Friday, April 4, 2014

High-Frequency Trading: On Ethical Leadership as a Remedy

Seemingly overnight in late March, 2014, Michael Lewis managed to pierce the public’s strangely high threshold of awareness of societal systemic moral-lapses with "news" of a moral cancer already well-established in the New York stock market system. The well-known financial author did so through the narrative of a moral leader who had managed to expose the problem from the inside. As appealing as such a figure is on account of the self-sacrifice involved, this case raises the question of whether we as a society are best served by relying on moral leaders to bring the sordid antics of elites behind dark windows to light.

In prominent interviews on CBS’s 60 Minutes and PBS’s The Charlie Rose Show, Lewis made galvanizing headlines by claiming that the stock market was rigged in favor of Wall Street insiders able to pay steep fees to use the electronic “super-highway” built and maintained by high-frequency-trading firms. Jumping on the bandwagon, Eric Schneiderman, the NY Attorney General, suggested that such trading may be illegal where it uses speed in order to gain an unfair advantage over other participants in the market. Although his investigation had been ongoing for more than a year, the fortuitous timing of his announcement struck Lewis as suspicious, in that more was to it than met the public’s eye.  Not to be left out of the spotlight, the US Attorney General—Eric Holder—raised the possibility days later in Congressional testimony that high-frequency trading might violate federal insider-trader law.

In his interviews, Lewis suggested that Schneiderman (and presumably Holder) had felt they could come out publically against the trading because some major Wall Street interests had tacitly given him the nod, no longer on the high-frequency “bandwagon.” Goldman Sachs had recently invested in the IEX exchange, whose “speed bumps” maintained a “level playing field.” A $9 billion hedge fund was losing $300 million a year to high-frequency traders.[1] Those traders explicitly wrote institutional clients of investment banks (including Sachs) out of the loop. At least one high-frequency-trading firm limited investment banks’ use of the super-quick fiber-optic line to their own proprietary trading (i.e., the banks’ brokerage client accounts were excluded).[2]  Goldman Sachs’ bankers had no problem with the restriction, in spite of their avowed claim that their bank was a market-maker.[3]

Like other banks, Sachs used “black pools” instead of routing client trades on the wider market, so “investors had to take it on faith that [the bank] had acted in their interests in spite of the obvious financial incentive not to.”[4] That the bank had been selling subprime-mortgage bonds to even its best clients even while shorting the same “crap” held (long) on its own (proprietary, non-counterparty use) books suggests an organizational tendency all too comfortable with exploiting conflicts of interest at the expense of the bank’s own clients.

So why then did Goldman Sachs invest in the IEX exchange? According to Lewis, the bank went to great lengths to keep Sergey Alexnikov, an ex-employee who stole the bank’s high-frequency-trading code, from being released on bail.[5] Yet by April 2014, discussions in the bank had come down in favor of efforts to wean the market off of the relatively risky high-speed trading. Lewis suggests that with Goldman Sachs’ reputational capital running low, the public would blame the bank for continued market volatility such as flash crashes and outages at exchanges and view the bank as behind and the opaqueness that blanketed the high-frequency-trading segment. Plus, Lewis maintains, the best at Goldman Sachs had realized that they were the best at high-frequency trading. Accordingly, switching to an alternative was in the bank’s strategic competitive interest.

Lest the general public feel reassured that the narrow financial interests of some disenfranchised hedge-funds and an already ethically-compromised bank on Wall Street can always be counted on to protect the public interest (the public weal) encouraging  or at least not discouraging the opportunism of governmental authorities, I submit that the public interest is not as protected as the public supposes. Indeed, societal recognition even of the shaky edifice of presumed protection may be lacking—at least until the thing comes crashing down thanks to some brave insider willing to turn the thing inside out, thus rendering it transparent to the rest of us. Why should it take such a dramatic trigger for the public to take notice? Must a moral leader rise to the occasion for the trigger to go off? 

