42 pages • 1 hour read
Flash Boys: A Wall Street Revolt
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Chapters 3-4Chapter Summaries & Analyses
Chapter 3 Summary: “Ronan’s Problem”
Chapter 3 introduces Ronan Ryan, who like Katsuyama was a Wall Street outsider by virtue of both his Irish origins and temperament. Unlike Katsuyama, he craved a job on Wall Street but struggled to land one, instead accepting a job from a fellow Irishman with MCI Communications. His work was unsatisfying at first, but he soon took a liking to the details of communications technology and learned more about it than many of his superiors. He rose through the ranks of the telecommunications industry and attracted the notice of Wall Street firms, but they saw him as a technician rather than a financier. While working for a firm that specialized in securing Wall Street’s communications network against external disruption, he learned that firms were trying to optimize the speed of their transactions by factors of milliseconds. Ryan demonstrated to a Kansas City-based firm that distance still mattered by moving their computers to New Jersey and reducing the transit time of their trades by nearly 40 milliseconds. Ryan became highly sought-after among Wall Street firms as the leading expert on “proximity services.” Ryan helped relatively little-known high frequency traders outpace the big banks in optimizing their transaction times while disguising what they were doing. Ryan then began selling the same service to stock exchanges around the world. In fall 2009, Brad Katsuyama offered Ryan his long-held dream of working as a stock trader as the Head of High-Frequency Trading Strategies at RBC. Once Katsuyama met Ryan, he explained that he wanted an insider to explain the details of high-frequency trading to other traders, and Katsuyama in turn would bring Ryan into the world of trading.
Ryan’s first job with Katsuyama’s group was to update the THOR program, which was struggling to deliver signals to different exchanges at the exact same time. Using maps surreptitiously sourced from his former employers, Ryan explained how the most prominent exchange closest to RBC’s office was a major hub connecting New York to the rest of the country. Since they received so much traffic, high-frequency traders would post small orders on it to gauge the reactions of the big firms and then make their own purchases accordingly. HFTs had also put together “latency tables” measuring the average speed of travel among brokerages to gain additional intelligence on market developments. The big Wall Street firms all had algorithms for carving up and sequencing large orders, along with minimizing fees. This behavior made the big firms vulnerable to HFTs who detected their patterns and had the speed to beat them to the punch. THOR then became a product RBC could sell for protection against HFTs, and they pursued several prominent clients but struggled to establish trust because RBC was not a major player. These high-profile clients could not believe that the threat of HFTs had escaped their detection. Ryan’s expertise and experience helped presidents of big firms test out his explanations and see the proof for themselves, shocking them into believing RBC.
The reality of HFT became hard to ignore after a so-called “flash crash” in 2010 where certain stock prices fluctuated wildly over a few hours. Ryan then told Katsuyama about Spread Networks, which he had known about but could not mention due to signing a non-disclosure agreement. Ryan explained that Spread Networks were granting big firms the speed that HFTs first exhibited. RBC’s efforts to blow the whistle on HFT, alongside their development of THOR, led Greenwich Associates to nominate RBC as the top firm of the year, catapulting them from 19th place the previous year.
Chapter 4 Summary: “Tracking the Predator”
Chapter 4 introduces the next member of Katsuyama’s team, John Schwall. Schwall worked for Banc of America (not to be confused with Bank of America) and was on his way to the North Tower of the World Trade Center when the first plane struck the building during the 9/11 disaster. He also worked for Merrill Lynch and was disillusioned when the financial crisis wiped out the rank-and-file while the executives paid themselves lavish bonuses, although Schwall was able to keep his own job. His frustration with the system only grew the longer he remained within it, until Katsuyama hired him to be a product manager for THOR. Schwall became a bridge between the THOR programmers and the traders. While working with Katsuyama, Schwall came to view the entire system of stock trading as rigged against the average investor, and saw government efforts at regulation as well-meaning but counterproductive. For example, the Securities and Exchange Commission (SEC) passed a regulation requiring exchanges to buy stocks at the best available prices for their clients. In practice, this made it easy for high-frequency traders to swoop in and buy a set of shares at the best price, which then drives up the price and lets them sell the same stock at a profit, all within an incredibly short span of time. Computerization was supposed to take human corruption out of stock trading, but instead it gave an enormous advantage to whomever could trade the fastest. Schwall believed that the only solution was to eliminate any intermediary between buyers and sellers. In the meantime, Katsuyama struggled to convince the big banks and regulators to join in his efforts against high-frequency trading. Firms were offering him and Ryan enormous salaries, presumably on the condition that they drop their work on THOR. SEC regulators defended HFT as a natural stage of evolution in stock trading, and counterargued that it was THOR that was unfair for placing additional delays on transactions to multiple exchanges.
