Is the stock market rigged?
It's a question you might expect from a wild-eyed conspiracy theorist or a down-and-out day trader with the DTs convinced computer-wielding aliens have implanted secret servers on the floor of the New York Stock Exchange.
But what if it came from one of the pioneers of computer trading?
Because it did. In a scene described in Scott Patterson's new book Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System, Thomas Peterffy, billionaire founder of the computer trading goliath Interactive Brokers, poses that very question before a gathering of market leaders. Indeed, Peterffy, broadly known as a the grandfather of electronic trading (he was the first trader to wield a handheld computer on an exchange floor), called the current state of the market "a complete mess." He did this right in the face of the people who'd built that market.
The question about whether the market is rigged is explored broadly in Dark Pools. You might find the answer disturbing -- and Mr. Patterson assures us he has never once encountered an alien (although he has had some interesting experiences of late on the floor of the NYSE).
On the morning of October 11, 2010, Thomas Peterffy stepped onto the dais of the ornate Opéra Salon on the ground floor of the Inter-continental Le Grand Hôtel in Paris. It was a gala event, the fiftieth annual meeting of the World Federation of Exchanges. Attendees included Bill Brodsky, chairman of the Chicago Board Options Exchange, the NYSE's Duncan Niederauer, Christine Lagarde, French minister for the economy and future head of the International Monetary Fund, Nasdaq CEO Bob Greifeld, and Atsushi Saito, CEO of the Tokyo Stock Exchange.
The speaker who would set off the most fireworks was Peterffy, the founder of Timber Hill, one of early users of Island. He looked out over the podium at the upturned faces of his peers and grimaced.
Peterffy had become extremely disillusioned with the market he'd helped create. It wasn't just the deceptive tactics of firms like Trillium, it was the unregulated speed traders who were picking off his own firm's orders, with no firm obligation to stick in the market during tough times. The stock market had been turned into a Wild West of dueling algos -- and some firms, it seemed, had special advantages. Like Haim Bodek at Trading Machines, Peterffy was steamed that his orders were getting clipped time and time again. He wasn't going to take the abuse without fighting back.
He cleared his throat, adjusted his glasses, and launched into his speech.
"An exchange used to be a place, yes, a physical place, where people would come together to buy or sell, hoping to achieve the best price for themselves," he said. "The more the exchange was able to attract all of the buy and sell interests in a product, the more the prices on the exchange would reflect the true state of supply and demand."
It was the old mantra: liquidity breeds liquidity. But something had changed.
"In the last twenty years came computers, electronic communications, electronic exchanges, dark pools, flash orders, multiple exchanges, alternative trading venues, direct access brokers, OTC derivatives, high-frequency traders ... Reg NMS in the U.S. -- and what we have today is a complete mess."
He looked out at the crowd. Dead silence. Peterffy hadn't bothered to warm the audience up with a joke, a humorous anecdote. He cut straight to the point -- and most in that room didn't like what he was saying.
"It is not so much anymore that the public does not trust their brokers. They do not trust the markets, the exchanges, or the regulators either. And why should they, given our showing the past few years? To the public the financial markets may increasingly seem like a casino, except that the casino is more transparent and simpler to understand."
Visible tension spread through the room. Did Thomas Peterffy just call the market a casino? That was an attack they might have expected from the likes of Arnuk and Saluzzi or Senator Ted Kaufman -- but from the founder of Timber Hill and Interactive Brokers, the godfather of electronic trading?
Peterffy, of course, was fully aware that his words seemed to contradict his own history.
"I must confess to you that I was an ardent proponent of bringing technology to trading and brokerage. Unfortunately, I only saw the good sides. I saw how electronic trading and record-keeping could be used to force people to be more honest, to make the process more efficient, to lower transaction costs and to bring liquidity to the markets. I did not see the forces of fragmentation and the opportunity for people to use technology to keep to the letter but avoid the spirit of the rules -- creating the current crisis."
He gazed out at his audience. Peterffy wasn't shocked to see the stern faces, the shaking heads and averted eyes. He was certain that he'd become their enemy -- and he had little hope that they would listen. The computer-trading elite would never admit that the markets they'd created were deeply flawed. Still, he kept hammering away.
"It is vitally important that we bring an end to this crisis of trust before it spreads any further. That we bring back order, fair dealing, and trust in the marketplace. The financial markets of ... the world's developed countries are at a turning point. Technology, market structure, and new products have evolved more quickly than our capacity to understand or control them. The result has been a series of crises over the past few years that have caused many investors to lose confidence or to think that the whole system is a rigged game."
After Peterffy finished speaking, there was silence. Then a scattered handclap. And then the room burst into loud applause.
Everyone realized: Peterffy had actually done it -- he'd come out and said what so many were thinking, what they all knew deep down. The market was a complete mess. And the old guy was the only one with the balls to stand up there and call a spade a spade.