Data Information Knowledge WISDOM
Location: Forbes, New York, New York
About Bill O'Brien ............................................................................... 2
Debriefing O'Brien ......................................................................... 3
O'Brien in Forbes
"IsNaked Shorting Really A Problem?,” 10/01/09................... 7
"Gone In A Flash," 08/28/09…………………………………….. 9
“Flash Fizzling Out," 08/06/09…………………………………... 11
"Direct Edge: Exchange In 2009," 05/19/09............................. 13
The O'Brien Interview …………………………………………………... 14
ABOUT BILL O'BRIEN
Intelligent Investing with Steve Forbes
Bill O'Brien is the chief executive officer of Direct Edge.
Before joining Direct Edge, O'Brien was senior vice
president at The Nasdaq Stock Market and held senior
management positions in Nasdaq's new listings and
market data units.
O'Brien joined Nasdaq in 2004 when it acquired Brut,
LLC, where O'Brien was chief operating officer. He
joined Brut as senior vice president and general counsel
He was also an attorney in the legal department of
Goldman Sachs from 1998 to 2000 and at Orrick LLP
from 1995 to 1998.
O'Brien received a bachelor's degree from the
University of Notre Dame and his JD from the University
of Pennsylvania School of Law.
Intelligent Investing with Steve Forbes
Interview conducted by Alexandra Zendrian
October 22, 2009
Forbes: How are volumes in the equities markets and on your trading
platform doing now?
Bill O'Brien: We're doing incredibly well when you think the fact that we've more
than doubled in size in the past year and even in the face of some very stringent
competition and have continued to grow, that's the story. If you're talking about
volumes for our company, I'm very, very proud of that.
If you're talking about volume in the market and how that's ebbing and flowing,
you definitely see volume starting to level off a bit for a variety of reasons. Overall
market volatility, the VIX is touching 20 again, the lowest it's been in quite some
time, you see some of those low-priced stocks that were a big, big mover of
volume, whether it's Citi or Fannie or Freddie, maybe some of the individual
company issues of them has changed that to some degree and are driving
volumes lower. And even the use of some products like leveraged ETFs
declining to some degree as well. You've definitely seen volumes level off and if
you look at overall market volume month-to-date, the average daily volume in the
market October month-to-date is below nine billion shares, which is the lowest it's
been all year.
For quite some time, it's been more of a traders market with a lot of volatility but
uncertainty about fundamental valuations and some people are trying to play
catch-up with substantial account declines. People were in and out of stuff a lot.
Where it seems like now the pendulum swings back and it's becoming to a
greater degree more an investors market.
Why do you think retail investors should be trading with your firm?
There's really two kinds of retail investors. Some self-direct what platform and
what exchange they trade on and the vast majority are in the other category
where they don't and they decide they want to buy 500 shares of Exxon Mobil
and they let their broker decide where to trade it. But really for both groups, the
first thing that they need to realize is now much volume is done on venues like
Direct Edge and not the legacy exchanges. I mean, most average investors
would be very surprised to hear that only 12 or 13% of all stocks trade at the New
York Stock Exchange every day or on the floor. Because of some of these legacy
brands and some of the media coverage, that still leads you to believe that that's
where the financial capital of the world is when really, the overwhelming majority
of the volume doesn't get done there. Moreover, one of the reasons why is that
markets like Direct Edge, who have been much more innovative, giving
customers more opportunities to trade in different ways with better economics
and execution quality, they've gotten a significant amount of flow. So if you're the
type of trader who chooses what exchange to put your order on, you definitely
need to think broader in terms of what your alternatives are and what each of
them have to offer. And for Direct Edge, it's a greater ability to customize your
trading strategy with a broader set of products and services. And for the person
who delegates that to their brokers, it's to make sure that when they're doing their
diligence on their broker that they really understand how their order is being
executed and what tools and exchanges that broker is using.
Do you think retail investors need to be concerned about whether their
orders are going into dark pools or not?
No. I actually think the average investor should not be afraid of the dark, to use a
pun, in the sense that dark pools have been around for a very long period of
time. The SEC has always allowed for trading of stocks off-exchange. It used to
be that it was a lot more manual, that big pension plans or mutual funds would be
calling brokers over the phone and trying to work out these trades manually. With
the advent of automation and other factors, that became a completely automated
process which was very good for the retail investor because it gave people the
opportunity to introduce products and services that get them access to these
dark pools for the first time bundled with getting it done on exchanges at the
same time. That's one of the things that we pioneered with our ELP program
which was about giving the average investor access to these dark pools in a way
that made sense for them, in a way that made sense for the brokers or other
companies that were running the dark pools and made sense for everybody.
Which is what any good exchange does – bring as many buyers and sellers
together as possible in a way that makes sense for everyone.
What is the ELP program and what benefits does it offer retail investors?
Basically, it is integrating access to dark pools and other ways to get a trade
done that have historically not been part of an exchange into our exchange. An
order comes into one of our markets, we try to match it, but if we can't, we'll try to
execute it in these dark pools and other places before we would send it on to
another exchange. So it basically gives you true one-stop shopping. You have
access when you put an order on Direct Edge not just to our exchanges but over
30 other exchanges, dark pools and other sources of liquidity. So you really have
You hear a lot about the fragmentation. It's a lot like Craigslist to some degree
where yes, there are zillions of people across the world that are trying to sell a
bicycle but Craigslist re-aggregates all those markets in a way that you can use
where it's effective for you and it's effective for everybody else on the other side.
