IEX Group Brad Katsuyama: Masters of Business (Audio)

And it's really a fascinating, um fascinating tale. You know, stop and think about what it's like to leave a million and a half dollar a year job in order to take up something that essentially was a cause. He started doing this because there were only a handful of people in the world Alds who knew what he knew. He figured out what was actually driving markets and market structure a little kookie and basically said, I have this knowledge, and I have an ethical obligation to use this knowledge

for the betterment of markets and the broader economy. And you know, lots of other people had figured out the structural issues and some of the loopholes that were out there in in the world and in the markets, and they were taking advantage of it by running al go driven high frequency shops and quite bluntly making hundreds of millions of dollars a year for themselves. But but Brad, who is as as nice and down to earth the person as you would ever want to meet. In the book,

he's described as RBC nice. He works at Royal Bank of Canada, and as any American will tell you, Canadians are just terribly nice people. They're delightful and Brad is you know, part for the course. He's just a real person, very very open, very transparent, totally ethical. I couldn't imagine a better person to set up a market based response to some of the abuses and problems that we've seen in high frequency trading. He's absolutely um just a fascinating,

fascinating guy. The story he tells is just amazing how he figured all these things out, Uh, just all around terrific. So I'm gonna tell you, Uh, sit back, relax and get ready for a fascinating story. Our interview with Brad Katsuyama of i X. This is Masters in Business with Barry Ridholts on Bloomberg Radio. My guest today is Brad Katsuyama.

You may be familiar with the name if you either a Michael Lewis's best selling book Flashboys, all about how the market structure has changed in light of high frequency trading, or if you saw an infamous segment of sixty Minutes where actually it was Michael Lewis who said the markets were rigged and that caused all sorts of mayhem over the next couple of days and weeks. Brad, Welcome to Bloomberg.

So little background on your history. You grew up in Ontario and are a graduate of Wilfred Laurier University in Waterloo. Is that correct? Came to New York City as an intern at the Royal Bank of Canada in two thousand two. I was here. I came as a full time employee, but I interned in Toronto, but I moved here. I moved here in two thousand two. Yes, and eventually you became the global head of Electronics Sales and Trading, which

is quite a responsible position. So being a kid from a relatively I don't want to say small town, because some Ontario is in such a small region, but Waterloo certainly is a relatively small town, as is Markham. What was it like coming to New York City and and landing on Wall Street? Yeah, so, I mean it was

it was a bit of a culture shock, I'll be honest. Um. I remember driving through the first time through New York and looking at all of the buildings and it seemed like every single building was as tall as the tallest building in Toronto. It was. It was. It was, you know, outside of the Sea In Tower that you know, the downtown core of Toronto was very pretty small. Um. New York just seemed massive on every scale. Uh so it was pretty overwhelming. Um, but you know, again adjusted and

I got used to it. And when you start working on Wall Street, what did you how did you find? You know, they talked about people from Canada being nice, the expression about Royal Bank Accounada is there there RBC nice? Yeah? How was Wall Street as an adjustment? Um? You know, I think I got really lucky you know when I when I worked at RBC in Toronto, in Canada, you know, they they're the number one bank there. Um. And when I moved down, when I got offered a job to

come to New York. RBC had just bought a bank, Dane Rousher, and they were ranked twenty three in the United States. I jumped at it just simply because you know, there's there's nowhere to go but up, and I felt like, you know, it was kind of a it was a very underdog mentality. UM. My mentor in the business was this guy Bobby Grubert, who was my boss for eleven and a half years in in in UH in the US. UH. And he was just a great role model, just kind

of kept me on the straight and arrow. Was a twenty three year old kid, and I could have gone a lot of different ways probably, and uh, you know, I owe a lot to him to kind of keep me on the on the right path. So so you began in the early two thousand's, and let's let's go back a decade and change what was trading like in those days? What was the execution like back? Sure? I mean, my you know, it was funny because I went from trading in Toronto, UM, where the market was entirely electronic.

My first job in the US was I was trading listed energy stocks, which meant I was dealing with the New York Stock exchange floor, so it was calling an order down to a floor broker. UM. And I remember being informed of the three minute rule, which meant if I give an order the floor and I saw print hit the tape, I saw trade hit the tape. If it happened within three minutes, it might not be my trade. And I was completely mind boggling to me. Um, I said, well,

why does the guy just get out to the post faster? Um. You know, I was the first trader at RBC to trade both listed and over the counterstocks. I was trading technology. They they promoted me to run technology UM Trading, and I traded NASDAC and I traded New York. And I could never understand why anyone would want to trade with the floor, because it was so much more efficient to trade electronically over the NASDACK terminal. Um, what you wish for? Well,

you know, it's funny because it's it's always um. You know, electronic trading has always been a more efficient way to trade than to trade through middlemen per se. UM. I think the evolution of that technology has gotten a little bit perverse. But I was always of the inclination that, you know, technology was was a good thing for the markets.

It has been so so. Now let's fast forward to around two thousand seven, when you notice the market was acting a little squirrelly, that every time you went to buy a stock, the market would run away from you. Just describe that early sensation of hey, something's a little funky over here. I mean, it was incredibly frustrating. UM two thousand and six. If I saw a hundred thousand

shares of Intel on the offer, I'd buy. I'd buy a hundred thousand shares of Intel if I wanted to, and U two thousand seven, I could buy eighty thousand and two thousand and eight, I could buy seventy thousand and two thousand and nine, I could buy fifty two thousand. The number kept going down, and when I would try to buy the next level of stock two, I would get a smaller percentage than I got the time before. UM.

It drove me crazy. And the funny part is I would I would call my tech team and I'd say, hey, guys, what is happening like? Watch the screens, look at what I'm looking at. UM. The most common answer I would get is it's a coincidence. You know, many people want to buy Intel at the same time you do, and I'd say, Okay, I'll prove you wrong. I'll cant to five and nothing's gonna happen until I press this button. And I can't to three or five or seven whatever.

Nothing would happen until I press the button. I'd blow the stock and um, meaning the offers would just all disappear, they would run away. I would get a fraction, most of it would disappear, some of it would trade, and then I would be forced with two choices. Right, you either wait and the stock might never come back to your price, or you have to chase it higher. And every time I chased, I got a smaller fraction and I'd be left with the same decision the next time. So, UM,

it became incredibly frustrating. And this at the time in O seven, I was running all of you as trading for RBC. UM. It was happening to every single person on my team. UM, so that that kind of was It was obviously a very frustrating time, and it was the financial crisis. So not only are we dealing with this market, that's kind of an illusion of what we thought the market was. Um. The world was melting down around us. It was. It was a pretty it was

pretty unbelievable time. Actually, I'm Barry rid Hults. You're listening to Masters in Business on Bloomberg Radio today. My guest is Brad Katsuyama, made famous in the book by Michael Lewis called Flashboys. He is the founder and CEO of i e X, essentially an exchange, you know, like the New York Stocktor Exchange or NAZDAK. You are a full on exchange at this point. We're called or classified an alternative trading system. Hopefully will be an official exchange by

the end of this year. Okay, that'd be great. And so you were made famous in the book Flash Boys because you were one of the people who had noticed that the market had gotten a little funky and weird and you couldn't execute orders. You're firm authorized you to

lose up to ten thousand dollars a day experimenting. Tell us about that, well, I think once we started to learn more about the exchanges and how they were set up uh and the things that they were selling to certain participants high high speed traders, we started to realize that the exchanges had a lot to do with the experience that we were having. UH. In order to test these theories out, we had to set up a series

of experiments interacting with different exchanges in different ways. Um And when I brought this proposal to RBC, I think it was very fortunate that I had run risk trading before, because they knew I could be responsible with capital. But I said, we need data points. We're running an experiment, and we can't use client orders to do it, which means that we're gonna have to spend a bit of our own money. But I'm not. It's not going to

get egregious here. You know, my limit is ten thousand, and that that limit might sound large, but in my prior job, we were managing millions of dollars of capital, so it wasn't really a lot between friends. Well, the interesting part is we didn't actually end up losing hardly any money. Because I would I would we buy stock on the offer, it would disappear, and you know, stock would move higher, and then I turned around and sell

on the bid and the stock would take again. So you're actually buying and selling that kind of the same price, and you get to data points for almost nothing, right, So so we did that we traded hundreds of millions of shares, testing out various series. Yeah, absolutely, we and it really it almost ended up a wash. So the part of the book that was fascinating, and it was also excerpted trying to remember where I saw the Wolves of wool Street New York Times magazine was it was

