“Our biggest beef is how complex modern markets have become,” Arnuk said in a Jan. 21 telephone interview. Money managers have “to expend energy and cost into making sure that they are interacting properly and policing what’s going on.”
On a snowy day in January, the Themis trader has heard enough of O’Brien’s comparisons between today and the past.
“Bill,” Arnuk tweeted to O’Brien, “have to get past comparing versus 1987. Bogus argument.” Instead, he asked, why will the combined Bats and Direct Edge need to maintain four different exchanges? “Why not consolidate?”
O’Brien responded with six tweets about how each exchange is more attractive to certain types of customers, how different fee structures create different “eco-systems.” The free market will decide how many exchanges are needed, according to O’Brien.
“Any exchange operator has to prove the unique value of each platform,” O’Brien wrote, “or it will die on the vine.”
As criticism of electronic trading and the diffusion of the market grew, O’Brien said he saw a void that needed to be filled in its defense. His efforts included having lunch with Ann- Christina Lange, a Copenhagen Business School assistant professor. She arrived at Direct Edge headquarters on Jan. 16 with typed pages of questions and a Danish accent.
Lange is investigating what role crowd psychology plays in high-frequency and algorithmic trading. She asked about the techniques being employed: Is psychology written into the computer algorithms? And exactly how intelligent are they? What does Direct Edge do to supervise their use?
“The best-developed algorithms really understand how markets and regulation and technology combine,” he tells Lange. “It’s simply the automation of a decision-making process. Still human-driven, but machine implemented.”
While Direct Edge monitors the market and shares data with the Financial Industry Regulatory Authority, he said the company doesn’t review or certify algorithms used by trading firms.
Lange asked about Direct Edge’s order types, including its “hide not slide” option, which automatically re-prices orders to avoid “locked markets” where bids equal offers to sell. How many order types does Direct Edge actually have?
O’Brien offered another analogy.
“Ask someone how many models of cars does Toyota have,” he replied. While they offer only a handful of basic models, some customers want a better radio, bigger tires, leather seats or racing stripes. “You do all those permutations, you could say, well, Toyota really has 26,000 cars. Right? No, they don’t. We have a handful of basic order types,” he says, with a lot of permutations.
Regulators have been interested in exactly what kind of racing stripes exchanges offer traders.
The Securities and Exchange Commission was examining whether order types were being abused, Daniel Hawke, head of the SEC’s market-abuse unit, said at an industry event almost two years ago. The commission looked at issues such as co-location of computers and rebates that venues pay to traders to spur transactions, he said.
No actions have been taken, and O’Brien said he’s not worried that the SEC will fine his firm over order types.
“If we’ve broken any rule we should be held accountable to it, but I believe we really strive very hard to act and be perceived as a model exchange,” he said. “We have an active dialog with them on tons of issues.”
O’Brien didn’t always expect to follow his father into the business. After graduating from Notre Dame in 1992, he went to law school at the University of Pennsylvania, joining Orrick, Herrington & Sutcliffe LLP in 1995. He worked for attorney Sam Miller, a former partner at Paine Webber who focused on broker dealers and market regulation. Miller counted Instinet, one of the original electronic trading networks, as a client.
A two-year stretch as an assistant general counsel at Goldman Sachs Group Inc. followed. O’Brien left Goldman to become general counsel and later chief operating officer at Brut LLC, another of the original electronic communication networks, or ECNs, that traded stocks.
“He produced a competence in market microstructure for us, and a presence in that area, whether it was commenting on the SEC’s regulatory work or just helping us,” said Richard Schenkman, the former Brut CEO who hired O’Brien. “An ECN is all about market structure and making markets more efficient for clients, and Bill was integral to that.”
NYSE and Nasdaq OMX Group Inc., scrambling to keep up with the market’s switch to electronic trading, began buying up the original ECNs.
Nasdaq bought Brut in 2004 and O’Brien joined the second- largest exchange operator, raising some eyebrows when he hung his painting of the NYSE floor. It was a good gig: an office on the 50th floor of One Liberty Plaza overlooking the Statue of Liberty, trips uptown for the bell rings at Nasdaq’s MarketSite in Times Square, and a chance to go to the World Economic Forum in Davos, Switzerland.
Then the second generation of ECNs starting to take off. Bats was established by Ratterman and Dave Cummings, a software expert turned day trader at the Kansas City Board of Trade who founded HFT firm Tradebot Systems Inc. In Jersey City, Knight Capital Group Inc. had entered the ECN business and wanted to spin its Direct Edge product out to a consortium of investors. The ECN was handling about 1 percent of market volume at the time, O’Brien recalls.
It was time for another of the “educated risks” in his career, O’Brien said. He left Nasdaq to become Direct Edge’s CEO in 2007. “What excited me the most was that I felt like we had the potential to break that oscillating wave of competition and consolidation,” he said.
One source of growth was embracing rather than fighting dark pools which, unlike traditional exchanges, match orders without listing bid and offer prices for the rest of the market to see. Direct Edge offered what O’Brien calls “one-stop shopping” by connecting his exchanges with the alternative trading venues.
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