And that's kind of the evolving definition of an exchange. An exchange used to be
a building, people have to walk into that building to participate and there's one set
of rules that has to apply to everyone except for maybe one special person the
exchange picks. Where the new kind of exchange that Direct Edge has
pioneered is much more open architecture. It brings as many buyers and sellers
together in ways that make sense for everybody, not just the chosen few.
The average broker or the investor doesn't want to have to check 25 dark pools
and then go to our exchange. They want us to handle all that for them quicker
than the blink of an eye, which is what we do through this product.
During the flash order debate, the ELP program got roped in. What did you
make of that and do you think that was fair?
Obviously I don't think so. ELP program does use flash technology but it's not in
the way that drew a lot of criticism and concern. Most people try to conflate this
with other concerns about the market. We really used flash technology as a way
to give people access to as many dark pools as possible as quickly as possible.
And get better prices when they trade and bigger sizes when they trade. There's
a comment process going on about whether that should continue. If it doesn't,
we'll co-opt. It's not the only technology that we use to give investors access to
dark pools, but for us it's been about making this as open architecture as
possible and using technologies that people were comfortable with. We'll adapt to
How is your exchange status coming along?
That's progressing pretty nicely. And most people don't realize, we run an
exchange today through the acquisition of the ISE Stock Exchange, so we
already operate one exchange but that's under the license of the ISE, which is
one of our owners. We're applying for licenses for our two main platforms, our
two ECN platforms, EDGX and EDGA. The application has been published by
the SEC for notice and comment. And we would expect, we're hoping for
approval by the end of the year. And then there's usually a 60 to 90 day ramp up
time, so by the end of the first quarter, we will be America's newest stock
What changes when you become an exchange?
In many ways, yes, it's the same thing, but there are some important new
advantages. When you're running as an exchange, you have lower costs from a
clearance perspective. You don't have to have your brokerage firm in the middle
of every single transaction. We are at the same time, as we go live as an
exchange, switching to brand new, updated technology, an upgraded data
center where our computers sit, so that will be an improvement in the quality of
our product. And it will give us the opportunity to look at other businesses, other
asset classes, there's listings, market data. And just as importantly, it's a big
boost to the brand. We think we've built a company that's innovative, that's
different, better, special and can really endure and so we want to make sure that
people know who we are and it's hard to describe what you do until you become
One of our biggest innovations was extending our trading hours to 8 p.m.
because it helped us handle retail flow more effectively because retail brokers
could actually provide a seamless execution all day long.
Why would it benefit a retail investor to have another exchange or two to
Well, it's weird, because this is an alternative that they already have. We're just
changing our regulatory classification but it'll basically just provide more
competition, greater innovation in our trading products and prices that'll
ultimately, whether you're controlling where you put your order or not, really
benefit every investor. We can lower execution speeds, and the amount of
liquidity that you can buy and sell everyday is better. So really when you moved
over the last 10 years from a state of singular monopolies, the NYSE or Nasdaq,
to an environment where there's open and vibrant competition, like any other
market, it improves the product especially relative to the price that in this case
the investors are paying.
Are there any new innovations that you're working on right now?
How we think about the future is we see a lot more convergence. To us, it's less
about, "let's get into this country or that asset class," and more about we see all
of our customers and vendors reflecting the fact that this is a very interdependent
world. Stocks and bonds and options and futures, other asset classes and other
countries are all being traded simultaneously. So we keep thinking about how do
we make our stock exchange better to reflect that.
Like when Apple got into the phone business, they didn't try to create a $9
version of the Motorola Razor. They said, "We see telecommunications,
entertainment and information all converging at the consumer level. Let's deliver
a phone that reflects that." So we're seeing that convergence in the investment
space and we said that we're gonna keep focusing on how to make our stock
exchange reflect that.
O'BRIEN IN FORBES
Intelligent Investing with Steve Forbes
Trading And Exchanges
Is Naked Shorting Really A Problem?
Alexandra Zendrian, 10.01.09, 01:30 PM EDT
A discussion at the SEC on Wednesday makes the naked shorting problem seem
At a Securities and Exchange Commission roundtable held Wednesday, traders and
regulators argued about how common naked short sales really are and whether or not
there's truly a problem with traders failing to deliver shorted securities. Indeed, some traders
argued, firms have overcompensated to make sure they're complying with the rules. Maybe
overborrowing rather than naked shorting is the problem.
Before the roundtable convened, Senator Kaufman (D--Del.) and Senator Isakson (R--Ga.)
issued a joint statement: "It is clear that the panel is stacked against the need for restrictions
on naked short selling … The recent bull market, however, has lulled us into a false sense of
security. If we do not enact these proposals--the uptick rule and either a preborrow or hard-
locate requirement--the same people who drove down certain stocks in the past will just do it
William Conley, a Goldman Sachs managing director, noted that exchange-traded funds
and penny stocks are a large number of stocks that have had issues with delivery by the
three-day settlement deadline. William Hodash, managing director of operations at the
Depository Trust & Clearing Corp., found that ETFs made up 49% of the stocks that failed to
be delivered on time this July. This could be because ETFs are so frequently traded, said
Paul Lynch, senior managing director at State Street.
