Book: Wall Street Meat
Author: Andy Kessler
Quick takeaway: I guess I needed a break from all the investing-related books, so I picked up this US Weekly equivalent of financial books, where Andy Kessler, an ex-sell-side equity research analyst talks about his spoils (and to an extent, lack of, since he missed the big run-up in tech in late 90s) on the Wall Street as a semiconductor analyst.
Madness of the 90s and the difference in how analysts are hired/promoted etc. aside, the book has one really interesting takeaway. And that is how the role of sell-side analyst changed over time, leading up to the 90s and the infamous Global Settlement reached in 2003, all of which has roots in the panic crash of 1987, when Dow crashed 23% in a single day. On that day, some OTC traders at Wall Street stopped answering calls from panicked investors. SEC asked Wall Street to put in a system called SOES-Small Order Execution System, which would automatically trade small orders, which in turn led to the ECNs, the electronic trading networks that are eating the lunch of the Big Board aka NYSE and other big exchanges, and represent near 75% of all the trades being executed today, and are leading to increasing volume being represented by the HFTs… but that’s a topic for another day. This changed the way Wall Street got paid; the commissions got hammered.
Andy Kessler lays it out pretty clearly – “Before 1975, commissions were 75 cents a share. After the Big Bang that ended fixed commissions, they dropped to a quarter or an eighth (12.5 cents) per share. By 1989, when there were more firms on Wall Street with big trading operations, commissions were five or six cents a share. By 2003, they were often a penny a share.”
He also details very well about how SOES led to ECNs – ”
Two smart programmers, Jeff Citron and Josh Levine wrote an MS/ DOS program on their PC that could game the SOES system, electronically sending in rapid-fire trades to pick off over-the-counter traders. These guys were not so affectionately known as SOES bandits, and roadblocks, including limits like only one trade every five minutes per trader and only so many per day, were put in to slow them down. This led to the creation of day traders— whole rooms filled with SOES bandits to get around the per trader rules. When a trader had a big block of shares to buy or sell, it was impossible not to run into these bandits and lose your shirts on these trades. So traders would often signal to others on the Street to get the hell out of their way, they had a big trade to cross, and other traders would pull their bids and asks to make room for the other guy to maneuver around the SOES bandits.
In 1996, the day trader loophole led to a massive domino dropping in the middle of every trading floor, a class action lawsuit called the “NASDAQ Market-Makers Antitrust Litigation” led by William Lerach. It alleged collusion amongst Wall Street traders. In 1998, Lerach proved his case. Of course he did, since they had to collude to get around day traders. Wall Street settled for $ 1 billion. The SEC also put in a regulation, Rule 11Ac1-4, the Limit Order Display Rule, authorizing Electronic Communications Networks or ECNs. These were computer systems that could match trades without human intervention.”
All in all, (in)actions during 1987 crash led to SOEC, which in turn led to ECNs, and all these killed the Wall Street commissions, which in turn led to increasing dependence on the investment banking business to bring in the revenue, which led to the Global Settlement. Very interesting; had no idea of this long link.