Even though the public awoke in seemingly utter amazement  and immediately started debating whether “beating slower trades to the punch”—essentially seeing that someone is placing an order to buy the one remaining hotel room listed at only $68 on Travelocity and snagging the room first in order to sell it to the person at $74—is inherently unfair, I submit that the public’s retarded recognition of a societal problem (and subsequent over-reaction as the media all-of-a-sudden obsesses on it) is itself a massive problem, particularly in a representative democracy (i.e., Government by the people).  That the general public must be hit squarely on the head before a societal problem is even seen on a societal level suggests that tremendous breaches in accountability are possible, even inevitable, in an extended republic. In other words, wieldy institutional hives and their aggrandizing creatures can easily take advantage of the slack in the people’s attention.

Over at CNBC, Jim Crammer initially seemed underwhelmed, yet came around to openly marvel at the bizarre nature of the all-of-a-suddenness as if the market had only recently been rigged. He first pointed out that day-trading (as distinct from buying and holding a portfolio of diversified stocks over the long term) is not the way for individual investors to make “big money” in the market anyway. As though offering a mere footnote, he lamented that the novel traders had been so secretive about what they were doing. On the morning in which Holder’s statement was broadcast, Crammer was still in his “what’s all the fuss about” mindset.  High-frequency trading had been around for years. Why now, all of a sudden, is everyone taking notice? Crammer seemed to view the watershed as artificial, or at least bizarre. The fact that Michael Lewis had a book to sell was not lost on the neo-realist capitalist at CNBC.

Was Michael Lewis a Moses figure, or Nietzsche’s Zarathustra, descending from a mountain to destroy the false idols or raise all boats with the surfeit of generosity that only a wealthy person can manage? Lewis, who had penned The Great Short to proffer an explanation of the 2008 Financial Crisis, had a financial interest in hyping the story by proclaiming that the market is rigged, for he was selling his just-released book on the topic, Flash Boys. Admittedly, the title sounds a bit like Flash Gordon meeting the Lost Boys. We, the general public, are the lost boys and girls. Even though The New York Times had published excellent reports and analyses of the high-frequency trading whose foundations were being laid as early as 20008—even as foreclosures from liars’ loans almost caused the US financial system to collapse amid a “credit freeze”—it took an interview on 60 Minutes to “blow the cover” of the stealth flash boys.

Actually, as Lewis willingly admits, the credit properly goes to Brad Katsuyama, who left a high-paying job at the Royal Bank of Canada to fix the problem by proffering an alternative, the IEX exchange. Lewis argues that Katsyama recognized that “(t)he deep problem with the system was a kind of moral inertia. So long as it served the narrow self-interests of everyone inside it, no one on the inside would ever seek to change it, no matter how corrupt or sinister it became.[6]  

Brad Katsuyama at his IEX exchange. A moral leader who got very practical in restoring the public's faith in Wall Street. Can we as a society afford to rely on such individuals to fix our problems? 
(Image Source: Stefan Ruiz at NYT)

Being on the inside, in a rather unique position by having learned just how the rigged equity market works, Katsuyama believed that the moral inertia would continue unless he acted on the duty he felt to fix the problem that had harmed many, even among the unknowing financial elite, to the narrow benefit of a relative few.[7] So he set about creating an exchange as a transparent “level playing field” complete with financial incentives capable of restoring the credibility of the financial system in the greater society.  With the mutual funds and pension funds burned by the ultra-exclusivist high-frequency traders as powerful backers, Katsyama sought to restore an equitable and stable infrastructure for the New York stock market. After Lewis managed to galvanize the public’s attention on the highly suspect preferential peaks that high-frequency traders had constructed and profited from as though oligarchs, it is easy to assume that a moral leader of Katsuyama’s fortitude would eventually rise and save Wall Street from itself.