Some companies and investors have blamed stock-price declines on naked shorting. Dennis
Nixon, chairman of International Bancshares Corp., wants a firm location requirement, as
his company's short volume recently rose to 11 million shares, which is up 891%, and his
company's stock price fell from $24 to $6.55 in a matter of months.
Nixon expressed a lot of frustration at short selling, citing the lengthy process companies go
through to issue shares of stock when short sellers can "create another 11 million shares"
almost instantly. He called the short-selling side of the market the "wild, wild west."
Bill O'Brien, chief executive officer of Direct Edge, which recently had its two exchange
licenses published for comment by the SEC, said the current rules regarding shorting prompt
overlocation. (See "Can Flash Trader Get Its Own Exchange?").
Commissioner Elissa Walter was surprised the industry hasn't imposed a cost on locating
stock to avoid overborrowing. If a fee were imposed on the stock location process, "We
would locate less for sure," said Michael Mendelson, director of global trading research at
Dr. Frank Hatheway, Nasdaq OMX Group chief economist, asked that these fees be
different for each user, since retail investors sell short as a hedge or other investment
strategy and shouldn't be charged the same amount as a trader that is trying to take down a
company. "One-size-fits-all pricing would be a challenge," he said.
Gone In A Flash
Alexandra Zendrian, 08.28.09, 04:00 PM EDT
By the time you heard about flash trading and BOLT orders, they were on their
(temporary) way out. But the debate's not over.
By the time most people off the Street heard about flash trading, some of its major
proponents halted the practice in anticipation of an SEC review (the promised comment
period still hasn't begun) and a lot of skepticism from the Senate, including New York
Democrat Charles Schumer and Delaware Democrat Ted Kaufman.
Flash trading, or high frequency trading, occurs when an exchange waits a half second
before a bid or offer is transmitted to the entire market, giving the members of a specific
exchange a very fast first dibs on the trade.
The issue is of major importance to Direct Edge, an alternative trading company that is
seeking exchange status and is widely recognized as the industry leader in this kind of "early
look" trading, though Duncan Niederaurer, the chief executive of NYSE Euronext recently
told Steve Forbes that it was the New York Stock Exchange that pioneered the practice and
that Niederaurer abandoned it because he didn't feel it was good for the markets. (See
"NYSE Faces The Future").
"Flash orders are orders that flash in milliseconds to only a select group of market
participants, which can disadvantage other investors," said Mary Schapiro, chairman of the
Securities and Exchange Commission, in recent testimony.
A type of flash order is available currently on Nasdaq OMX Group, BATS Exchange, the
Chicago Board Options Exchange and International Securities Exchange. Nasdaq and
BATS, which both started using Flash in June, will stop on Sept. 1. A CBOE spokeswoman
says the exchange expects the SEC will be publishing formal comments on flash trading
soon and the CBOE will work with and give its input to the Commission at the "appropriate
time." The International Securities Exchange has received no complaints from its customers
about the flash order and anticipates keeping it, a spokeswoman says.
Industry officials and market watchers began asking about the fairness of these order types
after Nasdaq and BATS began using them in June--the two exchanges were responding to
competition from Direct Edge, which has won order flow from TD Ameritrade Holding Corp.
A comment letter from NYSE officials to the SEC says that the exchange is concerned that
investor liquidity could be stifled as certain orders may not be executed because liquidity
might be "held for the benefit of" Nasdaq and BATS users.
Another concern about flash orders is that they may make finding the true price of the
security in the market more difficult. Since flash orders are only shown to participants within
a certain market center, that price and liquidity is kept at the originating market center. While
the orders, if used sparingly, may not have much of an effect on the market and its price
discovery, some market watchers worry that if the majority of trading is done through these
orders and not broadcast to the overall market it could make prices a little wonky.
Matt Samelson, of research firm Woodbine Associates, says he isn't sure where the cutoff
point is when these orders could hurt price discovery, though that concern does exist. BATS
typically executes 85 million to 100 million shares a day via its BATS Optional Liquidity
Technology order. BATS has been executing between 1 billion and 1.5 billion shares a day
since the start of this month.
Patrick O'Shaugnessy, an analyst at Raymond James covering capital markets, notes that
flash trading at its peak made up only about 2% of the overall trading volume; since Nasdaq
and BATS announced the end of their order types that number has dropped below 1%.
Still, flash trades are highly profitable for exchanges. Even a small percentage of flash
volume can yield a very high percentage of trading profits, usually an order of magnitude
greater than the volume so that 5% of volume might provide over 10% of profits.
Direct Edge calls its flash trades the "Enhanced Liquidity Provider" program. The prospective
exchange has a data feed that incorporates orders from its ELPs. Direct Edge has no
intention so far of stopping its program.
In a recent letter to Direct Edge subscribers, Chief Executive Officer Bill O'Brien said, "While
a small portion of our business, ELP functionality is an important choice for many of our
customers, including certain customers handling retail order flow."
Some worry that because flash orders, by definition, give certain market participants a first
look that it could lead to front-running, especially if traders who get the sneak peek have
algorithms that can reacted quickly enough to the information.
Joe Ratterman, chief executive officer of BATS Exchange, thinks that rather than promote
front-running, flash trades push information into the market faster than the consolidated tape
can. In a recent interview, he told Steve Forbes that "the firms that were looking at the orders
were not the firms that the media thought were looking at the orders." He adds, "So flash
ended up being, in practice, a means for the faster firms to actually publish flashed quotes."