The Times magazine. Was the description. You hire a guy you know who's about this fantastic telecom backgrounds, and he explains how the physical distances from from Wall Street out the Holland Tunnel that BATS was located, the exchange. BATS is located closest to the Holland Tunnel, and literally you could track the cell line I'm sorry, the fiber lines out the tunnel and to each of these exchanges, and

that time difference is what affected execution. Yeah. We we had a lot of theories, and uh, Ronan Ryan is the guy you're describing who's a partner of mine at I X and and Ronan Ryan, you know, kind of just by a stroke another stroke of luck, we ended up meeting and he explained a lot of the missing pieces.

He turned it into physical geography, he turned it into architecture and networking and the things that he had built for high frequency trading clients at the different exchanges, and um, you know, everyone came to the you know, we hired a lot of people at RBC, and everyone came with a little bit of information. No one knew the whole picture. We kind of like put the jig saw together. Speaking of which you hire, you have a guy working for

you called Puzz one the Microsoft Puzzle Solving Championship. That's right, it was a team event. Uh, and we hired Puzz and his nickname is because he won that championship, Puzz. And And now at i X we have three people that have won that same championship in different years. But uh, it's it seems to be a you know, it's probably a good recruiting ground for people. It's we found some very bright, uh you know, talented people from from that competition.

So so you're not losing ten thousand a day, but you're experimenting. You're figuring out physically where all the exchanges were. And one of the things you discovered that when you routed orders to specific exchanges that were very different results.

That's probably being most notable. The first one out of the Holland Tunnel and and for people who are listening who may not be familiar with New York City, you could get out of Midtown to New Jersey and when you literally see daylight, the BATS building is not that far from the opening of the tunnel on the Jersey side. That's right. It was physically the closest to RBC, and hence we would always arrive there first. And the interesting

thing about Bats, meaning the orders would physically arrive. And we're talking about milliseconds between orders. Milliseconds, yes, um, and actually we we were looking at the world in milliseconds and Ronan was looking at the world in microseconds. Uh. And it just happened that Ronan could get an order

from BATS to various other exchanges. Um, and about four d seventy six micro seconds at the time is what is what he draw it drew out and said, here's the inn exchange latency between these buildings and RBC's was about four or five times greater than that, which meant that he could pick up a signal at BATS and race us. Now he didn't know that, you know, we

had a hundred thousand shares to buy. But what he would know is that the entire offering at BATS just disappeared, which gives me a very high statistical probability that this big buyer is going to try to buy stock in other exchanges. So you're out there running to cancel stock, or you're already out there to buy stock to turn around, and seldom me at higher prices. So so he was the guy doing the telecom side of Yeah, he didn't know.

He Ronan did not know a thing about trading nothing, which was amazing, right because you know, he came at this with a huge amount of knowledge, but he didn't understand the value of that knowledge. Um and it does now he does absolutely. You know, Ronan is probably one of the greatest assets anyone could have found. I feel very lucky that I that I was the one that

found That's amazing. Now, when you used to send, and when you say you arrived first, or you arrived at BATS first, your order electronically would arrive that message through the fiber in the ground would actually just arrive there first. So when you would route and order just to BATS, you would get filled. But if we would route in order, let's say to BATS in New York Stock Exchange, concurrently we get filled on BATS and we would miss it

on New York, which is amazing. Yeah, So the very first sequence of experiments was going to each exchange in isolation, and what you would find is you would always get a percent of what was offered if you only went to one exchange. And now they may be offered at different prices, so you're not exactly going to the best price.

Now it's all it's always at the same price. It is, but if you pull up and offer in Intel, you'll see it at multiple different places, or if you pull up an offer in forward stock, you'll see a multiple places. But we said, okay, we'll just pick one exchange, one amount. We'd always get a hundred percent. But as you started to add exchanges to exchanges three, four or five at the same time, the PHIL rates started to drop, but you were always getting a percent at bats you were

completely missing stock in other exchanges. So if if traders want to defeat high frequency trading and they only and they only routed orders to a single exchange, would they get filled that way? Well no, because not one exchange typically can satisfy your entire order. So when I pulled up my screen and I saw a hundred thousand shares of Intel, offered. It was typically spread across multiple exchanges.

Ten right, Um, if I only went to one, I'd probably get you know, five thousand or whatever was offered at that one. But you want to get what you saw. And and the interesting part it was in two thousands and six you could actually buy or sell what you saw on your screens. In two thousands seven that wasn't the case. I'm Barry rit Helps. You're listening to Masters in Business on Bloomberg Radio. My guest today is Brad Katsuyama.

He is the founder of I e X, which is a alternative trading system and soon to be in exchange hopefully, and the star of Michael Lewis's book Flashboys. Lewis was looking for research on an article for Vanity Fair and how did he end up finding you? So he he talked to a couple of people, a couple of characters in the Big Short who just happened to be clients of mind and Um. When he asked them, you know, I'm looking to do research on high freakncy trading. Who

should I talk to? They pointed him to to me, UM, a lot of people same name a couple of times. Eventually get some curious Yeah, I get you know, it's it's the most interesting part about it was really it was just about giving him background. He didn't ask a ton of questions about what we were doing, in particular I X. But when he came to New York, he has to drop by our office and he walked in um to meet with Ronan and I and uh, there

was twelve I think twelve or fourteen. I can't remember how many at the time, maybe twelve or fourteen people. We were in a two hundred square foot office with no windows. It was it was it looked it must have looked ridiculous to him. Absolutely closet. That's right. So we're there and all of a sudden, I can see the wheels turning his head is what are you guys doing here? And and then and then at that point kind of it went to I got to write an article about I X two. Maybe I'll take these two

articles and make him in a short book. And by the end he had done a lot of research, he had talked to a lot of people, and he came back and said, this is gonna be explosive. And to say the least, it was so speaking of explosive. You guys were on uh an episode of sixty Minutes where Michael Lewis famously said the markets are rigged and that caused a huge explosion. You know the next days and weeks it's resonated to this day. What was the sixty

