to what should have happened, or what used to happen, when the stock market as stated on his trading screens was the market he experienced. “The difference to us was tens of millions of dollars” in losses plus fees, he said. “We were hemorrhaging money.” His bosses in Toronto called him in and told him to figure out how to reduce his rising trading costs.