(See: "Transcript: Joe Ratterman").
Schapiro has asked the SEC to conduct an examination of flash orders. No timeframe has
been set for the end of this examination, according to a spokesman, but Schapiro is looking
for an approach "that can be quickly implemented."
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Flash Fizzling Out
Liz Moyer, 08.06.09, 04:00 PM EDT
Nasdaq and BATS to stop offering controversial order type, putting pressure on Direct
Edge to throw in towel.
Nasdaq and BATS Exchange are withdrawing controversial trade order types that raised
alarms about fair access to the markets.
The cancellation of their so-called "flash orders" puts pressure on Direct Edge, an electronic
communication network owned by Goldman Sachs, Citadel and Knight Trading, which was
the first to offer the service and has used it to gain substantial market share in recent
In response to Direct Edge's success, Nasdaq OMX and BATS rolled out flash orders in
The Securities and Exchange Commission is looking into flash orders, which hold up the
routing of stock orders between various market centers while quote information is shown, or
flashed, to traders for a few milliseconds. The main criticism is that they interfere with
efficiency in the displayed market, where everyone can see pricing information, and allow a
limited group of traders advance access to order flow information, a perceived advantage.
(See "Hot Flashes On Wall Street.")
The issue has been simmering in trading circles for months and came to national attention
after NYSE Euronext, operator of the New York Stock Exchange, filed a public comment
letter to the SEC in May asking that the practice be stopped.
The controversy, now taken up by politicians like Sen. Charles Schumer, D-N.Y., is similar to
the debate over the fairness of an order type called "indication of interest," which block
traders use in dark pools to sniff out order flow. The SEC, in an ongoing examination of the
effects of dark pools, is taking a close look at both flash orders and indications of interest.
I call on the other exchanges and trading venues who offer flash orders also to move now to
eliminate flash orders and begin the first step to a level playing field for investors," said Sen.
Edward Kaufman, D-Del., in a statement.
Flash orders have become a competitive issue in U.S. stock markets, where the traditional
exchanges are vying for volume and courting traders with rebates and special order types in
competition with new electronic communications networks and dark pools.
Direct Edge has used its enhanced liquidity provider program, which flashes orders into dark
pools, to become the third-largest U.S. stock trading center, surpassing rival BATS
- 11 -
Exchange. Last month it handled 16% of market volume overall and sent some 116 million
shares through its flash-order program. It has applied to become an exchange itself. BATS
was granted its exchange license last year.
Chief Executive Bill O'Brien has been a vocal proponent of allowing the order types to
survive, saying they are a sign that the markets are evolving. "While ELP-eligible order types
are not right for everyone, no one has offered any hard evidence that usage of such orders
by a broker or investor is causing quantifiable harm to themselves, anyone else, or the
system as a whole," he said in an e-mail to members Wednesday.
But even the heads of the other exchanges using flash orders say it has the potential to
create a two-tiered market where those without access to the quotes are at a disadvantage.
Nasdaq and BATS are canceling their programs as of Sept. 1.
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Direct Edge: Exchange In 2009
Alexandra Zendrian, 05.19.09, 03:35 PM EDT
Direct Edge plans to launch two exchanges by the end of the year.
Direct Edge, an electronic communications network and the third largest market center
worldwide, anticipates operating two stock exchanges by year's end as it awaits approval
from the SEC for its applications filed on May 7.
The firm operates two trading platforms: EDGA, which is free to both provide and take
liquidity, and EDGX, which charges liquidity takers and rebates liquidity providers. If the
exchanges gain approval, they would become separate entities and target different customer
"No single exchange can be all things to all people," said Bill O'Brien, CEO of Direct Edge.
EDGX tends to appeal to clients who use limit orders and appreciate a relatively high rebate;
EDGA users trade market orders and like taking advantage of free trading, he said.
In April, Direct Edge had a higher daily volume than the BATS Exchange, which became an
exchange last year. Direct Edge executed 1.41 billion shares a day in April; BATS executed
1.112 billion shares a day that month. Direct Edge has grown in part because of its
Enhanced Liquidity Provider program, which allows users to connect to about 25 dark trading
Direct Edge, through its acquisition last year of the ISE Stock Exchange, has been getting
some revenue from market data. Another advantage to exchange status is having a
protected quote, he noted, adding that Direct Edge is hoping to enhance its brand
recognition. Further attention coming toward the firm could also help with its initial public
offering, which may come about after its exchange applications are approved.
With new exchanges entering a market place almost entirely controlled by Nasdaq OMX
Group and NYSE Euronext at the start of the decade, it seems like the fragmentation story
heralded by the electronic trading networks will continues.
"With more exchanges comes more information, more competition and more innovation,"
O'Brien said. It could also mean lower prices for trade execution, even for retail investors
says Brian Hyndman, senior vice president of transaction services at Nasdaq OMX Group.
"Any time you introduce more viable exchanges, it helps. It tends to drive down the cost of
transaction services," he said.
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O'BRIEN IN THE NEWS
Intelligent Investing with Steve Forbes
Edging Out The Legacies
Steve Forbes: Thank you, Bill. First, quickly describe Direct Edge. What's
different from you from BATS, and not to mention the traditional exchanges, what
you call legacy exchanges?
Bill O'Brien: Legacy exchange, that's right. Well, thanks for having me, Steve.