Similarly, Frank Snowden had been an insider whose role in making abuses in the NSA transparent can be reckoned as an instance of moral leadership that few people were in a position (and felt moral inclination) to accomplish. Although former US President Jimmy Carter acknowledged that Snowden had broken the law and should be prosecuted, the elder statesman added, “but I think it’s good for Americans to know the kinds of things that have been revealed by him and others, and that is that since 9/11, we’ve gone too far in intrusion on the privacy that Americans ought to enjoy as a right of citizenship.”[8] With Snowden’s leaks and Obama’s subsequent proposals to restrict the NSA’s access to phone records part of the public lexicon, it is tempting to believe in the inevitability of both the increased transparency and the governmental attention to reform.

Yet the NSA was able to over-reach for years without any insider willing to accept the personal sacrifices necessary to let the rest of us in on what had become the status quo in batch-data collection. Similarly, Katsuyama himself had noticed pricing irregularities strangely dependent on his buy and sell orders as early as 2008—six years before Lewis came along and flooded the problem with transparency on the societal stage. 

Is accountability in a republic retarded at best? Insiders who have managed to accrue enough power can stave off even the eventual "outing" by a moral leader. Just as Lewis was opening the public door on the rigged market, the US Senate Intelligence Committee voted to declassify part of a report on the CIA's use of "interrogation methods" since the attack in 2001 at the World Trade Center in New York. According to Sen. Dianne Feinstein, the report "exposes the brutality that stands in stark contrast to our values as a nation."[9] That such a tale would come almost thirteen years after the attack gives us some indication of how long the public can be kept from knowing even of practices "in stark contrast to" the public's own core values as a people. 

Simply put, relying on moral leaders to make the People aware of systemic ethical lapses going on behind closed doors is severely sub-optimal both in terms of severing the largess to a few at the expense of the many and fixing the systemic problems themselves. This is not to say that such leaders are not heroic, only that republic is ill-served in relying on them to keep the People apprised of what the insiders are up to and fix the problems. We the People, as well as the representatives we elect, are more properly the agents of self-governance, including in the policing of the back rooms in which dangerously powerful interests lie pretty much unfettered from the light of day.

[1] Michael Lewis, Flash Boys: A Wall Street Revolt, p. 77.
[2] Ibid, p. 19.
[3] Ibid., p. 20.
[4] Ibid., p. 87.
[5] Ibid., p. 1.
[6] Ibid., p. 88.
[7] 60 Minutes, March 30, 2014. In terms of ethical theory, Katsuyama’s decision is based on consequentialism generally and utilitarianism (greatest good for the greatest number being the most ethical) in particular.
[8] Susan Page, “Carter: Snowden Good for USA,” USA Today, March 25, 2014. Video:
[9] Susan Davis and Aamer Madhani, "Report Details CIA Tactics," USA Today, April 4, 2014.

Tuesday, April 1, 2014

Zuckerberg’s Vision: All Eyes on Oculus

The term visionary leadership came into the leadership lexicon in the 1980s; the media would popularize it as “the vision thing,” an expression that President George H.W. Bush used to counter critics who disparaged him as falling short of Ronald Reagan’s anti-government vision. Perhaps the preceding dyspeptic decade, weighted down with OPEC, Watergate, stagflation, and Carter’s micromanagement, fueled not only Reagan’s “government is the problem” vision, but also a thirst for leadership vision (and charisma) itself. From this macro scale, the (mis)appropriation of the term by garden-variety CEOs can easily come off as claiming a bit too much (i.e., a gray lily gilding itself in gold). This claim may become all the more apparent or transparent by demonstrating that the term does indeed apply to a few notable exceptions, including CEOs such as Steve Jobs and Mark Zuckerberg. In this essay, I focus on the Facebook founder in particular.

