Brad Katsuyama suddenly finds himself at the intersection of fame and controversy.
As the protagonist of Michael Lewis’s latest bestseller, Flash Boys, the 35-year-old founder of IEX trading, a stock trading venue that went online in October, he is in midst of a weird moment where he is simultaneously being hailed as a hero on Main Street and a villain on Wall Street. The day after Lewis’s book debuted, for instance, Katsuyama, a former Royal Bank of Canada stock trader who founded IEX after discovering that he was unable to fill stock orders because high-frequency traders were essentially cutting his clients in line, found himself in a verbal brawl on CNBC with the president of rival electronic exchange BATS.
Yet, the publicity from the book is driving more people to use IEX, a “alternative trading system” that features a built in delay — what Katsuyama calls a “magic shoebox” full of cables — that eliminates any advantage high-frequency traders might have. So far this month, IEX’s daily volume is averaging 27.6 million shares, up 8.7 million shares from the 18.9 million shares it had been averaging since it opened for business in October.
“We’re still only five months in, we’re way farther ahead than we thought we would be,” said Katsuyama, who spoke at length with Buzzfeed from a conference room at IEX’s headquarters on the 30th floor of 7 World Trade Center.
And now Katsuyama wants to grow as big as he can before his 15 minutes of fame expires. It is sort of a misnomer, after all, to promise to revolutionize how investors trade stocks and only command a roughly 0.38% market share in U.S. stock trading. Indeed, IEX is still magnitudes smaller than rival electronic trading firms. One of the Kansas City-based BATS two exchanges, BZX, moved 600 million shares a day in April, for instance. If IEX were a full-fledged exchange, it would rank as just the eighth largest in the country.
One way IEX can grow is by adding more heft in sales and marketing to scale up to where its technology is fully utilized. “Technology-wise we can scale this seven or eight times, the client facing piece is where we’d probably have to add,” Katsuyama said.
IEX’s staff of 34 is mostly devoted to the technology side of trading. In fact, its offices look more like what you’d expect from a tech startup in Silicon Alley than a stock exchange located up the street from Goldman Sachs: the employees are almost entirely male and have the requisite casual dress and inattention to the finer points of Wall Street grooming. Even Katsuyama appeared more casual than you’d expect from a Wall Street CEO, wearing a dark purple shirt and dark jeans in place of a finely tailored suit. He also portrays IEX the same way many technology companies describe their mission — and yes, it’s a mission — as bringing the benefits of technology, which has made trading faster and cheaper, to long-term investors so they don’t have to worry about getting picked off by abusive high-frequency traders.
For its part, IEX does this via a physical distance between the servers for brokers and high-frequency trading firms in Weehawken, New Jersey and its servers in Secaucus. The slight delay in transmitting information back and forth, some 350 microseconds, helps put all traders on an equal footing.
Some critics of high frequency trading look to the Securities and Exchange Commission or the Commodities Futures Trading Commission to do more to fix what they see as a broken market structure. In the wake of Flash Boys’s debut, The Justice Department and the New York State Attorney General both said they’re investigating to see if some high-frequency traders violate the law by using non-public information.
Ironically, the problems born out of the rise of high-frequency trading are largely owed to recent regulations, particularly Reg NMS, implemented in 2007.
Reg NMS which mandated that trades be executed at the best available price, is credited for leading to today’s highly fragmented stock market where exchanges and other trading venues compete for as many orders as possible so they can display and trade at the best possible price. This has lead to a ballooning in the number of exchanges and “alternative trading systems,” also known as “dark pools,” to trade stocks, as well as a complex system of fees and rebates charged by the exchanges and other venues to attract orders. Dark pools are often set up by brokers so their clients can unload stock without putting their orders up publicly.
There’s also a large business for exchanges to sell data feeds, which broadcast the prices of the stocks they list, for massive amounts of money to trading firms so they don’t have to use the consolidated feed available to all market participants. Rosenblatt Securities estimates that dark pools and other off-exchange venues (there are 45 dark pools alone) make up 36% of U.S. stock trading and that 50% to 55% of U.S. stock trading is done by high frequency traders.
Not unlike many of his tech startup peers, however, Katsuyama would rather entrepreneurs step in with market-based solutions to the problem, which is how he described IEX.
“We built IEX and all this hoopla has been generated off a solution that’s free market and exists in the current regulatory structure,” Katsuyama said. “All the venues before us, any one of them had the opportunity to do what we’re doing right now, but they chose not to, which is interesting in and of itself. The regulators should be evaluating what’s happening now carefully. It seems as if the market is trying to correct itself.”
Another characteristic IEX shares with tech startups is that the other avenue for it to grow is by getting bought. It can be the stock exchange version of Whats App or Instagram. Katsuyama, as Lewis reported in Flash Boys, has already turned down an offer from ICE, the massive exchange company that started in 2000 as an energy futures exchange and in 2013 bought NYSE Euronext, the company that owns the New York Stock Exchange.
When asked point blank about the possibility of a sale, Katsuyama wouldn’t rule it out, saying, “as long as philosophically the goals are aligned, yeah.” And while he was quick to add that he didn’t feel a lot of exchanges were of the same mindset as IEX, he did feel that the management of ICE was in tune with his way of thinking.
“I have a ton of respect for [Jeff] Sprecher and Tom Farley [the CEO of ICE and the COO of the NYSE] and I would say yeah, our philosophies are aligned,” Katsuyama said. “We’ve had conversations, I think they’re really thoughtful.”
But for now, Katsuyama’s goal, which dovetails with the boilerplate tech entrepreneur response to acquisition talk, is to become a full-blown exchange.
Katsuyama’s newfound fame has brought out the claws of his competitors. Flash Boys documents some of the scratches Katsuyama has endured, among them when an employee at the investment firm ING sent around an email saying IEX had a conflict of interest or how UBS, which operates its own dark pool for U.S. stocks, would not execute trades on IEX.
The hostility surfaced again on the day Flash Boys came out — John Nunziata, the head of electronic execution at BNP Paribas, wrote an email to his clients that Lewis had a stake in IEX. The claim was untrue and later that day BNP Paribas publicly rebuked Nunziata.
Katsuyama refuses to criticize other brokerages and high-frequency trading firms by name, though. When asked about some of the more unfriendly comments directed at him and IEX by other brokerage houses, Katsuyama said only that, “We evaluate people more about what they do than what they say they do.”
Further, other, more well-known Wall Street banks are eager to tout their willingness to work with IEX. In a memo distributed to its employees in March, Goldman Sachs said that the firm was “consistently the most active broker in IEX” and that “it would be best for the overall market if IEX achieved critical mass” even if it meant taking business away from its own dark pool, Sigma X. Goldman also criticized the current market structure for U.S. stocks, telling employees that “the variables associated with increased speed, fragmentation and complexity have not yet been fully matched with stronger infrastructure and operational mechanisms.”
Of Goldman’s warm embrace, Katsuyama said, “It was humbling the support that we got publicly. On a day to day basis we see that support from them.”
IEX is owned by some of the most prominent investors in the world, including the hedge funds run by David Einhorn, Daniel Loeb, and Bill Ackman. But its clients are exclusively brokers who execute trades on their own or on behalf of their investor clients. Katsuyama’s ultimate plan is to get his investors to get their brokers to trade with IEX.
“We want one marketplace in the United States,” Katsuyama said. “I came from a broker, and realized that the broker provides value to the client so much so that you can’t disintermediate them from the process. If the goal of this was to build a market that was one percent of total market volume we could probably let the buyside connect directly. But if you want to take over U.S. stock trading, then you need to sign up the people taking the investors orders, the brokers.”
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