Well, Direct Edge is the nation's, and by some measures the world's, third largest
stock market operator. So, we compete with the old line exchanges, Nasdaq and
the NYSE, along with some newer competitors like BATS for the share of the
trading volume and stocks in the United States every day.
I think what separates us, makes us, you know, different, better and special is
we've always taken an innovation-based approach to being an exchange. We
don't look at trading stocks and matching buyers and sellers as a commodity.
We look at it as something that we, as part of the financial marketplace, can add
a lot of value to, through new products and solutions and structured offerings so
our customers can trade more effectively and their customers, investors, can get
Forbes: Now, just to be competitive, would you say this difference, as you say,
value added, would you describe, say, BATS as more commodity oriented?
O'Brien: Well, yeah.
Forbes: How do you distinguish your brand?
O'Brien: Some of our other competitors and some of the legacy exchanges just
focus on scale. And scale is a way to try to strip cost out of the business and
maybe help their returns, but not necessarily help their customers as much.
Other firms are focused more on technology in terms of getting down to the
millisecond, the microsecond, the picosecond.
And that's not to say that technology isn't important. But we always view having
first-rate technology as an enabler, right. It's something that allows you to
But it's not a differentiator. It's not going to be how you win. So, on that platform,
I think, of solid technology, we go to the next level and try to provide creative
solutions and products for our customers that allow them to have basically better
products and better executions and for us to earn a good rate of return on the
- 14 -
Forbes: Can you give some examples? Say I'm an institutional investor. Why
you instead of Arca or BATS or the others?
O'Brien: Sure. Well, first of all, we have a much broader, more customized
range of product offerings.
Over the last five to 10 years, most exchanges were catering predominantly, not
exclusively but predominantly, to the higher frequency, automated trader, one
that would often use limit orders primarily focusing on the rebates or the explicit
payments that most exchanges, including some of ours, offer. And they're a very
important and valuable segment. But they're not the only segment of customers.
So, other types of customers, ones that were more apt to use market orders, who
wanted a very fast execution, or one who cared less about the rebate and more
about the priority of getting their execution done, found some of our products
more attractive. So, for example, when you're using a limit order, when the
market's moving against you, right, when a forward's going from $7.50 to $8 and
you're a seller at $7.50, it doesn't really matter so much which of the exchanges
you put the order on because you're going to get filled because the market's
moving against you.
You're a seller. And five minutes later, the stock gets higher. But when the
market is moving lower, and there may be only one trade at $7.50 before the
market starts to move south, you want to make sure that trade's yours, you know.
That first print, if you will, can be priceless. So, we pioneered a market where we
actually made it as cheap as possible for the person who's looking to trade, the
market order customer, to do business so that person putting in the limit order
can make sure that they had a higher probability of getting filled, and thus having
a more effective trading strategy as a result. So, if you're an institution and you
really want to get at a position but you don't want to chase the market as it's kind
of fading away from you, putting an order on our market may result in you getting
done, getting filled, when you otherwise wouldn't have.
Connecting To The Dark
Forbes: Well, now, one of the challenges of investing is if you're buying large
blocks of shares, you have to, you know, almost sell one share or buy one share
at a time numerous times over. Do you do that differently than the other
exchanges do when you say you can do these things faster?
O'Brien: Well, in a couple of ways I think we do. And every institution, I mean,
you know, subdividing large orders into smaller orders to kind of mask their
impact is a practice as old as financial markets itself. We give customers a
variety of tools in order to do that, get executions inside the spread, in between
the best bidder offer and that's often called price improvement.
- 15 -
What we've also tried to do is, as the amount of places to get a trade done have
kind of proliferated, you know, dark pools that you hear about a lot, we were
really one of the first exchanges to try to bring those dark pools into our network
with the certainty of getting a trade done on our exchange at the same time. So,
rather than try to figure out, "Okay, how do I split my order to put some here,
some there," give them a real integrated solution to get the best of what's
available on exchanges and off-exchange at the same time, try to keep the
market impact of handling large trades as low as possible.
Forbes: How did they come up with such a hideous name as "dark pools?"
Sound like a swamp.
O'Brien: It is. It's something that, in retrospect, I think they would probably have
named something else. But it's interesting. Because dark pools really have
always existed, right, in the sense that it used to be the phone-based market,
where an institution who wanted to trade, you know, a million shares of IBM
would call the upstairs desk of a Morgan Stanley or a Goldman Sachs or a UBS
and say, "I have an amount of stock," and maybe not show their full hand but
say, maybe, "I want to buy 100,000." And so, they start to shop it around to a
variety of different firms. And those firms would shop a little bit of it around to
their customers, usually through the sales trader who got the big bonus at the
end of the year and played golf with you a couple times a year.
So, what's happened over the last five years or so is with, you know, computing
power rapidly expanding, with much better telecommunications capability like
broadband and some of the economic pressures of that business, that's become
completely automated, right. All those sales traders have all been fired. It's on a
server that's got a cool sticker and a cool name on it. And it started to be
marketed more as a product. So, to some degree, they wanted to market the
exclusivity of that product. So, you start using names like, "Well, it's dark," or you
have access to it and nobody else does. And that started to create some of the
perceptions that when it's exposed to the broader investing community kind of
triggers some of the reactions you've seen recently.
Becoming An Exchange
Forbes: You're applying to become exchange, exchanges?
O'Brien: Exchanges, exactly.
Forbes: Why two instead of one?
