42 pages • 1 hour read
Flash Boys: A Wall Street Revolt
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Chapters 5-6Chapter Summaries & Analyses
Chapter 5 Summary: “Putting a Face on HFT”
Chapter 5 returns to Sergey Aleynikov, whose 2009 arrest sparked Lewis’s interest in HFT. He grew up Jewish in Soviet Russia at a time when Jewish people were carefully monitored by the state, and the authorities would not let him switch from his assigned subject of math to his preferred subject of computer science. He moved to the United States at the age of 20. While he had trouble adjusting to certain aspects of American culture, his computer skills were evident enough to secure steady employment. Aleynikov specialized in writing code for optimizing speed, and by 2007 he accepted a job with Goldman Sachs. Although Aleynikov seemed to embody the American dream as an immigrant with a wife, three children, a house in New Jersey, and a prestigious job, he was disgruntled with suburban life and spent most of his time working a job he found unsatisfying. At a time when Russians were gaining a reputation as proficient coders, Aleynikov was among the best, able to write out problems on paper so that the program itself had few bugs. By 2008, he noticed the growing importance of high-frequency trading, as a decentralizing stock market created new opportunities for intermediaries to pop up between buyers and sellers. Goldman was not a major player in this newly burgeoning all-digital market. The main reason for this was that their speed was halted by old software which programmers could patch but not overhaul without catastrophic damage to Goldman’s wide-ranging interests. Aleynikov’s job became maximizing the speed of transactions for Goldman’s “prop traders,” those it employed for their own corporate portfolio, giving them an advantage over the customs on whose behalf they conducted trades. To ensure plausible deniability, the executives purposely distanced themselves from programmers such as Aleynikov, and the programmers generally saw their task as a technical one without moral implications. Despite their immense resources, the big firms like Goldman Sachs could never design software to run as fast as a small HFT outfit, since every new development had to be layered onto their existing code.
Much of Aleynikov’s work came from downloading open-source software and adding minor tweaks, which then became proprietary to Goldman Sachs. Aleynikov thought this was unfair to the people who had contributed the open-source material in the first place, but Goldman was fiercely protective of both their intellectual property and employees, discouraging the collaboration which Aleynikov had experienced elsewhere. Aleynikov jumped at the opportunity to leave Goldman for a small HFT firm where he could design software from scratch. As he prepared to leave, he emailed batches of software to himself, some open-source and some proprietary, and then deleted the record of his keystrokes from his computer. This was standard practice for him, but shortly afterward the FBI arrested him at Newark Airport. The interrogating agent was clearly out of his depth in trying to explain the nature of Aleynikov’s offense, and it became clear that Goldman Sachs dispatched this agent, a former stock trader, and that he was working on Goldman’s behalf without quite understanding what Aleynikov had done wrong. Aleynikov tried to explain precisely what he had done, but the FBI doctored the transcript and called it an admission of guilt. Aleynikov went to trial and was sentenced to eight years in prison without parole.
Chapter 6 Summary: “How to Take Billions from Wall Street”
Chapter 6 returns to Katsuyama and his team as they plan to counter the effects of HFT by forming their own stock exchange. The move was extremely risky and asked each member of the team to give up a steady salary for a project that might never get off the ground. Katsuyama resigned from RBC, which meant giving up on THOR since it was RBC property. In attracting investors, Katsuyama had to come off as both sincere in wishing to make Wall Street more equitable and capable of generating profits. He didn’t want money from big banks that might compromise his independence and felt guilty about support from family and friends that he might not have been able to pay back. He welcomed the support of mutual funds and hedge funds, but many feared that the new exchange would soon feature the same iniquities as the existing exchanges. The next step was to assemble a team capable of turning a concept into a workable program. This included Don Bollerman, an eccentric former Nasdaq employee who had witnessed firsthand the growing influence of HFT.
The proposed new organization, Investors’ Exchange (IEX), also brought on a group known as the Puzzle Masters. The Puzzle Masters were actual puzzle champions whose job was to ensure that there were no technical loopholes for HFT to exploit. This required an in-depth knowledge of HFT strategies, incomprehensible to the average investor. Most HFT trades used the vast majority of their orders (which had become 99% of all orders submitted) for intelligence gathering rather than actual trading. They then used this information to detect discrepancies in price between the same stocks on different exchanges. HFTs could buy at the lower price and then sell at the higher before the markets could even notice what was happening. Although the differences were often in a couple of cents, doing this every day at an extremely high rate of speed ultimately netted billions for HFTs.