On March 25, 2014, Facebook bought Oculus VR, a start-up venture specializing in virtual-reality technology, for $2 billion. This included $1.6 billion worth of Facebook shares; hence Zuckerberg was making use of his company’s highly valued stock to expand strategically.[1] The strategic element needs some unpacking here. Unlike Facebook’s announcement a month earlier that the company would purchase WhatsApp for about $15 billion in equity and $4 billion in cash, Zuckerberg’s vision of social-media experience in virtual reality laid beyond the sights of Wall Street. John Shinal lays out the problem well. “Wall Street didn’t mind when Facebook gave away that huge chuck of equity because a possible future payoff from acquiring WhatsApp was at least in view—something that can’t be said of the Oculus deal.”[2] Accordingly, Facebook shares fell 7 percent on the Oculus announcement, whereas the stock had risen almost 3 percent on the WhatsApp announcement.

One day, Facebook may offer an expanded virtual social element.
(Image Source:

To virtually no avail in relaying concerns that social experience in virtual reality could not become a revenue engine for his company, Zuckerberg claimed that the Oculus deal would enable Facebook to proffer “a network where people can communicate and buy things.”[3] In other words, strategy was indeed on Zuckerberg’s mind even as he formulated his vision of internet-extended social experience. That a vision is not necessarily realizable in the existing infrastructure does not mean that the idyllic picture is cordoned off from business strategy; in fact, such vision may distinguish visionary leadership from the term’s quotidian or common use as jargon by the typical CEO while not necessarily sacrificing strategic leadership

Zuckerberg’s vision stands out in that it applies virtual reality to the social element of social media rather than as typically done at the time to video games. For all the "value added" in this vision, it is not as "far out there" as Wall Street analysts may suppose. 

As a sort of a "vision on vision" move, I submit movies and video games could fuse with the social element of social reality in social media. Imagine "sitting" in a virtual living room with a few Facebook friends. After chatting for a while, you all watch a movie, only rather than watching it on a virtual screen, the film itself is shot and edited to be viewed in virtual reality so you and your friends are virtually surrounded by the world of the film. That is, you are all immersed in the visual story-world, watching the characters interact. In such a way, the suspension of disbelief gets a boost as you and your friends loose yourselves in the film's world. Finally, at the conclusion of the film you and your friends are in a virtual coffee shop at a table chatting about the film. Perhaps the film's director or an actor "stops by" the "chat room" to join in. Imagine discussing the innovative computer technology used to film Avatar with James Cameron while in virtual reality! 

Even such a vision on top of vision need not be assumed to be totally disparate with strategic leadership and thus too futuristic to be relevant to business and have a discounted (present) value today. Zuckerberg could take a look at acquiring a content provider such as Netflix or Hulu. Facebook could offer the content seamlessly right away to Facebook users for viewing on a computer or television screen (or ipad). Additionally, the social media company could establish some relationship with a person (e.g., James Cameron) or a company in the film industry to develop content oriented to being viewed on Oculus virtual reality. 

In short, real visionary leadership in business need not be mutually exclusive with strategic leadership (and thus with monetized value today). From the standpoint of Zuckerberg's vision and my ideational extension above, we can see just how much “the vision thing” has been conveniently misappropriated by pedestrian CEOs and their epigones to puff up, or distend, their own importance. In other words, real visionary leadership in business lies within the rubric of transformative rather than transactional leadership. While I’m not sure if the needs of followers are necessarily transformed as a result of a business leader's vision, as in Burns’ notion of transformational leadership, I submit that for vision to apply to business, the content must be sufficient to intimate or imply a transformed company, industry, and even society.[4]

1. John Shinal, “Tech Bull’s Run Stirs Up Some Froth,” USA Today, March 31, 2014.
2. Ibid.
3. Jon Swartz and Brett Molina, “Facebook Snaps Up Oculus,” USA Today, March 26, 2014.
4. How such a societal transformative impact differs from that which a political vision (e.g., Reagan’s) can have is an interesting question. I suspect the respective impact ‘types” differ qualitatively.