Minutes experienced? Like? First, how tell us? What what was that it? Like? I mean, it's it's kind of you know, it was the first time I've ever been on television. Um, it's kind of amazing. Uh, you know, to be a part of that, and you know, it was nerve racking because we got we interviewed for hours, and we knew the segment was twelve and a half minutes, so you know, it could go a variety of different ways. But when one funny thing is that, um, we were the first

segment of three on sixty Minutes. By the end of the hour, I had more linked in requests than I had connections. Yeah, it was it was pretty amazing. I just said, I turned my wife and I said, holy caah, this is this is real. Right, that's astonishing. What what was the fallout over the next couple of days and weeks? I mean, I think you know, again, it's it's people were reading the book at that because the book just came out the next day. So it was just phenomenally well,

it exploded, It did well. Um, like there was just there was a huge amount. It was it was it was crazy. Our phone was ringing off the hook. Uh, tens of thousands of people reached out to us, and um, you know in a positive way. You know, the industry was upset. Um and uh you know that was to be expected, but again it was for all. There were so many great things that happened as a result of that. It's just you know that that's we knew that there

was gonna be a little bit of that. Um. You know again, when you talk about things people don't want you to talk about, that's kind of the fallout. So now let's do a follow up to that. Subsequently, on CNBC, you're on with the head of the Bats Exchange and Michael Lewis and a few other people, and that exchange turns surreal. He starts saying stuff that turns out to

be not true. He challenges you. You were almost you know, I know you don't want to say this personally, but it looked like you were holding back because you don't want to beat down this poor guy who's only the president of of the biggest exchange at the time. What was that about? That? Uh? That was that was an interesting experience. That was my first time on live to levision. I've never actually been on live TV. And you look like a pro. You were just so smooth and in

the middle of it. Um. I just remember saying to myself, like, is this is this actually happening? It's just it was, it was, it was. It was kind of crazy. What what stood out was you turned him and said you really want to do this, Let's do this. That That was the quote. It's like, I'm giving you an out and you're not taking it. So for those people who may not have seen this exchange, he made a number

of statements that turned out to be patently false. The New York State Attorney General General Eric Schneiderman forced Bats to issue a I didn't want to call it a clarification, it was a retraction and basically said we were wrong. I was referring to what we're gonna do in the future or some nonsense like that, And a few months later he's out of a job. Any correlation between that incident and it wasn't like he announced his retirement. He was gone and they announced he was no longer with them.

It's hard to say, Um, you know, I think what was important about that is that, um that the Attorney General made him correct his statements. And what you have a lot of times is you have what what we're arguing about is completely unknown to the to the general public. Anyone watching that. Very few people, i'm sure, understood even what we were fighting about. And we're fighting about a very important part of the market, meaning there are multiple

ways market datas distributed. And essentially, are you using a slow feed to price trades for all of your participants, knowing that some people who trade on your exchange have a very fast feed and that that that was the argument, and that's what yes, And I think without that level of accountability, no one would have known who was saying what. It just would have looked like, you know, a bunch of crazy people yelling at on television. Um. So, I

think holding people accountable is extremely important. It's the way to make the markets better. Everyone says that they want the markets to improve, gonna start holding people accountable. That's the way to make them mark. If there's if there's no recourse for saying whatever you want, UM, you know, at some point the more it's just not going to improve. And I think that, you know, that was an important step. At least somebody took charge there and said, you know,

you have to own up to what you said. I'm Barry Ridhults. You're listening to Masters and Business on Bloomberg Radio. My guest today Brad Katsuyama. He was featured in Michael Lewis's book Flash Boys, and he is the co founder of the I e x alternative training platform, hopefully soon to be a major exchange. Let's talk a little bit about I e x um dark pools, something that was commonly used by big firms. Explain exactly what dark pools are. So. Dark pool is kind of the the you know, the

street lingo for alternative trading system. And really what it means is that, um, they're slightly less regulated um than exchanges. And what they can't do is they can't publish bids and offers, which means everything that happens in them is essentially dark um. But but you know, they're good guys. They're not gonna hurt anybody. They're not gonna scalp a quarter from everybody who comes in there and not tell them about it, right. I think, you know, the interesting

thing about dark pools is they were started with good intentions. Um, you know, if a bank has a buyer and a seller, they shouldn't have to go on the exchange and trade that and pay the exchange to do so. They should be able to do that internally. And um, they ended up. I think the competition was so fierce, many of them ended up morphing into something that, um, that was not intended. And uh, you know, over the course of you know,

the past decade. Um, that's kind of what's happened. And I think we have forty over forty dark pools in the United States. That number probably comes down over the next couple of years. So I began my career as a trader, and the question was always, hey, do you put the order out on instantet? I know, you know, uh salar nuk and is trading. Those guys started an instantt or at least we're there for a long time

before they decided to launch their own own farm. Also critics of of high frequency trading, So the thought of these dark pools where nobody really knows what's going on and which just relying on brokerage firms to uh, you know, do the right thing and be on their best behavior wasn't very satisfying to you as someone trying to get

orders executed. Well, I think, you know, there there are some dark pools I think that serve a very good purpose um and there are others that I think have sacrificed quality for trading more volume and um you know it's there. There's there's a direct correlation between the quality of trades and the and the frequency of trades. Um So I think that again it's you know, you look back to the days of instant net um. You know

there was a purpose. If if someone has a million shares to buy, you can't just force them to put that all out on on the exchange and display it. It's gonna have a very adverse impact on the ability to you know, to complete that order. Um So, there

is a home for large orders in dark pools. I do feel like, you know, we need more disclosure, We need much more transparency and how dark pools operate um And I think as we get more transparency and disclosure, you're gonna see a lot of dark pools you know, shut down um, but the ones that are left, you know, will serve a purpose because there there definitely is. A stock exchange can't solve every problem that every investor has because a lot of times their orders are too big

for the markets themselves. So now let's talk a little bit about I e X. And in the process of setting up or trying to execute orders, you came up with a few insights which had to do with, hey, if we can find a way to get the orders to arrive at all the exchanges at the same time, we're not going to be scalped or picked off by high frequency traders. Uh. That was originally the Thor product that you have developed at RBC. That was the Thor

router at RBC. Was was really to say, if there is this geographical disparity, meaning you know, our order arrives at the exchange closest to us first, why not you know, stagger when you send out the orders to try to arrive at all places at the same time. And it was it's a lot harder than it sounds because latency changes throughout the day, and it's milliseconds we're describing now. Now we get down into microseconds, so you have to be within a few microsoft few millions of a second

have the order arrived at a dozen exchanges. Our goal was to have it done under four hundred micro seconds, and we got it down to about two d and ninety microseconds. But when we did that, our phil rate went to a d um. That product could actually now

buy or sell what people saw on their screens. Uh. And it was the easiest product to sell because you were just walking to a client's office and mutual fund or hedge fund and say, if you see a million Bank of America on the offer and you try to buy that, what percentage do you get And they're gonna say anything from I'll get you a hundred percent. They'll say, give me the product. I mean, it was it was

really that. It was pretty simple. The challenge was this is that our our our revenues took off and then they started the flatline um And one client put it put it the best when he said to me, Brad, we love what you've done, we love your team, we love RBC. You've only solved three percent of my problem because that's the amount of commissions, that's how much I can trade with RBC, I have to trade with all

these other banks for for legitimate reasons banking, etcetera. So UM, that was kind of the moment when we decided to leave OURBC and start i X, because we realized, number one, no broker can solve this problem. Even the biggest broker. If I'm Goldman Sachs twent of market share, what does that mean? UM still leaves absolutely the way to solve this was to actually be a stock exchange, because the

stock exchanges have enabled what's really happened. You know, I think that that in a way there was a responsibility by the exchanges to prevent some of what's happened, and they they've kind of enabled it. Were speaking with Brad Katsuyama, co founder of i e X, so let's talk a little bit about the shoe box. You came up with the insight that said, hey, everybody is racing to go faster and faster. What would happen if we forced everybody

to slow down? Yes, and the original idea was, well, let's put our exchange in Omaha, ne Brasta and not

let anybody co locate their servers there. But then UM, one of the guys came up with a suggestion you don't need physically miles, you just need a spooled fiber optics, which is essentially a shoe box with thirty eight miles worth the fiber optics of coil cable of coil cables, and and explain what the shoebox of coiled cable does to orders that come into And it's interesting because the guy who came up with the idea worked at a high freakin see trading firms previously, absolutely and worked at

