Not everyone gets to be in the midst of a full-blown media storm — just ask Richard Gates. As head of TFS Capital, an asset management firm based in West Chester, PA., he plays a pivotol role in “Flash Boys,” the explosive indictment against high-frequency trading and its impact on the markets by Michael Lewis. Traders recently spoke withGates and his role of whistleblower cited on pages 114 through 118 in the book that everyone is talking about. Gates offered Traders his insightson HFT, dark pools and why he was so suspcious that he contacted the SEC in the first place.
Traders: In “Flash Boys,” Michael Lewis writes that you were suspicious of the trades that were taking place on dark pools. What caused these suspicions back then?
Richard Gates: Several brokers came to TFS Capital to offer their algorithms. When selling the products, the sales people frequently referred to the “anti-gaming” logic of the algorithm that would supposedly protect our trades. I wanted to learn what that meant. Because I had a strong desire to look out for the best interests of my own clients, I asked a lot of questions, dug into the market’s microstructure, and tried to understand how this sort of protection they claimed fit into our industry.
Traders: You traded against yourself by offering a buy and a sell order in various markets around the same time. How did you come up with this idea?
Gates: Since early 2009, TFS explored several paths to confirm our suspicions that latency arbitrage was occurring. Unfortunately, none of the evidence we could produce was particularly compelling. Then, in early 2010, this rather simple idea just sort of popped into my head. Once I had it, I knew it was dynamite.
I have been in the money management business since 1997. TFS Capital has spent a lot of money on guidance from securities attorneys to help guide our firm through the years.
During the course of my career, our securities attorney has advised TFS that buys and sells of the same security in the market at the same time are not considered manipulative wash trades if the transactions have economic value. So, I was really confident that the trades that I was contemplating were okay and legitimate. We only wanted to use our own personal money for these test trades because we anticipated that, if our hypothesis was right, the trades would lose money. And we discussed the test trades in advance with our securities attorney before we placed them.
Traders: Do you still have these suspicions or have they been confirmed since then?
Gates: I think the SEC has been all over the market structure since 2011. While I am sure they have work to do, I believe the market’s structure has become a lot more effective since that time.
Traders: In “Flash Boys,” the SEC heard your comments. Did they tell you whether they are pursuing these complaints/findings?
Gates: When dealing with the SEC in this manner, you can only expect that information flows in one direction; I gave them information and they told me nothing. I respect that process.
Traders: The Wall Street Journal reported that Goldman Sachs might shut down its dark pool. Care to comment? Did you use Sigma X?
Gates: First off, Goldman has been a leader on Wall Street with its support of IEX. That is thrilling. It is noteworthy that my firm, TFS Capital, is in active communication with Goldman brokers to use its algorithms for our executions going forward.
Our other brokers have also accessed Sigma X the last several years. During this time, we believe the executions we have received in it have been good.
If Goldman closes down Sigma X, I assume it is related to the support it articulately several weeks ago related to its desire to simplify the overly complex market structure.
Traders: What kind of impact will “Flash Boys” have on the market, market structure and how firms like yours trade?
Gates: I hope “Flash Boys” will encourage industry participants, market experts, academics, and regulators to continue the ongoing dialogue about the market’s microstructure. This should help it continue to improve, as it has over the last 100+ years. It’s a process. We all need to participate to keep making it better for all investors.
I also hope it encourages the “buyside” to nudge their brokers into considering routing orders to IEX. The simplicity and design of the platform is brilliant.
Traders: Will we see new regulations because of “Flash Boys?”
Gates: With all of the attention that book has caused, anything is possible. But I do not think big changes in the regulations for equities are necessary.
Traders: What’s it like to be in the hottest media storm to hit the financial industry since the 2008 collapse? What changes do you hope to see come about from your appearance in “Flash Boys?”
Gates: It has been fun! I like doing my part to help the market improve. Plus, from a business standpoint, this exposure has given us contacts and relationships in the industry that we otherwise would not have had.
