From the 60 Minutes Archive: Rigged - YouTube

60 minutes rewind

this month marks the fifth anniversary  of the current bull market on wall street  

making it one of the longest and strongest in  history yet u.s stock ownership is at a record  

low and less than half of americans trust banks  and financial services in the last two weeks the  

new york attorney general and the commodities  futures trading commission in washington  

have both launched investigations into high  frequency computerized stock trading that now  

controls more than half the market the probes were  announced just ahead of a much anticipated book on  

the subject by best-selling author michael lewis  called flash boys in it lewis argues that the  

stock market is now rigged to benefit a group  of insiders that have made tens of billions of  

dollars exploiting computerized trading the story  is told through an unlikely cast of characters  

who figured out what was going on and devised a  plan to correct it it could have a huge impact  

on wall street tonight michael lewis talks about  it for the first time what's the headline here  

stock market's rigged the united states stock  market the most iconic market in global capitalism  

is rigged by whom by a combination of the stock  exchanges uh the big wall street banks and high  

frequency traders who are the victims everybody  who has an investment in the stock market  

michael lewis isn't talking about the stock  market that you see on television every day that  

ceased to be the center of u.s financial activity  years ago and exists today mostly as a photo op  

this is the stock market that lewis is talking  about the one where most of the trades take  

place now inside hundreds of thousands of  these black boxes located at more than 60  

public and private exchanges where billions  of dollars in stock change hands every day  

with little or no public documentation trades  are being made by thousands of robot computers  

programmed to buy and sell every stock on the  market at speeds a hundred times faster than you  

could blink an eye a system so complex it's all  but invisible if it wasn't complicated it wouldn't  

be allowed to happen the complexity disguises  what is happening if it's so complicated you  

can't understand it then you can't question and  this is all being done by computers all being done  

by computers it's too fast to be done by humans  humans have been completely removed from the  

marketplace fast is the operative word machines  with secret programs are now trading stocks in  

tiny fractions of a second way too fast to be seen  or recorded on a stock ticker or computer screen  

faster than the market itself high frequency  traders big wall street firms and stock exchanges  

have spent billions to gain an advantage of a  millisecond for themselves and their customers  

just to get a peek at stock market prices and  orders a flash before everyone else along with  

the opportunity to act on it the insiders are able  to move faster than you they're able to see your  

order and and play it against other orders  in ways you don't understand they're able to  

front run your order what do you mean front run  means they're able to identify your desire to  

to buy shares in microsoft and buy them in front  of you and sell them back to you at a higher price  

it all happens in infinitesimally small periods of  time their speed advantage that the faster traders  

have is milliseconds sometimes fractions of  milliseconds but it's enough for them to identify  

what you're going to do and do it before you do it  at your expense so it drives the price out so it  

drives the price up and in turn you pay a higher  price michael lewis is not the first person to  

allege the stock market is rigged or that high  frequency traders are front running the market  

but he was the first to find brad katsuyama who  was the first to figure out how it was being done  

a very unlikely character a traitor at the  royal bank of canada a young canadian man named  

brad katsuyama realized that the market that he  thought he knew had changed the market seemed to  

be willing to sell stock but the minute he went to  buy it uh someone else bought it the stock went up  

it was this someone knew what he was doing before  he did it back in 2008 katsuyama was 30 years old  

and running the royal bank of canada's  stock desk in new york with 25 traders  

working for him every time one of them tried  to buy a large block of stock for a client  

their order would only be partially filled  and the price of the stock would go up  

it kept happening over and over again the best  analogy i think is that your family wants to  

go to a concert you own a stubhub there's four  tickets all next to each other for 20 bucks each  

you put an order by four tickets 20 bucks each and  it says you bought two tickets at 20 bucks each  

and you go back and those same two seats that are  sitting there have now gone up to 25 what did you  

think the problem was i had no idea i couldn't i  couldn't get answers at first katsuyama thought it  

must be that the technology at rbc was slow until  he went to stanford connecticut and paid a visit  

to one of the largest hedge funds in the world the  same things that i was experiencing as a trader  

one of the most sophisticated hedge funds  in the world was also having the same  

problem then the light bulb goes off you say  holy cow this is this is a huge problem you  

were determined to get to the bottom of it yeah  why because because it just didn't feel right  

it didn't feel right that people  who are investing on behalf of  

pension funds and retirement funds are getting  bait and switched every single day in the market  

katsuyama suspected that the problem had something  to do with plumbing the way the trades were routed  

through fiber optic cables from his trading desk  in lower manhattan to the 13 public exchanges in  

northern new jersey but no one would tell him  exactly what happened to his orders once he hit  

the buy or sell button so he put together a team  of technical experts traders and most importantly  

an irish telecom guy named ronan ryan who was  an expert on high-speed fiber optic networks  

i knew nothing about trading until my first  day at rbc when i sat in a three-hour meeting  

on algorithms i called my wife afterwards and i'm  like holy crap i have no idea what they just said  

ryan had done work for the high frequency  traders he knew what they were building  

and he knew about the colossal amounts  of money they were prepared to spend

he told brad about a company called spread  networks that had laid a high speed fiber  

optic cable from the futures market in chicago  to the exchanges in new jersey they spent 300  

million dollars just to shave three milliseconds  off the fastest route and releasing access to  

high frequency traders and 10 million dollars  a pot from brad katsuyama's point of view when  

you heard they were willing to spend that kind  of money for milliseconds it told him that the  

sums involved are vast that was one of the first  questions he said he had he says all right i'm  

getting ripped off everybody's getting ripped off  but what does it add up to i think when he heard  

the story of spread networks he realized this is  tens of billions of dollars we're talking about  