I And what they do is they use these spools to recreate geographical distances. So like in Europe when you're looking at the difference between different exchanges, it's all done in the same room. There's just different levels of spooling happening, and you can recreate quote, physical distance in a single room right as they're testing strategies. But so he came up with the idea. The premise behind the idea was that we never wanted anyone to be able to execute

a trade on I X with advanced information. Right, Um, there's this. There There's two things exchange is really look to sell. One is they all very fast data. Right, so if you want high speed data, you gotta pay for it. Um, there's nothing inherently wrong with someone buying fast data because someone will always get it first, and someone will always get it last. Right. Um, someone in New Jersey will get it before someone in London, just

basically based on the speed of light. Right, So the sylgical distances how long it takes that message to go to from from the exchange New Jersey or the exchange across the Atlanta absolutely right. So, so fast data is one thing, but the notion of co location place your server right next to the exchange matching engine, buy this

high speed cable. What that allows is the person that's buying the fast information to trade hundreds and thousands of times before that information makes its way to the end the last person. Right. Um, we inherently see a problem with fairness in that. So we've done is we take very fast data into i X, we buy all the direct feeds. We've spent a lot of time, uh and money and effort and getting very fast data to i X, but we we realize will never be as fast as

the fastest high frequency trader. The shoebox. Essentially, that coiled cable is to say that's that's our heads start. So if they get information that the stock has gone from ten to nine, and they want to come in here and sell stock at ten against a buyer who doesn't know that the stock has moved lower. Right, Um, they send that order to I X and it starts to go around the shoebox and it goes around the coil.

And as it's going around the coil, I X will get the update the prices changed from ten to nine, and we will not let that trade take place at ten. That's the whole thing, right. The exchange's job is kind of like the referee in a way. Um, you have to understand what the conditions for fair trade is. It's both parties having equal relative information the prices nine, don't

let the stock trade at ten. The issue is that high speed traders have faster information than the exchanges, which means that they always know about a price before the exchange actually understands this is the market wide price. And I think that's that's the shoe boxes about us slowing them down. How much does the shoebox actually slow h f T It's fifty micro seconds is the total. So the shoe box is located in a different data center. That data centers about five miles away, plus the shoebox

adds another thirty eight miles. In total, it's three fifty micro seconds millions of a second, one one thousand of the blink of an eye. Um. But it's enough time for i X to always ensure that we know the most up to date market information so that we can fairly and consistently fairly priced trades. So their orders can't front front run anybody else's inform, they can't pick someone off who doesn't have information that they have, Yes, milliseconds

ahead of them, milliseconds thousands of a second. That's too slow. Yeah, I mean it's we now measure everything in microseconds. That that's just absolutely astonishing. So there was a conversation the part of of the book where i X launches and flashboys, and you were concerned, Hey, you know, is anybody going to come to this party? We we just built this whole exchange on the theory that people want fair pricing.

They didn't want to give anybody an advantage. And you had no idea if anybody was going to show up. What what was it like launching into that circumstance. It was nerve racking, to say the least, because because if there was this kind of chicken and egg problem, UM brokers would say, well, you have no volume, so why would I send you any volume? Meaning liquidity begets liquidity.

If everyone takes that approach, you'll never trade a single share because everyone's waiting for someone else to trade a share, So you need someone to go first. And fifty million shares was your number that you thought, all right, if we get at least fifty million a day, maybe we can survive. Fifty million was kind of yeah, it was. It was a survival number UM, and we ended up doing five hundred and sixty thousand our first day. Uh. Some people were predicting we do shares the first day,

so nobody, nobody had. The guy with the most experienced launching markets is the guy Matt Trudeau. He runs, he runs our products. He's launched seven different markets globally. His prediction the first day was share is UM and what are you doing now? Well, our record a few weeks ago was a two million shares. That's fantastic. So yeah, the the growth has been nice. Can you stick around a little bit. We'll throw the rest of this on the podcast portion so I've been speaking with Brad Katsuyama.

He is the co founder of i e x Exchange. If you like this conversation, be sure and check out the rest of our chat that'll be on Bloomberg SoundCloud and of course Apple iTunes. Be sure and check out my daily column on Bloomberg View or follow me on Twitter at Rid Halts. I'm Barry Rihults. You're listening to Masters in Business on Bloomberg Radio. Welcome to the podcast portion of our show. Now I could uh throw my papers away and just kind of cut back. Rad. Thank

you so much for doing this. You know, I've been somewhat of a critic of high frequency trading for a while. UM. One of the interesting things that Joe Saluzzi had said not too long ago was on a SCAE all of zero to ten, where where are we in the process getting better? And he said we're out of four, um, which was kind of surprising. You know, the pushback that I've gotten from people, um who I don't want to say or pro h f T but just aren't as critical,

let's say. UM. Jack Brennan is chairman of Vanguard. He says h f T has lowered costs lowered expenses for them Titan spreads. Um cliff astness of a q R is a huge shop runs a hundred plus billion dollars. He thinks his comment was, Hey, listen, look, you guys complained that liquidly disappears when h f T guys unplug their machines. How is that any different than what specialists used to do. If they don't like the price, you don't get executed. They just dropped their bid further and further.

How do you respond to those sort of comments? I think a lot of times, Um, you could interchange h f T with just technology. Technology has made things cheaper, has allowed spreads to titan. Decimalization helps press titans as well. But you know, I think a lot of the benefits people bestow on the general category of high frequency trading have more to do with technology than it does to

do with anything. UM. The difficult part about the debate around high frequency trading, which is why it's still a debate five years later, we're still talking about a lot of the same things, UM, is that we haven't even talked about the flash crash, which there's still disagreements as to what the unsaying. Absolutely, you know, that the toughest part is is that not everyone who uses a computer to trade is doing harm to the market, and not everyone who's using a computer to trade is doing it

for the benefit of society. Right. It's people are doing both and I feel like, you know, the one the one part about i X that that that I'm really proud of UM is the fact that we never made this about shutting out high frequency traders per se. We just built a market we felt could not be gamed, and as small segment of high freakingcy traders still showed up,

and I give them a lot of credit for doing that. Right, So Virtuo is one and UM they're they're pretty huge, They're they're one of the biggest UM and I'll say they're they're they're a very good partner of ours at i X. But when we walk through the things that we're not giving them the thing, the advantages they won't have that they might have on other markets, they didn't care at all. They said this is good, this is

good for the market, will be their day one. We like what you're doing, and we've both been supportive of each other. So it was never really about saying all computerized trading is bad. You know, my my when I when I traded New York listed tech on the on the Stock Exchange floor, and I also traded over the counter on the NASDAC terminal, I liked electronic trading a hundred times more UM master cheaper, better, easier, instantaneous, con more efficient. Absolutely, It's just it was. There was no

question the way the market was gonna go. UM. The challenges that a lot of people are using technology UM to make money and scalp off of traditional every investors. The markets become at times more volatile, intra day volumes are inflated. It's just you know these it's it's sense.

It can go both ways. The people that want to provide cover can use very generic statements about technology driven trading and call it h f T UM, and then we can come out, or or Joe and Sal can come out, or Michael Lewis can write about h F T and and really focus specifically on the parts of it that are bad. UM. And the fact that you know, it's cheaper to trade now than it was twenty years ago, that's not a defense for the things that we're saying,

because we're getting you very specific critiques. UM and and there's very generic replies to that, and I think again it's it's part of the argument, but for us, it's you know, it's more about fairness and and that's why, you know, I'll come on here and say a firm like Virtue is a partner of i X, even though they're quote classified a high frenzy trader because they've chosen to play by our rules. We've set the rules. You know, we're experts in the market. We know what we're doing.