IEX could not prevent HFTs from being fast, but could prevent them from using their speed to gain unfair advantages. Katsuyama had the idea of prohibiting HFTs from setting up shop inside their exchange, so that all players were sending signals over the same distances and therefore at roughly the same speeds, on their own propriety fibers. If one exchange was physically closer, IEX would run its line in a coil to simulate an equivalent length. If this worked as intended, it would eliminate the need for brokers to charge their clients to execute their exchanges, since IEX promised to restore parity between buyers and sellers. This would cost Wall Street enormous amounts of money, and so they could be expected to fight back. IEX had no available means to prove that brokers would direct orders to IEX, since information on transactions rarely included the exchange where it happened. Katsuyama proposed the extremely controversial idea of a real-time method of informing investors where their brokers had sent their money, comparing it to a hidden security camera for a child’s sitter. If the brokers turned on them and pulled money from IEX, it would collapse. Their only hope was to put pressure on investors to demand accountability from their brokers since the information between them was confidential. Debating how to move forward, the group wondered if their attempts to make things better would only create new and even more innovative ways to break the rules.
Chapters 5-6 Analysis
Lewis’s books feature a unique pair of qualities. One is the ability to break down high complex, data-driven fields such as the stock market in a way that the general reader can understand. The other is to enfold that information within a compelling story with engaging characters and high stakes more common in fiction. Lewis’s combination of typical fictional narrative frameworks, tropes, and archetypes with comprehensive analysis of complex topics makes these topics accessible and engaging for the general reader, and seeks to break down barriers of specialized knowledge that might otherwise make individuals cautious about engaging with forces that shape the world around them. With the exposition well established in the first few chapters, Lewis transitions from educating the reader about the circumstances that led to HFT and its dangers to a more complex examination of how Katsuyama’s team attempts to address them.
Just as Lewis narrates Katsuyama’s grand ambition to create his own stock exchange, Lewis stops the action to tell the story of Sergey Aleynikov. The break in Katsuyama’s story, just as conflict looms on the horizon, allows tension to build while Lewis turns to another aspect of the story that has yet to be explored. The reader does not learn from Aleynikov’s story anything that the narrative has not already covered about HFT. Aleynikov is a personification of a trend that lends itself to abstractions. Lewis’s stories are full of big personalities clashing against one another, where hope just might eke out a victory over cynicism. Aleynikov’s story is tragic; He is a man whose success brought him little happiness, and at the moment he earns the chance to live out a long-held ambition, the FBI arrests him, and his life as he knew it ends. Aleynikov’s story reinforces Lewis’s main thrust about The Culture of the Stock Market: Corrupt systems ultimately devour the very people that run them, but those at the top will do everything to ensure that the wrath is reserved for those at the bottom. IEX’s story does not sufficiently illustrate this point, as it is an organization with power and access to friends in high places; Aleynikov is an everyman who is devoured by the system, without powerful friends to help him.
Lewis uses the sentimental tragedy of Aleynikov’s story to prepare the reader for Katsuyama and his group’s effort to challenge the system that ruined his life. This frames the efforts of Katsuyama’s team not just as an act of business savvy or ethical enforcement, but as the result of The Desire for a Purposeful Life. The team endeavors to even the financial playing field by arresting the power of institutions and empowering individuals. Chapter 6 acts as a denouement for HFT practices and demonstrates how knowledge of these practices is key to foiling HFTs. Chapter 6 escalates the stakes by placing Katsuyama in direct conflict with the big names of Wall Street in addition to the no-name tiny HFT firms. Katsuyama’s team has sacrificed great material reward to do what they believe is right. Aleynikov’s tragic fate hangs over IEX’s mission. Lewis juxtaposes Aleynikov’s tragedy against IEX’s ambitious plans to show the potential consequences that await those who cross the big names of Wall Street. The IEX team members wrestle with doubt and wonder if they might reinforce the very system they are fighting, foreshadowing the importance of the conflict between Reform Versus Revolution in coming chapters.
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