roon and ryan also knew where all the cable was  buried and had detailed maps of the fastest routes  

from the financial district in lower manhattan  to the various stock exchanges in new jersey all  

calculated down to the millisecond so i would sit  there roll out maps and draw this data center as  

a box and a line going through it and they had no  idea what i was on about and then i'd be like hey  

are you guys aware of where these data centers  are located of course you're arriving there at  

different time intervals for brad the map's turn  would have been an abstract idea into something he  

could actually see the first place his orders were  landing was the bats exchange across the river in  

weehawken new jersey and high frequency traders  were lying there in wait brad realizes oh my god  

that's how i'm being front run i'm being front run  because my signal gets to the bats exchange first  

and they can beat me to all the other exchanges  it only took a tiny fraction of a second for  

brad's trade to reach the next exchanges on  the network 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 that adds up you make  it sound like a skim what else would you call it  

one hedge fund manager said i was running a hedge  fund that was nine billion dollars and that we  

figured that the just our inability to to make the  trades the market said we should be able to make  

was costing us 300 million dollars a year that  was 300 million dollars a year in someone else's  

pocket is this illegal no that's the thing that's  so shocking about all this well you shouldn't use  

the word front running front running is illegal  this form of front running is legal it's legalized  

front running it is crazy that it's legal for  some people to get advanced news on prices and  

of other of what investors are doing it's just  nuts shouldn't happen ronan knew the only way  

to beat the high frequency traders was to take  away their milliseconds advantage that allowed  

them to sniff out slower trades and beat them  to the exchange he had an idea how to do it and  

he said you're probably better off trying to go  slower which means send the order to the exchange  

located the farthest away first and send the order  to the one that's located closest to you last  

so stagger when you send them out with the goal  of arriving at all places as close to the same  

time as possible katsuyama and his team developed  software that did just that allowing the orders of  

royal bank of canada's customers to reach all  of the exchanges at the same time cutting the  

high frequency traders out of the equation  and essentially our fill rates went to 100  

we couldn't believe it when we actually figured  it out um so you beat speed by slowing it down  

yeah as crazy as that sounds the story will  continue after this katsuyama and his team  

went out and began selling and explaining what  they had discovered to the big mutual funds  

pension funds and institutional investors people  who had suspicions that they were being front run  

but didn't know how and nobody had really bothered  or tried to figure this out until brad katsuyama  

came along it was in nobody's interest too  correct i spoke to dozens of investors big  

investors famous investors who who said that when  brad katoyama came into my office and laid out  

to me how the market was rigged my jaw hit the  floor i mean i knew something was wrong i knew  

i didn't know just didn't know what it was and no  one had told us part of those meetings led us to  

believe holy cow this is this is really something  because some of the most sophisticated largest  

asset managers in the world this is the  first time they were hearing this story  

and some of the most famous names in the american  stock market heard the pitch the capital group t  

rowe price fidelity vanguard i mean it one  after another he was in their offices they  

said this man walked in why is he gonna know how  the stock market operates and and at the end of  

an hour they said oh my god he understands hedge  fund titan david einhorn of green light capital  

is one of the believers was he able to show you  how your orders were being front run oh yeah they  

had a um they got the marker and the white board  and started drawing maps and boxes and wires and  

locations and yeah we went through it in some  detail did you find it interesting it was it was  

clients like einhorn encouraged brad and his team  to do something bigger that's when katsuyama a  

conformist even by canadian standards decided  to do something radical in 2012 he quit his  

high paying job as head trader at rbc and went  off with some of his team to start their own  

exchange you were making good money at uh royal  bank of canada right millions of dollars right

i guess i guess everyone knows that now right  

right yeah why did you want to go off and walk  away from that job and start a stock exchange  

yeah wasn't an easy conversation having my wife  that's for sure it almost felt like a sense of  

obligation to say we found a problem it's it's  affecting millions and millions and millions  

of people people are blindly losing money they  didn't you know they don't even know they're  

entitled to it's just it's a hole in the bottom  of the bucket they set out to build an exchange  

funded exclusively by large traditional investors  they called it iex the investors exchange and  

quietly launched it in october with the support  of some of the biggest players on wall street  

and it comes with built-in speed bumps to  eliminate the advantage of high-speed predators  

and the way they did it was they coiled 60  kilometers of fiber optic cable between themselves  

and the high frequency traders computers so it's  called the magic shoe box it's a box and it looks  

like it's got fishing line in it but essentially  a high frequency trader uh if he tries to react  

on the iax exchange his trade goes for 60  kilometers until so he's he's an east jesus  

so it gets there at the same time everybody  else's do you think that they can game you  

i think that they'll try to game us i think  the fact though that we've gone and met with  

the majority of the biggest high frequency firms  to explain what the magic shoe box is doing  

and that people haven't said oh that's rubbish  that won't work we've had many ask us for a back  

door to be honest so that says something  that it'll work we're up to 38 and a half  

million shares the exchange is off to a  strong start although it is still very  

small with lots of powerful enemies that like  the status quo and are trying to starve iex by  

discouraging customers from using them green light  capital's david einhorn is one of the investors  

do you think iex will survive i think it's going  to succeed i think it's going to succeed in a  

very big way just last week iex received  a strong endorsement from goldman sachs  

whose top executives cited it as a model for a  more stable and less complicated stock market

selling trust we're selling transparency and  and to think to think that trust is actually  

a differentiator in a service business is  kind of a crazy thought right why is this kid  

why is he able to all of a sudden sit at the  center of the american stock market the answer  

is when someone walks in the door who is  actually trustworthy he has enormous power  

and this is the story story of trying to  restore trust to the financial markets