We have people from exchanges and high prency trader, any firms that work at i X. We set the ground rules. They've decided to play. I give him a lot of credit for that. What what other firms that are thought of as h f t s will trade through uh X so G GTS Securities is another one, um, you know I M C Trades uh You know Night has it as a variety of businesses. Um, but Night's a good partner of ours as well, right, so they at one point in time where one of the biggest, if

not the biggest volume on the deck. Absolutely, but you know they have a very diversified business. But they've been good partners of ours, right, So it's you know, and it's in Goldman Sacks. Uh. You know in two fourteen was our largest volume providers. So um. The the goal for us really was to build a market that we've believed to be fair and fair consistently. That's I mean, if if the stock market is not fair, what does

that mean for everything else? Right? It is, it's it's it's That was the goal and I've we've done that. And the fact that of a wide variety of people have shown up uh and provided support that gives us a lot of confidence that this this is this is the right model. And I think a lot of people like the fact that the market itself is fixing some of the structural eras it has. This is a market

based solution to a whole series of problems. You know, we're we if you look back at the last century, right, we're caught in this pretty pretty vicious negative cycle. You have a scandal, it's followed by regulation. There's no such thing as a perfect rule. That regulation will create loopholes and inefficiencies consequences. People look to exploit the loopholes, and they exploit it so badly that it creates the next scandal,

which creates the next set of regulation. And as as regulation increases, it raises the barriers to entry for disruption. It makes it harder to disrupt an industry that's so heavily regulated. UM. Which means that in a way, the people causing the scandals are the ones that are that that remain in this industry as the walls get higher and higher. UM. So you guys are the uber of mind. We feel like, you know, in a way, we're trying to We're trying to we're trying to disrupt Wall Street

in a productive way. UM. It's not productive the relationship Wall Street has with main Street because main Street needs Wall Street whether they like it or not. Um, they just don't like the way Wall Street has behaved over the last you know, a few years. And I think that, UM, you know, we're huge proponents of of what Wall Street does, but we think it can be done in a better in a better way. There's no no doubt about that. The cycle you described of scandal, regulation, loopholes, gaming it

scamp what was a little different. And I have a lot of criticism of HFT and maybe we'll get to some I'd love to hear your responses. Was the fact that suddenly we had the New York Stock Exchange that was a nonprofit sort of public commons. Almost suddenly it becomes a for profit entity whose goal is no longer serving the investor, but serving their clients, who turned out to be the ones who could pay the most, or the h f T who are paying for the early look,

who were paying for co location. The way that structure came about was, look if I if I said, hey, here's the system where you could look at people's orders before they're executed and front run them, that can't possibly be legal. But if I set up a series of high speed lanes and slow speed lanes and you could sniff this and see those packets, effectively, it's the same thing,

but somehow legal. Well, the funny part is is that you know, as you when you read certain things, certain fines that come out, or when you read, if you replace the act of a computer with an actual person, that person would be penalized a lot worse than the computer gets penalized in today's market, because some of the stuff is kind of outrageous what happens in it. But but programmers don't get penalized. They're taking advantage of you know,

it's like playing a video game. You're you're not penalized for shooting them out of the sky in a video game. That's all this is is a video game for money. Yeah, I think I think you know, you kind of hit the nail on the head where you know, in essence, I X is a free market solution. Um, it's our choice, and we're trying to correct inefficiencies. We're trying to patch up the loopholes. We're trying to and trying to make the system better. Um. In a way, the exchanges could

have done what we've done. We've done it all within the regulation. We haven't asked for any rule change. But they chose to sell technology and sell data. They're they're they're part of in a way, exploiting loopholes, and it's very hard to get them to fix themselves. There are very few companies that can disrupt themselves. Well, you know, if you look what Apple did with constantly lowing the price of the iPod, most companies and to a point

where huge huge improvements. The same thing with the phones, and that's unusual. Typically companies are disrupted from the outside. Not hey, this is our bread of but bread and butter what do you mean we're gonna drop the price in half but will be twice as good. Nobody does it. Yeah, I mean part of a lot of people will say, you know, this is the right thing to do for my shareholders. I make as much money as humanly possible from my position in the market. And UM, you know,

I think that's it's a it's a it's a valid statement. Um. It also serves to excuse a lot of really bad behavior with without question, without questions. So I think you know you for us, it's you know, starting a new market in two thousand and thirteen, Uh, understanding very clearly the mistakes that others have made. Um, you know, we just feel like we're in a very good position to just build a different kind of marketplace. And let's talk

about that a sex. So you know in the book, um, and I want to talk a little bit about Michael Lewis and a little later um, because I think if he keeps it this writing thing, he's gonna be really influential one day, because he shows a lot of potential. I love his stuff. Every time a new book of

his comes out, I save it for vacation. And it's my It's just my favorite, most delightful vacation reading so um and he his columns that he publishes here are ridiculous because you can have a column that's doing really well in the terminal and then a Michael Lewis column comes out and that's that. Nobody is even close. It's like number one with a bullet for three days. It just hangs around. You look at most you know, other ways on the terminal, most most emailed, highest ranked, most read,

and his are just like glued to the top. It's it's almost it's almost funny. So you get the idea to set up this company, you have to think, geez, this is gonna cost tens of millions of dollars. Was RBC supportive of this with an investor in this No, so OURBC non investor. Originally we went around to try to do this with URBC. I brought the idea to to my boss is there and I said, this is

an idea, let's start in exchange. Uh. The feedback we got from our clients, the big mutual funds um was that we like the idea, but RBC can't be involved because they're a broker, or because because other brokers would not want to use a solution provided by RBC. UM. You know, so, so are any of your sun investors brokers? So Goldman is not an investor, it was an investor. Yet no one who's a subscriber to our platform, meaning Broke is an investor. No broker is an investor in

in a so mutual funds, hedge funds. Uh. There's some venture firms, there's you know, entrepreneurs, there's it's all sorts. In the book they mentioned David Einhorn and I think was Bill Bill Ackman, Don Lobe Lobe Capital Group, Franklin Templeton, Mass Mutual, Jim Clark from Netscape, Steve Wynn UM. So we have we have a really great group of end users, UM. And it's it's very you know, most people own a percent,

like it's very very small, UM. But we wanted, you know, a broad consortium of interests that represented the end users of the stock market. And really it's the issuers and it's the investors in the stock market that matter most. Um, How are you gonna avoid the temptation when I don't even know who owns arkinnet these days comes along and says, here is a billion dollars we want to buy you or when Goldman says, hey, we can take you guys public,

What what do you do about that? I think? I mean, you know, we we we thought a long time about i X starting as a nonprofit UM. And the reason we decided against it is because we're competing against for profit entities and when it comes down to competing for talent, when it comes down to a lot of things, UM, we couldn't let the solutions suffer because of the way we structured the company. UM. So you know, we'll continue to look for you know, just doing the right thing

for the mission. That's the that's the key. There's been a lot of interest in i X already. UM. You know, we've we've turned we've turned all that down because we feel like we're you know, we're still on a mission. But you know, if the right partner comes along and you think it's the right thing to do for the mission. In the business, it's really this, this is a mission based company. UM. We care a lot more about that than anything. And it's very distributed. You know, I don't

own a huge chunk of i X. UM. I mean we're going around talking to your partners all every single person that I excellent equity UM and it's very evenly spread out amongst you know, kind of the the top. There's there's uh you know, uh you know, what's the structure. What's the structure at the company. It's you. So it's it's so yeah, So it's me. Um Ronan Ryan is our chief trategyman Rob Parts described in the book, and

Rob Park was our CTO. He he worked with me at RBC and and John schwall is our chief operating officer. UM hired him at RBC from Bank of America. He was the he was kind of the the LinkedIn guy that did all the background research and um, you know, we Don Bullman was a co founder. He came from NASDAK. UM so we you know, Zorin Perkov ran global operations at Nasadak. He came aboard. John Ramsey came from the SEC. Sophia Lee came from Liquid Net. We just we just

you know, we just feel very lucky. Claudia Crowley we just hired at their chief regulatory officer. She came from the New York Stock Exchange. It's like the nineteen nine Yankees. That's a uh, that's a murderous row. We're building you know. And and the great part about it is, you know, it's i X is not the best short term uh lucrative place to work, right, people are getting rich this year. UM.