Katsuyama found these arguments absurd; HFT was triggering a vicious cycle where multiple opportunities to distort the market made the market more volatile. Katsuyama viewed HFTs like concert ticket scalpers, interposing themselves between the buyer and seller to jack up prices without contributing anything of value. Another new member of Katsuyama’s team, former mutual fund head Rich Gates, came to suspect that the complacency of the big firms had less to do with a principled argument than an interest in profiting from HFT. Big firms were doing more and more business in their own dark pools, exchanges they owned which had minimal transparency to the outside world. The firms sold access to their dark pools, but despite their secrecy, it was easy for an HFT computer system to work both the dark pools and the public exchanges to manipulate prices. Executives were tight-lipped, but the actual technicians designing the algorithms were surprisingly public about what they were doing, although they did not seem to understand the moral implications. While Katsuyama and his team pondered the idea of starting their own stock exchange, which would entail taking on the entire Wall Street system head-on, they decided to learn more about the people who best understood the technical details of high-frequency trading.
Chapters 3-4 Analysis
With each new chapter, Lewis introduces someone with a unique perspective on HFT so that the overall portrait of HFT becomes increasingly more comprehensive both logistically and ethically. Lewis begins with the simplest piece of infrastructure, a single line of fiber running across half the country, with the promise of faster transactions. Katsuyama is the hero who stumbles upon HFT and grasps its potential implications, while struggling to make himself heard in an indifferent and corrupt system. Ronan Ryan is not as instantly sympathetic as Brad Katsuyama, and his penchant for profanity and derogatory humor complicate Lewis’s portrayal of Katsuyama’s goals. Ideally, Katsuyama’s team would be as kind as they are capable, but for all of Ryan’s irascibility, no one was better positioned to explain to traders what exactly HFT entailed and how it would affect their bottom line. Just as Katsuyama pursues equity within an inequitable system, Katsuyama’s own team features internal ethical complexity.
The diplomatic Katsuyama and the irreverent Ryan act as foils to one another to persuade investors and banks to use THOR. Ryan uses his insider-knowledge to illustrate the problem of HFT with a combination of intricate knowledge and blunt language, while Katsuyama swoops in to offer THOR and its successor projects as the solution with genteel language. Between them, they are able to both capitalize on and subvert expectations about the motives and personalities of those working in the finance industry. Lewis’s narrative framework for Flash Boys echoes the narrative framework of disaster films, borrowing the genre’s suspense and penchant for focusing on the individual personalities of the rogue whistleblower’s team of misfits. This emphasis on characterization and dynamic teamwork creates an energetic tone that maintains the book’s momentum as Lewis describes complex technology and explains industry jargon.
As the picture of HFT grows clearer, Lewis also takes care to define how HFT both informs and is informed by The Culture of the Stock Market. Where Ryan brings in technical expertise, John Schwall brings the perspective of a true Wall Street insider who had been around long enough to see the system evolve into its present form. This gave Schwall the ability to trace the problem back to its origins, which in turn sprang from an even earlier crisis, so on to the earliest days of Wall Street. The perception of Wall Street as an endless series of crises, with regulators always at least a step behind, bred a cynical attitude that excused corrupt behavior as an inevitable byproduct, and attempts at reform as hopeless. Schwall does not succumb to cynicism or despair; he believes that the answer is not that there is no solution, but that too many attempted solutions have followed the same ineffective playbook. Schwall’s entry into the narrative personifies the debate of Reform Versus Revolution as the answer to corruption in the financial sector. Katsuyama’s team could not deal with the problem with patchwork fixes of individual behaviors, because all the behaviors were manifestations of a fundamental problem—the power of HFTs to “front-end” other investors and gain enough information to skew the markets in their favor. The big firms believed HFT was an inevitability and believed they had to also engage in HFT, so neither Katsuyama’s integrity nor Ryan’s brutal honesty could win the big firms to their side. Schwall, like Katsuyama, was a person of big ideas rather than technical application, so he recognized the need to eliminate intermediaries between the buyers and sellers of stocks. This realization drastically raised the stakes of their looming confrontation with the powers of Wall Street, and to be prepared for such a task, they would need many more Ronan Ryans who possessed technical expertise if not social graces. Lewis uses the small setbacks and personal triumphs of individual members of Katsuyama’s team to foreshadow the group’s inevitable clash with Wall Street status quo when IEX is formed in later chapters as an answer to Wall Street’s corruption.
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