Berman recently sparred with Block over SOES on CNBC. Their "debate" turned into a shouting match, after which Berman sent Block the following letter: "Dear Chris, You seem like a lovely guy. I wouldn't mind having you as a friend or neighbor. I could probably beat your ass in tennis even though I'm sixty-three and fat. Take my advice. Don't try to defend the SOES bandits. The regulators will be forced to change by Congress, and then there will be a bounty out for you....Don't be among the pigs that get caught."
CUTTING OUT THE FAT
Chris Block sloughs off such slurs. "This is a business where people lie all the time to make money," he says. He adds that the simple truth is that numerous studies of SOES have been done, and none has suggested the system would destabilize the market.
Robert Battalio, a professor of finance at Notre Dame, Robert Jennings at Indiana University, and Brian Hatch at the University of Delaware studied SOES's effect on the market with data provided by the NASD. "We found, in fact, that volatility causes SOES trading as much as SOES trading causes volatility," says Battalio. Moreover, an NASD internal study turned up no evidence that SOES bandits had reduced the number of market makers supporting individual stocks. Battalio, rather, came away with two firmer truths: "SOES makes the market more informationally efficient. The NASD doesn't like SOES, so it will look for any reason to get rid of it."
Courtland Huber, a professor at the University of Texas who studies the relationship between price and information in securities markets, provides a deeper understanding of what's really going on in the debate over SOES. He says Berman's comments are representative of an industry old guard that sees itself under assault in a time of profound and rapid change. "I see this as a similar phenomenon to changes in retailing that have come about through Wal-Mart. The old channels of distribution that are smaller and more fragmented required greater markups to bear the costs," says Huber. "As Wal-Mart came in, there were winners and losers. The winners were customers; the losers were the people in the old distribution channels. We are not surprised to see resistance in the old channels. It's amusing to hear those who don't want change. They're really wondering out loud, 'How will I get paid in the future?' "
THE NEXT ARMY OF ANTS
Block and Burke's sudden rise to success has taken many in the industry by surprise. When Burke started at Lehman Brothers, he was making all of $5 an hour. "I wasn't even making cold calls," he recalls. He was simply dialing the phone and "shooting" the calls to brokers. "When I left Lehman, the managers told me, 'You guys are crazy.' "
Block's old boss at Merrill Lynch, where he'd worked before going to Lehman, was even less encouraging. "He called me a whore and said I'd never make it in this business," says Block.
It hasn't worked out that way. Not only have Block and Burke prospered, but Lehman has had to close its Houston office. And Block has had a laugh at Merrill Lynch's expense as well. When Block was looking for quarters for the company, he was shown the Galleria space the firm now occupies. Merrill Lynch was a major tenant and had been successful in barring all discount brokers from the premises. Block Trading sneaked in by classifying itself as a "day trading" firm--and ended up renting space that happened to face Merrill Lynch's right across the atrium. Recalls Block, "I told them I'd pay double for the opportunity to be up here and wave across at my old boss at Merrill Lynch every day."
Asked what a giant like Merrill Lynch will do to a gnat like Block Trading, Block waves the question away. "They're not going to do anything." What he and Burke spend their time worrying about is the next army of ants ready to steal their lunch at the picnic. Who is the next Block Trading and what technology will it leverage to grind Block's profits to dust?
Block and Burke have already been down to Mexico City, studying the technologically challenged Bolsa. When Block thinks of other foreign exchanges, he fires up another Marlboro and starts orating. "Do you realize in Israel they have little kids posting the prices, who all of a sudden disappear for lunch every day at 11?" He and Burke have asked themselves, Why not trade stocks using decimal points instead of fractions? That would give customers even better prices and steam the market makers all the more. Says Block, "After we're done with the United States or have gotten kicked out because they've made a rule or we can't make a profit, then we'll go to the foreign markets."
Then they'll worry about Merrill Lynch, where across the mall, office manager Roger Kinghorn stresses that "Block Trading has absolutely no impact on our business."