So people come for the mission. They come because they believe in it, and they believe in it long term, um, you know, And and the goal is to be successful long term. So there's a long term payoff to this. People come, um looking out three five years and that those are the kind of employees that you really want. And you know, part of the that the challenge you on Wall Street in general is a lot of people live year to year on guarantees. Um. There's a huge

sense of loyalty. Um. What I find is that, you know, certain firms are incredibly well cultured and certain firms are just completely toxic. And um, you know, you want to build long term culture. UM. And again it's it's we're trying to build that at i X. That's that's really interesting. So now you've hit a hundred and fifty plus million shares a day. What sort of revenue can this company do?

I mean, you guys always going to be a niche player, or can you scale up to be five or ten percent of the total daily when you look at it, Um, we're one, We're around one percent of the total market right now. Um, but we can only really compete for fifteen or twenty of the hundred pie. Fifty six percent of the volume every day is displayed quotes, which only

exchanges are authorized to do. UM. You know, ten percent roughly is the open closing auction plus pre and post market trading trades, retail, you know, with wholesalers and internalized So there's so much volume that we don't have access to right now. Um. Becoming an exchange obviously unlocks a lot of a lot of potential for us. So UM, you know, we feel like this is kind of just the beginning. You know, if you back to you know, talking about Joe thinking we're in the fourth inning or

four out of ten. Yeah, I think we're a third or fourth inning of the game. There's a there's a lot of there's a lot of ball to be player. So once you become an exchange, and I have a hard time imagining that the SEC isn't gonna say, hey, these guys solve a lot of problems, take the workload off of us. You become an exchange. Over the next twelve months, eighteen months, somewhere all those time that timeline. We're hopeful, Well, we're hopeful it happens this year. Okay,

so before is over. What does that do to the potential volume that you guys can count. I mean it unlocks more than half the market that we just can't touch right now. And I think that, Um, you know that's significant. And and we're we're keeping the principles of what we do. Um, we're not paying rebates, maker takers obviously, no maker taker, no order flow payments. Basically, it's just a fair price. And that's what you get. Simple, transparent

and fair stock exchange. I mean, that's what we're trying to be. And um, you know, there's an elegance that comes with simplicity, meaning people understand what your market does and why and why you exist. Um, and the stock market is anything but that. It's you. You need to hire people from a firm to understand what that firm actually does. Right, and so we you know, most of what we've learned from exchanges you can't find by going on Google. You have to find people that have worked

that exchanges or find people that know them intimately. Well, So I think you know, it's amazing the function of the stock market is so central to the economy. It's amazing how few people know how the stock market actually works, myself being one of those people five years ago. Right, So, um, you know, we want to build a market that people understand.

That's that's amazing. So let's talk a little bit about Michael Lewis, because he's come up as a thread throughout and full disclosure, I write for Bloomberg View, which is published The publisher is David Shipley, and I know they have a longstanding relationship. Um, but you and I haven't discussed this beforehand. Sure, so I'm kind of drying. I sent you, Hey, let's talk about these things. But let's

talk a little bit about Michael Michael Lewis. So you finally meet him in in your window Lists office with you and you and Ryan, and he starts to you see the gears turning mentioned yeah earlier. How long does that conversation go on? What? What is that? Like? This is for the in the Fair magazine article, not for the book. Yeah, it was, Um, I had I had read almost everything that he had ever written. Um, I read Lars Poker. I'm sure like everyone does before they

come into business. You ask what book should I read? You read Liars Poker, which I always tell people market Wizards. But Margaret, I read that too, But because I find Liars Poker gives them, Hey, that's an eighties perspective that universe does hasn't existed. The funny part. The funny part is Michael Lewis is kind of horrified that that people read Lars Poker as a how to manual, and because

he wrote it as kind of like a warning story. Right, it was an apocryphal tale, Hey, don't let this happen to you, and people actually use it as Oh, so that's that's what it's right. Um. And Moneyball, Um, it's probably my favorite Michael Lewis book, including Flashboys. I love Moneyball kind of changed my perspective on on business and and and and challenged me to think differently. Um. The book was great, the movie was great. You mentioned him Clark The New New Thing, which I think maybe his

least known book is another one. It's amazing. It's a great it's a fat and it's amazing that you mentioned Wait, that's a Michael Lewis book. Yeah, it's a huge book. And the next one I have cued up for vacation is The blind Side. Yes, the football book, which I have not yet. Fantastic, That's what That's what people have said. It's it's so you finally get to meet this guy

who you have a tremendous amount of respect for. What's that first meeting, Like, you know, we we just try to um convey what we knew, UM and and do it in a way that that would make him somewhat interested in us. At the time, we had no money. UM, we had nothing. You had already launched the firm. We we had started the firm with our own money, which

was which basically we ran out of UM. And you know, at the time we kind of you know, it's I don't think it ever would have been a personal choice of mine, UM to be in the position I'm in, UM, because it just it changes your life, UM, to be it being on sixty minutes, being in this book, it has changed my life. UM. But as the CEO of I X, it was absolutely the right thing to so

we we kind of went all in. We had nothing to lose at that point, and I think, um, uh, you know, the very first thing we did is we went and got in a in a car and drove to all the different UM centers with Michael Wis in the car. We drove, We drew out the map and said, you know, here's why our orders were getting into different exchanges at different times. So you go out the Holland Tunnel and you take it. He says, I want to drive these routes, so we are we okay? So, which

sounds like him. Yeah. So we got in the car and um and and and drove the routes and um, you know, spent the day with him, going to different datas and you know, he walked away his head was spinning to think, I just I just saw the stock markets, but not the Star War because people see on TV building in New Jersey, that's right. And um. So so it went from I'm gonna write a short story about I X and which again was super exciting, He's gonna put in Vanity Fair. Um. But he started talking to

more and more people. He just he every time he came to New York. He'd spent a little time with us, but he was out there canvassing meeting. The amount of connections he has is incredible. It's the amazing part is that we were going around to the asset management community to try to raise money. UM. And as we started to talk to Michael Lewis, Oh yeah, we talked to him for for the Big Short. We talked to him for the Big Short, like every other person I talked

to talked to him for the Big Short. I was like, now, they never would offer this information if they didn't know that we were talking to him. Um. But you just realize how many people he actually knows UM and some people at firms that I'm sure they'd be fired if they knew that they were talking to Michael. Absolutely, it's uh, you know, and he's got away, He's he's uh, he's brilliant at what he does. I call him the poet Laureatete of Wall Street. He nobody tells a finance story

the way he does. And it's always focused on these interesting characters, of which you're now one of you strike by the way. Anyone meets you on the street, they're like, oh, yeah, I met Brad. He's a good guy, you know. Yeah, I think he's Canadian. That would be it. Most of the other characters in his books, there's Jim Clark or Michael Barry, or or some of these other guys. They're

always a little off kilter and fascinating. I'm the most unlikely Michael was character probably ever to be in a book, and I think that's right. He he had. He told me he had a hard time writing about me, Um simply because um, he said, he goes it's he was trying to dig up anything he could on me being in the Israeli Air Force. That was really, you're fired