O'Brien: Well, under SEC rules, you can't run basically two stock markets under
one exchange license.
- 16 -
And one of the strengths of our business model so we could be more things to
more customers is we kind of ran two trading systems side by side. One, Edge-
X, to cater more to people who use limit orders, the other, Edge-A, to cater more
to people who use market orders. So, to continue that business model as an
exchange, we actually needed two exchange licenses to do that. Most people
don't even realize that the NYSE and Nasdaq each own three exchanges today.
The NYSE bought Archipelago. They bought the Amex. Nasdaq bought the old
Boston and Philadelphia stock exchanges.
Forbes: Now, what advantages does being an exchange give you vis-a-vie what
you're doing already?
O'Brien: Well, I think it does a lot for us. I mean, one thing that it does is, it
takes some cost out of the business. When you run a business at this level of
scale as a brokerage firm, you have to clear and settle every trade yourself. And
when you're trading 2.8 billion shares a day, which is our record, oftentimes over
two billion shares, a lot of expense can be associated with that. So, you kind of,
without any incremental risk to the system, kind of step out and let each of your
members trade against each other. And that provides significant cost savings.
It'll improve the cost efficiency of our technologies. So when we migrate to
exchange status, we're going to do so in a new state of the art data center or,
you know, technological home.
And that'll lower our costs.
It will give us the opportunity to look at other businesses, trading other products.
And it's a boost to the brand, too. I mean, we're trying to build a company that
endures and maybe takes its place among other public exchanges someday.
And I think everyone can identify with those stock exchanges.
Forbes: What do you mean by one-stop shopping?
O'Brien: Well, if you're talking about it in terms of equities, right, like I said, it
used to be 10 or 15 years ago, if you sent your order to the floor of the NYSE,
you knew you were interacting with everyone who was willing to buy or sell one
way or another. Now, that had its own set of problems, which I think competition
has largely resolved. But one of the challenges of a more competitive
environment is that for any consumer that's looking to decide what's the best
place to put an order, it means there's a lot more choices.
And so, you need someone to try to re-aggregate, to basically say, "I will make
sure no matter where the other side of your trade is, that we will find them for you
to make sure you get the best possible price when you're executing your shares."
So, you know, all exchanges are at this point under SEC rules, kind of connected
to and required to trade with each other under certain circumstances. But even
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that's not enough these days. There's a lot of these dark pools and other venues
that have, while not a majority of them, a decent enough percentage of the
volume that a lot of our customers want access to that and what's on our and
other exchanges simultaneously. So, we rolled out products that allow them to
tap into everywhere they could potentially trade at the same time.
Flash Presents Choice
Forbes: And what's the debate about, or as you see it, on this whole flash order,
and front running?
O'Brien: Well, it's fascinating. Because it started with flash, but it also took on a
life of its own for reasons that I think are entirely different. I think the flash
controversy, in my mind, first started because we just became so successful.
And we were a pioneer of using this kind of technology. We were 1% of the
market, you know, two and a half years ago. We're 12% of it.
Forbes: So Senator Schumer is reflecting the envy of others?
O'Brien: I mean, he has concerns that I believe in his mind and heart are very
valid. But I do say that others, even before he went public on this issue, like the
NYSE, were agitated in that they saw issues with this. And I do believe that to be
driven primarily by competitive concerns. But I think what it tapped into and what
truly concerns me is that the large majority of American investors don't really
understand how technology has transformed our markets and don't understand
how that technology is really operating to their benefit. There is from the credit
crisis and the bailouts a real deep investor skepticism that Wall Street has not
operated to their benefit.
And so, when anybody, for whatever reason, starts to raise concerns, and
moreover, educates them that what they see every day on the news, which is a
physical floor, doesn't really handle the large majority of the volume anymore, it
starts to get them very concerned that things have spun out of control. When in
reality, by and large, that's not true. So, we're doing a lot to work with regulators.
I testified at a Senate hearing just a couple of days ago that says that the
technology does require our regulatory infrastructure to adapt. But that needs to
be done from a healthy vantage point, that this technological progress has really
been good for our nation's investors.
Forbes: So, how do you explain to somebody on Capitol Hill why flash trading is
not front-running and something nefarious at the expense of the --?
O'Brien: Sure. Well, I think you start with, and they try to compare it to the old
specialist system. And they say, "Well, specialists had this advance look. And
they used it to mistreat investors. Isn't this happening here in a micro or
millisecond format?" And at first, I start with the notion of choice, which is unlike
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the old specialist system, you have a choice on Direct Edge as to whether or not
to have your order flashed. So, if you don't see the benefit of using that
technology, you can choose not to use it on an order-by-order basis. So, that's
not a privilege or right you had under the old system.
The second thing is, there's choice on the other side. In the specialist system,
the exchange gave one privileged, chosen participant the right to see that
information. Whereas on our system, we make that available to anybody who
wants to see it. So, we, under SEC rules, have to take any broker-dealer as a
customer. We tell any broker-dealer who chooses to become a customer, "If you
want to see flash information, you're allowed to do so." So, this notion of a two-
tier market is really a fallacy because if you define a tier as everybody, then it's a
two-tier market. But choice really empowers people on both sides of that
process to participate to the degree or not that they're comfortable with. The
second is really showing the value is that in this technological era, they realize
dark pools, and especially now, maybe not when this issue first kind of came to
public consciousness, but now as this dark pool discussion has kind of entered
the fray, they realize that, "Wow, dark pools are a significant source of volume."
