An Irishman, Ronan Ryan, 34, is at the center of Wall Street’s latest sensational story which reveals how he and others figured out how high frequency traders rigged the system and made massive profits.
The traders did so by “front running,” jumping in front of trades about to be made and making them for themselves. The high frequency traders used microsecond delays in trades caused by different network routers to jump on the trades and make billions.
The impact was to deny legitimate traders and investors the same advantage as the high frequency players. It also led to dangerous “flash crashes” when high frequency traders all dumped stock at the same time leading to unexplained plunges.
The worst flash crash happened in May 2010 when the Dow Jones plunged 1,000 points in a few seconds before righting itself. The New York Attorney General Eric Schneiderman is now investigating what could become the biggest scandal since Bernie Madoff.
“There are situations where there really may be some illegal conduct and we are looking at it under New York securities laws," Schneiderman told CBS News.
The story appeared on “60 Minutes”, front page of The New York Times and is the subject of renowned writer Michael Lewis’s new book “Flash Boys: A Wall Street Revolt.” In the book Ryan is described as a man “having the uneasy caution of a man who survived on potato famine and is expecting another”
Lewis paints Ryan and his coworkers, first at Royal Bank of Canada and later with their own exchange, as the heroes who uncovered the scheme and who altered how business is done by creating an exchange where everyone has the same opportunity in real time to trade.
Lewis reveals how a 38-mile coil of fiber optic cable that creates a speed bump for every trade is helping make Wall Street fair. According to Ryan, the six-month-old Investors Exchange (IEX) gives every client the same opportunity by creating the speed bump that means every trade arrives at the same time.
The new exchange is now overwhelmed by business. Ryan, the son of an IDA executive moved to the US with his parents in 1990 at the age of16. When they moved back to Ireland, he stayed. He told Lewis Ireland at the time was “kinda like a shithole to be honest...it’s hard not to love America”
Ryan is now the chief strategy officer at IEX. IEX is the brainchild of former Royal Bank of Canada trader Brad Katsuyama, technologist Rob Park, and Ryan, who previously worked as a sales manager for network providers BT Radianz and Switch and Data.
Its story begins in 200, a few months after RBC purchased Carlin Financial, an electronic trading firm. Katsuyama, who worked for RBC in New York, noticed that trades were becoming harder and harder to complete. As Lewis writes, “Before RBC acquired this supposed state-of-the-art electronic-trading firm, Katsuyama’s computers worked as he expected them to. Suddenly they didn’t. It used to be that 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, however, when he pushed the button to complete a trade, the offers would vanish. 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."
When RBC’s tech team proved unable to get to the bottom of things, Katsuyama decided to figure things out for himself. Through collaborating with Park and others, he eventually realized that the bigger banks were creating a huge advantage for themselves through high frequency trading. It was a question of milliseconds – microseconds, even (microseconds are one millionth of a second).
When Katsuyama moved to complete a trade, his offer had to travel through fiber-optic networks to the various exchanges. How many milliseconds or microseconds this took depended not on how close the exchanges themselves were, but how far away and complicated the network of fiber optic cables that communicated his request to the exchanges servers was. Milliseconds between how long the requests took to land made a significant difference.
In Katsuyama's case and in the case of many of his contemporaries, the information would first reach the BATS exchange servers in Weehawken, NJ – which the high frequency traders were then able to take advantage of.
As Lewis recently explained on 60 Minutes:“It only took a tiny fraction of a second for Brad's trade to reach the next exchanges on the network [after BATS], but the high-speed traders were able to jump in front of him, buy the same stock and drive the price up before his order arrived, producing a small profit of just one or two pennies. But it was happening to everyone's trades millions of times a day."
Things were being further complicated by what are referred to as “dark pools,” the private exchanges performed by the major banks and investment firms that do not need to be reported in real time, and were often the spaces in which those firms were able to trade against their own customers, therefore reaping an even greater profit. Katsuyama and his team figured out that, in this case, it was better to be the tortoise than the hare: If they slowed down the speed at which their information traveled, it would reach all of the exchanges at the same time, therefore giving them a fighting chance at trading at the initial share price.
They began working on a marketable version of this solution, called Thor, but needed someone who truly understood the fiber optics networks. This was where Ryan came in.
Ryan had moved to the US with his family in 1990. When his father’s job was going to bring the family back to Ireland six years later, Ryan decided to stay in the US.
As Lewis writes, “He didn’t think of Ireland as a place anyone would ever go back to if given the choice, and he embraced his version of the American dream.”His personal dream was to work on Wall Street. But after he graduated from Fairfield University in Connecticut, none of the letters of interest he sent to the major Wall Street banks yielded any results.
Instead, through an Irish connection, he landed a job with the telecommunications company MCI Communications. From there, he went on to become one of the most sought after systems managers for major financial firms – who, he came to realize, understood very little about the technology they were implementing.
In 2009, a friend of Katsuyama’s told him about Ryan, and Katsuyama invited him to interview for a job with RBC.
Ryan got his chance to work on Wall Street, though in a very different capacity than he had dreamed of at the start of his career.
After two more years of working on Thor and attempting to educate investors, Katsuyama, Ryan and Park decided to make the leap towards starting their own exchange with built-in mechanism to guarantee fairness. This is how IEX was born.
The idea was to create an exchange with an automatic delay that would prevent traders from using the speed of their connection to their advantage.
At first, the plan was to house the exchanges servers in a remote location such as Nebraska, but it turned out that all they needed to do was increase the length of the fiber optic cable. With 38 miles of fiber coiled around and around in a compartment the size of a shoebox, they were able to create that necessary distance and delay, and still house their data center in New Jersey.
IEX launched on October 25, 2013 and has far exceeded the expectations of both its founders and the financial world.
It performed far better than expected in its first few weeks, attracting smaller-scale investors, and then really took off after Goldman Sachs began trading.
As Lewis writes, this officially confirmed that “IEX had made its point: That to function properly, a financial market didn’t need to be rigged in someone’s favor. It didn’t need payment for order flow and co-location and all sorts of unfair advantages possessed by a small handful of traders.
"All it needed was for investors to take responsibility for understanding it, and then to seize its controls. ‘The backbone of the market,’ Katsuyama says, ‘is investors coming together to trade.’”
As Ryan explained in a recent interview with Bloomberg Business week, a number of high frequency traders have also been expressing interest, though a few have been perplexed that they won’t be receiving any of the special treatment they’re accustomed to with the other exchanges.
“We went along [to meetings with 15 of them] and said that while some of the press might give off the perception we’re anti-HFT, we’re not, we’re pro-technology. I’d say the meetings went fairly well. At the beginning they weren’t that receptive, they were a little bit skeptical about our speed bump, that’s all they knew it to be. But when they went through our architecture, a lot of them said, ‘You’ve thought this through, I like the architecture.’”