a pilot. And I'm only kidding. I'm only by the way I find myself having to constantly when when you're a little bit sarcastic, you have to clarify because someone's gonna say, wait, Brad wasn't a fighter. You have to be, without a doubt, the most. Yeah, lacking abnormalities is the best. You're You're an ordinary Wall Street guy. Hey, you had a big job as a trader at RBC. You made

a lot of money. You were making seven figures. Now that that had to be a lot of a lot of fun, a lot of hard work, but nice to put a little money away. And now you're running a startup. That must that must be the most aberrational thing you're doing is giving up Uh, seven figure job to say, Okay, we're gonna go fix Wall Street and we're not gonna make a lot of money. First, quitting was was definitely at a character for me. I probably could have retired

at OURBC. It was actually the only company I'd ever worked for. I was an intern there and just and just stayed because it was comfortable. I got offered more money to work elsewhere. But I like the people. I had a great relationship with my immediate boss, and um, it was it was kind of a different thing part

of leaving. The big thing. The reason, one of the big reasons I left was that after we we created Thor and RBC's electronic platform, took off all of the people on on all of my key people, including myself. We're getting big job offers away at different firms. Um. And it became very evident to me that that doing nothing would have led to our team getting dismantled. It was gonna break up anyway, yes, and so you might

as well take the whole team together elsewhere. Well. That that part of that was I sat down with with John and Ronan and Rob and said, you know, how important is this for us to stay together? And and we had built. You know when you go through things like that and and you know it's it's you come, you come from nowhere to to you know, doing something, and you had discovered the problems we had discovered because every rock we turned over had something under it, and

it was just this amazing, like mystery story. Like every person you meet, you another piece ad gets out of the puzzle. Um, we kind of collectively decided, you know, we're willing to take this risk. And there's one really funny moment where I'm home and I'm talking to my wife. I'm like, you know, we're getting ready to leave, and she's like, well, what percent chance do you think this has of working? I think? I Am like, oh, I

think it's pretty low. I think this idea we have right now probably, and she's like, you should probably clarify that with Rob and Ronan and John. So I came in the next day and said, guys, write on a piece of paper, what percent chance you think this idea? Yea we have right now for I X. But it's not i X as you know it today. It was a different version of I X. It actually wouldn't have worked.

It wouldn't have worked. Um, this idea we have right? Now, what what chance do you think this idea has of working? I was the highest at everyone else was lower UM, which was funny, but they all what we all what we all agreed was that there was a seventy chance that the four of us would figure this out. Like so that's a very different set of odds. Hey, listen, this one issue may not work, but we could pivot to something right And what was that pivot? Was it?

The shoe box was part of part of it was the shoe But the very first idea we had was we wanted to be the smart order router for the street, which means everyone sent us your orders and will rout them out to the exchanges. UM. Now the problem with that is all the big banks have built their own smarter routers, so so it's a very invasive request to say, I'm gonna now we're oute all your orders on you know for you. UM that that idea never would have worked and UM, but we quit on the notion of

that idea, which which which was slightly insane. Except for that, we had a lot of faith in each other. And I think that UM had a great track record. You guys had Let's let's clarify this a little bit, because a lot of startups have launched with a lot less. First, you guys essentially figured out what the heck was going on with the market when there really didn't seem anybody else that really got it in the way that you guys did. Number one, Number two you created a product

thor which solved a lot of those problems. So there had to be some degree of confidence. Okay, we know more about what's wrong with the structure than other people have. We've already demonstrated an ability to use technology to resolve it. Can we take those two things and put it together and build a real company around it? Yeah, I mean you kind of you. You nailed it. Um. The one other big point um that I made to my wife was that because she was really the one she she

was the one who allowed I X to happen. Right are are are set? Son was born three days after my last day at RBC, so it was there's a lot going on in our personal She must have been thrilled with you. Yeah, well we we we got to the right place. Um, and she's been amazingly supportive. But what I said to is I said, there are very few people in this world that can solve the problem we're trying to solve, and it may not work, but you know, I would probably regret it for the rest

of my life if I didn't actually try. So you have you have no choice. This was this wasn't all we gonna do this. It's I'm running out of reasons not to do that. That was kind of it. And and uh, I ran out of reasons not to do it, and and um and and it's it's always scary to leave, especially a job you're comfortable at you've been at your whole life. Um, but yeah, it was by the end of it, it felt definitely like the right decision. And you know, RBC is still a great client of ours.

I still have a great relationship with with my former team there, and um, you know, they were very supportive and and they're still doing really well. So it's it kind of worked out for everybody. But um, yeah, it was. It was. It was interesting times, but you know, to in to be in a Michael Lewis book, never in a million I spent my entire life trying to just get along with people. I'm I'm more of a go

with the flow kind of guy. I don't have these like heroic tendencies where you know, I'm running for class press. I didn't do any of that. Um, fairly normal guy and this just happened. Michael Lewis described it best when he said, you're a normal guy in an abnormal situation. And so now you go from the conversation with investigating h f T to hey, I think I want to do a book. I want to do a short story.

Ones at what point did that magazine story become Hey, I'm going to do a book and you guys are going to be the driving factors in it. So so he came to the conclusion about the book. His his journey through high freguncy trading and the exchanges and market structure was similar to mine. Everyone he talked to, and the more rocks he turned over, the more stuff he found. Uh, and he stumbled on a lot of stuff himself, and UM, he's good. Oh he's amazing. And by the end he

basically said this is going to be a blockbuster. Now what I didn't did he really say that? He said this or the book was bubble. He said this is going to be explosive, This is gonna be explosive because he was consuming everything that was written, and he realized he was writing things that have not been written before. Um, and which is unusual because let's let's go back and look at well money Ball was unique. Uh, the new new thing wasn't so much unique, but just a uniquely

told story. Was a retrospective. Yeah, I mean, my you know, when I wrote Bailout Nation, it was one of the first books on the financial crisis, and I couldn't read anything afterwards. And then the big short comes out and I'm like, I'm dying to read it, and I'm like, you know what, I'm gonna hold this till February with Nona Barbados, So I'm gonna read so the year after the February after the book came out, and I think

came out in like May or June. I'm I have the book on my night table, night table for eight months before we go on vacation, and I can't wait to read it. And I thought he just did a fantastic job with that. It was such a compelling story and all the characters are so amazing. You know another you know, another Michael Lewis book that just you know, blows your doors off, and then this thing comes along. And at what point does he say to you, you guys, you know I've been talking to you for how long

this is going to be explosive? Well? He he, he knew he had a feeling it would be explosive. What I didn't know was how big a part of the book that I ended up being. I had no idea. I know when you got the book, you were as astonished as anything. I knew I was going to be a main character. Did you get a man obviously you got a PDF for a manuscript before the book. Nothing final copy shows up like this sounds Barnes and Noble, Amazon.