And at least as we've used flash technology, we've said, "This is how we bring
the dark world and the lit world together." Right, in that those people on dark
pools are never going to put orders on exchanges. They don't see it as beneficial
to them. But if we give them flash or other technology, they may be willing to
interact with orders on our exchange. So that really, it's doing what any good
exchange does, right. It brings as many buyers and sellers together in a way that
makes sense for all concerned. And so, you know, the SEC, I think, has taken a
very thoughtful approach here. They're right to be concerned when anyone
raises issues of inequities. They're going through, I think, a very thoughtful
comment process to try to solicit feedback from the industry that we're going to
participate in. And I think we'll have a pretty healthy resolution of the outcome.
Different Kinds Of Flashes
Forbes: So, some of your competitors have dropped it. Do you think that's to try
to make you have to drop it?
O'Brien: Well, going back to my earlier comment, I do think there's been a lot of
competitive jockeying throughout this issue, not only vis-a-vie us. But I mean,
many exchanges are, to some degree, battling their own customers. So, it's
something that for some exchanges was, you know, a proud new product offering
that three weeks later they had reservations about, that two weeks later they
decided no longer to do.
I mean, their implementations of flash were drastically different than ours. And
there's no such thing as flash trading or a flash order. But it's a certain
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technology you can use and certain order types. How they used it was a lot
different than how we used it, and I would say, more problematic.
Forbes: Can you quickly delineate the differences?
O'Brien: Sure. So, we really used flash technology, and we still are, as a way to
bring dark pools and the exchange world together. Dark pools did not want to
put orders on our exchanges.
Forbes: So, you're a mating service?
O'Brien: So, right, what any real exchange is. What some of our competitors
were doing, I think, was really giving high frequency traders a way to lock the
market, where they would flash an order, even though the national bid/best offer
said that that couldn't be accepted. So, they would flash it as a way to lock the
market, you know, earlier than they otherwise would have in a way that under
SEC rules has really, you know, in both spirit and letter been prohibited. So, it
was never meant to try, they really didn't integrate this with any kind of dark-pool
product offering. But they were flashing. So, they were using the same
technology, just for a different way.
Forbes: So, Schumer is partially right?
O'Brien: I think any technology has the potential to be misused. And that's in
trading and any other business. I mean, you could have a real argument as to
whether or not a locked market is a bad thing or not. In some ways, that's, by
some definitions, a perfect market. Right, because the spread is zero that
investors wind up paying. But I think it does show, and I would agree with
Senator Schumer, that with the pace of technological change as rapid as it is,
whether it's in the stock market or anywhere else, regulators need the tools, the
talent, the tenacity not only to move along with it, but, where they can, get ahead
Forbes: What other asset classes are you looking into?
O'Brien: Well, it's interesting.
Forbes: In other words, you're going to become a full-blown exchange?
O'Brien: As an innovation company, I think by definition, we think about it a little
differently, maybe, than some of our competitors, who oftentimes have said
they're good at matching trades, so let's get into another asset class or another
geography and find the way to cannibalize somebody else's business. That
doesn't, you know, by definition, excite us. I often think about Apple when they
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got into the phone business, right. They didn't say, "Let's make a $9 version of
the Motorola Razor," right. They saw a convergence happening. And they said,
"We saw, you know, information, entertainment, telecommunications converging
at the consumer level. Let's deliver a phone that reflects that." That's what the
So, the convergence we see, and you see that even in today's stock market
activity where, you know, the dollar's impacting equities which is impacting oil
which is impacting gold, is that all these asset classes and geographic securities
are being traded by our customers on a very, very interdependent basis. They
have technology on their desktop, there are vendors, to reflect that. Equity
exchanges, stock markets, really don't reflect that at this point. So, as we look at
ways to get involved in other asset classes, we want to reflect that convergence
in our products.
Forbes: One can understand with an iPhone, you can do virtually anything,
including cook your dinner. But trading stocks, bonds and other asset classes,
why would you want to do it on your iPhone?
O'Brien: Well, I'm not talking about the physical device, right.
Forbes: But I'm just making the, convergence, you called it.
O'Brien: Right. But, you know, many people are trading a stock and an option,
or a stock and a future, or stock and stock loan at the same time. But right now,
they're doing that in a siloed fashion at the exchange level, right. I go to my stock
market to get this piece done. I go to my option market to get that piece done.
They don't talk to each other, exactly. It's that kind of convergence that's
reflected in the products we roll out as an exchange.
Short Sale Regulations
Forbes: Now, short selling. Where do you see that going? There's still a huge
debate about naked short selling, the uptick rule. What's your ideal world on
O'Brien: Well, I think the first thing I have to start with is just acknowledging the
significant progress we've made since last year under the SEC's leadership. And
I think it's symptomatic of kind of the two tracks we need to talk about short sale
reform on. One is with reflect to transactions, and one is with reflect to the back
office, or securities lending, which is part of but fundamentally different from short
So, most of the progress, and I think most of the focus, should be on the back
office, securities lending, you know. The SEC basically made a rule tougher last
year, 204, that said, "If you don't deliver on a short sale transaction, you have to
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be bought in immediately and suffer the economic consequences of failing to
deliver the securities you sold short." And so, that really eliminated the free ride
that bad actors had. And so, as you saw as a result, failures to deliver went down
drastically, over 90% in some circumstances over a year ago. And I think, you
know, more can be done there to, in a rational way, improve securities-lending
technology and other requirements to drive that down even further. I think if you
do that, that's the large majority of where the effort should be.
Because it's so visceral and people want to go back to the remedy that they're
familiar with, there continues to be a lot of discussion about, you know, a tick test
or some other short sale rule on the execution of transactions. We see that as
not really delivering nearly the bang for the buck that securities lending reforms
potentially could have, and at the same time could do a lot more harm than good
in terms of making trading strategies hard to implement. So, we would argue for
a very, very limited reform here, maybe in most cases when a circuit breakers is
triggered in the real bear raid scenario that calls it kind of a temporary time-out,
or a limited time-out in terms of the ability of short sellers to materially impact the
price of a stock. And, you know, once again, this is a really good example of the
leadership the SEC has shown, which is to show focus and progress on these
issues, but at the same time, come to final resolution of them in a very, very
Wall Street Versus Main Street
Forbes: What regulations do you fear right now, potential regulations?
O'Brien: I guess that I think regulations that I fear most are ones that pit Wall
Street against Main Street because I believe the health of both depend on each
other. So, things like, you know, transaction taxes, for example. And, you know,
I admire your thoughts on tax policy generally. But most people don't realize that
whenever those types of reforms, and I put that lightly, or measures, have been
implemented, it has none of the anticipated benefits, and several unanticipated,
Things that are looking at the marketing kind of luddite terms. Shouldn't everyone
be slowed down? Shouldn't people only trade once a second, you know, our
markets are ecosystems. Traders and investors need each other to succeed.
While their interests are different, and I think the interests of investors should
always be paramount, I am a firm believer in markets as ecosystems which need
a healthy amount of all participants in order to really thrive over the long term.
Forbes: Trading volume, going down. Why?
O'Brien: I think for a variety of reasons. And it's really kind of ebbed and
flowed. One, I think a natural secular trend towards the automation of our
markets is kind of reaching the end of its useful life. You know, as the NYSE
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went from being primarily manual to predominantly automated, that's kind of run
its course by and large. So, that it probably isn't the tail wind that's going to drive
volumes higher. So as things like the volatility has ebbed out of the market,
individual and institutional investors have de-leveraged to a degree. Certain
products that might have spurred greater speculative trading like leveraged
ETFs, for example, have been kind of more thoroughly examined as to who they
are and aren't appropriate for, I think have all kind of started to moderate
volumes a bit.
Forbes: You feel the ETFs are a prime source of short selling abuse?
O'Brien: I don't think so. I think that they're, in this world of interdependence,
there were a lot of strategies where the ETFs and the underlying securities were
traded in concert with one another. And a lot of that's healthy. A lot of it's pure
arbitrage. Because it makes markets more efficient. I don't think that was the
root cause of any abuse.
Forbes: How can exchanges then improve investor confidence now?
O'Brien: Well, I think it starts with recognizing and embracing that responsibility,
right. We are all stewards of investor confidence. And that means we all need to
conduct ourselves in a manner that focuses on the long-term health of our capital
markets first. It's so competitive among the four major equities exchanges,
among the competitors in the options, and even this has become an international
competition, you know, as well. And it's very easy to use concerns about market
quality or practices and using the regulatory arena as a competitive weapon. But
that's very, very short sighted in the sense of the long-term impact it has on
investor confidence. So, I think we need to start by doing a much better job of
educating investors as to how stock trading has transformed.
It's not your father's market, probably not even your older brother's market at this
point, and make sure investors understand that, have the information to make
responsible choices when choosing how to execute their trades, and as a result,
feel more empowered to embrace financial market participation as part of their
own financial planning.
Forbes: Now, when you look around the world, first are you going to go
internationally? But two, you look at Europe, Western Europe, you look at Asia.
It's kind of far behind where we are on this, aren't they?
O'Brien: In many respects, although, they're catching up very quickly. We have
done a lot more in terms of the infrastructure, the market-data infrastructure, the
regulatory infrastructure, even the back office of the clearing, to really create that
platform on which you could see a lot of competition and innovation. Europe is
catching up very quickly, although there is more progress to be made there. Asia
less so, although I think that they realize that they need, you know, a significant
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point of presence in this area to really be considered serious global financial
market centers. So, I would expect that to accelerate over the next five or 10
years, quicker than you might think.
Forbes: So, the old boys' club, so to speak, is going to break down even in
O'Brien: I think so. I think you should underestimate what change will happen in
two years, but maybe overestimate what change will happen in 10 years.
Forbes: And how would you explain quickly to an investor why this
sophistication we have here is to his or her advantage when they see mayhem all
around them vis-a-vie what they're doing overseas?
O'Brien: Well, I think it's just more choices, more efficient markets, less
systemic risk and better prices when executing their transactions, pure and
Forbes: And how do you get them to understand that?
O'Brien: I said I think you just try to focus on the data, you know, in a way that
people can meaningfully understand and just the reality of their experience. I
mean, when you're an average investor trading U.S. stocks, you can have, you
know, your order executed in less than a second from anywhere on the planet
over the internet for, you know, $5 a trade or less. Those are things that were
erratically different than this time 10 years ago. And I think people can latch onto
that and the progress that's inherent in that.
Forbes: Bill, thank you very much.
O'Brien: Thank you.
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