I asked him, and I said, you know, I said to him, which was I said, Michael, this is a very technical subject. Um, do you want my help? And he goes, you know, you can't write a hundred thousand words without making a couple of mistakes. Um. And he goes, is, do me a favor after it comes out, make a make a note of the mistakes, um, and send them to me. And I found, you know a dozen things, small stuff, but I mean because people have been critical

the Intel. Intel doesn't trade on the new York Stock Exchange, right, because they only trade New York listed stocks. Well, who cares right that it's it's yes, it's a technical error, but that doesn't undermine the actual books. The book is absolutely so he na, he nailed the book. Um, he made some technical errors, which people are you know, people are gonna people are grasping at anything they can get

theirs there grasping and uh. And it's funny to watch, actually, because I've heard people say that what I experienced never happened. It's an amazing thing to tell a trader who has lived. Yeah, latency arbitrage doesn't exist. And I just I just I listen to that. And you can't even respond. A lot of stuff a book. I think a book has been written about you know why why this doesn't Michael lewis fiction. And the amazing part is is that again it's you know,

I can speak ab out this stuff. I'm so grounded in my experience. I've lived through this. Um. You know, I can testify in front of the Senate, I can get in fights on television and you but let me interrupt you. So you also more than just you as a trader. You went to some of the biggest mutual funds, some of the biggest hedge funds, some of the most storied traders on Wall Street, and they pretty much all said, yeah,

I'm going through the exact same problem. Yes, yeah, I mean this wasn't like you're an area fifty one and you saw the UFO that nobody saw. This was widespread. Hey, what's going on with the market? Something is wrong? Yes, well, you know the amazing part is the people that I have a common connection and understanding with our traders, They've lived in UM. Sometimes when you get on fights on television, you're fighting with lawyers, you're fighting with people who have

never traded a day in their life. If you look at heads of exchanges in markets, their firms, if you've never traded, you're only going based on what other people have told you is happening. UM. It's a very common bond I share with traders. Whenever I walk in, people have like I've lived through it. I've I know exactly

what you're talking about. UM. You know that experience allows you, me and our firm and the people the people that have gone through it to speak with such conviction because we know we know that it's happened conviction and authority. You actually became the you know. One of the guys in my office sent me a text this morning. There was a link to an article that said, if you read three books on a subject, you will know more

than the population. How many people know more about the structure of order, routing and execution than than you guys do. It's got to be a handful of it's it's it's probably a small number. The even smaller number is how many people will actually tell you about it right the the game. The value of that knowledge, um is not monetized by trying to help other people understand. It's monetized

by by gaming the system. UM. So I think that we were you know, one of the first things I realized after we discovered thor we ran these experiments at RBC. We realized that, hey, this by delayne when we send the orders, we get to all places at the same time. It was kind of like this Eureka moment. UM. I got home, I was in bed. I'll never forget it. I said, oh my god, we're not the first people to figure this out. We're not like fifth or tenth or fifty, like I don't know what, but everyone who's

figured this out. Are the ones that are that are getting enemy. They're all part of the problem. The ones who had had identified this as a potential issue, instead of trying to fix it, said we can make money off, which brings me to the next question. At one point in time, there were estimates of h f T I'm gonna use the word extracting ten, fifteen, twenty billion a

year in profits. But lately we've been hearing that volumes are down, volatility other than this past week, volatility has has been moderated, and that in general, people and markets are adapting and h f T isn't as lucrative as it once was. Any truth to that, I think, I mean in volatile markets, big investors are trading more um, which means there's more orders to get, you know, in the middle of so, I'd say volatility leads to a lot of a lot of volume and a lot of

profits um. I'd also say the margins are going down because it's becoming more expensive to trade. You know, you have New York Stock Exchange selling laser beams on the roof and selling no longer. The book begins with the cutting the fiber optic channel in a dead straight line from Chicago to New York that now is going away. We're gonna do point to point microwaves faster than than less reliable than than in the ground, but still but there's a cost, right and I think that, Um, when

you look at what's spent, it's billions. Billions are being spill. It was a billion dollars to lay that fiber from New York to Chicago. So part of it is about the money that's being made. Part of it's about the money that's being spent. Because ultimately, when you think about who's ultimately paying for the line between New Jersey and Chica, or who's paying for the microve tower, Um, it's coming

out of somebody's pocket. It's going to be the investors, because no one would buy the microwave tower if they weren't able to make money from the existence of the microwave tower. Um, what you want to do is you want to make the microwave tower redundant. You can't make it illegal, and that that's one of the issues. You can't regulate evolution of technology, but you can render it useless.

What we're trying to do at I X is create a level playing field where people don't feel the need to invest in microwve towers because it doesn't necessarily matter how much faster I am, because we're trying to create the fairest possible place, you know, the experience. But any new tower that goes up, someone's paying for that, and they're paying for it out of profits or else they wouldn't pay for it. It's coming out of grandma's Uh, if you follow, if you follow the money far enough,

it's yeah, it's coming out of everyday people's pockets. A zero Am I wrong in saying it's a zero sum gain. If HFT is extracting fifteen billion by front running half a cent on a hundred thousand shares over and over and over again, that has to become In the stock market, you can everyone can't win. Contrary to some people's beliefs, it's just not no, right, it's it's a zero sum game. It is um and and again. Should the distribution of winners and losers be a little bit more balanced and

more fair? Absolutely? Um, But that's again, that's that's what we're out there trying to solve. But it's it is zero sum. It's coming out of people's pockets, and and the hard part about it is that everyone's losing a little and a few people are making a lot. You know, David Einhorn wrote an investor letter I thought summed it up brilliantly. The problem is diffuse harm and concentrated benefit. That's brilliant, right, because people were trying to save people

money they don't even know they're entitled to. But the people were kind of going after know exactly what we're doing and are very upset about it. So it's it's a it's an interesting problem to be in the middle of. What what other areas in the market structure have you? I don't know if the right word is worried, concerned? Um, what do you see as as a related potential problem? I mean, I think, you know, we haven't We've seen

some changes, Um, but there's getting better. It's it's getting better more based on what people aren't doing versus what people have proactively done. Um. But I still don't see a huge amount of accountability. Um. You know, so you're making your money and fading into the background and riding off into the sunset. Um, you know, isn't isn't going to prevent prevent the next cycle. You know that What concerns me the most is the cycle that we talked about,

scandal regulation, loophole exploitation, scandal regulation. It's gone on for so long, um, and what it does is it prevents you know, talent scandals just drive people away. Right, Certain people that would have come to Wall Street that you want to work here, just don't want to work here. Right, They're going to Silicon Valley. They're going to work you know they So that used to be the complaint in

the middle of the financial boom. Oh, we're attracting people who would be better served going to Silicon Valley and inventing the next iPhone. It's of inventing the next al goo that uh yeah, is gonna come come after our orders. So it comes in cycles. But you know, I think that cycle overall leads to a heavily, heavily regulated industry with fewer players. Um, and the entrenched players are just far more powerful. Right there, There aren't there isn't a

huge amount of disruption happening. So I think, you know, the cultural cycle is it is a pretty tough one to break. Um. You know, we're hoping to break that in in a in in a minor or major way. We're just trying to do something different. The good part is that you know, we do have partners that think I X is good long term for the market. UM. So that gives us a lot of confidence. Well, I find myself in that same boat. I hope you guys become an exchange. UM. That would I think would be

a net positive for markets. UM. Any other thoughts you want to leave us with, what's the next book You're gonna find yourself start? I hope, I hope none others. UM. You know, it's it's just been Uh. You know, I just feel very lucky. UM. And you know, I do feel like I get way too much credit. Uh as a team. You know, our team has done a lot. Uh. Ronan and John and Rob we talked about them. There's a lot of other people that have that have been

behind this. I probably you know, again, I experienced a lot of the issues, um, but coming up with the solutions was was a lot of other people. I feel like, you know, the books kind of thrown me out in the into the front. Um. You know, it's definitely a role I'm willing to play. But you know, there's a lot of people that have made this happen so uh, you know it's I just feel lucky to be in this position. Well, thank you so much for being so

generous with your time. We've been speaking with Brad Katsuyama. He is the co founder and co team leader of I e X. If you enjoy this podcast, be sure and look an inch higher or lower on iTunes and you could see the other fourty or so of these conversations we've had. Um, I want to thank uh Charles Vollmer, who is my producer slash engineer, and Michael Batnick, who's head of research with the firm. I'm Barry Ridhults. You've been listening to Masters in Business on Bloomberg Radio.