How a Book Crushed the Virtu Financial IPO

It was going to be a stellar debut. The IPO roadshow was kicking off in just a few days. Goldman Sachs, Citigroup, Credit Suisse, and J.P. Morgan were lined up to take the company public in a matter of weeks.
With plans to raise $250 million from investors, the IPO pegged the value of Virtu Financial at $3 billion. The little-known firm had carved out an extremely profitable niche in the financial sector. Its business is known simply as “high-frequency trading.”
And it’s an incredibly profitable business.  In fact, it’s so profitable that Virtu never loses money. According to the firm’s S-1 filing with the Securities and Exchange Commission, the firm is profitable 99.92% of the time.
The SEC filing reports “As a result of our real-time risk management strategy and technology, we had only one losing trading day [out of] a total of 1,238 trading days.”
Aside from a little hand-wringing, the high-frequency trading firms Michael Lewis accused of “rigging” the stock market in his groundbreaking new book, “Flash Boys: A Wall Street Revolt,” haven’t been tangibly impacted yet. Except one.
Virtu Financial, a multinational electronic trading firm that claims to “lower costs for both retail and institutional investors,” was set to embark on its pre-IPO road show in early April. Yet immediately following the release of Flash Boys, Virtu indefinitely postponed its initial public offering.
No official reason was given for the delay of the Virtu Financial IPO. But every analyst knows why: In the wake of Lewis’ book, this is not a good time for high-frequency trading (HFT) firms to be going public. The public backlash has been too great, with investors around the world expressing outrage over some of the claims made in Flash Boys.
For those who aren’t familiar with the book, the premise is that high-frequency trading firms are robbing traders by using computers that are able to identify the way someone is about to trade. In doing so, they jack up the price by a penny or two before the investor is able to buy the stock. In essence, it allows traders who use sophisticated computer programs to skim profits away from traders employing simpler tools and techniques.
A penny or two more doesn’t sound like much. But when it’s done millions of times per day … that adds up.
“Legalized front-running” is what Lewis called this predatory trading activity in a recent “60 Minutes” feature (click here to watch the full interview).
Virtu Financial is one of the firms Lewis accuses of doing this “legalized front-running.” He only mentions them by name in a footnote in the book. But that was enough to turn public sentiment against them.
The Virtu Financial IPO has been indefinitely suspended out of fear that the bad publicity might result in a low valuation once the company goes public. Virtu was seeking to raise $250 million in its IPO, which would give the company a valuation of close to $3 billion.
While Virtu may still go public at a later date, the company appears to be waiting for the smoke surrounding high-frequency trading to clear first. That hasn’t happened yet. KCG Holdings (NYSE: KCG), another high-frequency trading firm with shares on the New York Stock Exchange, has fallen 17% in the month since Flash Boys was released.
Even financial exchanges with a distant connection to high-frequency trading have been under pressure. CME Group (Nasdaq: CME), which operates the Chicago Mercantile Exchange, has also seen its shares fall 10% after the release of the book.
Now three CME clients have filed a class-action lawsuit against the exchange, claiming that it sold order information to high-frequency traders that enabled high-speed users to trade ahead of other market participants.
In a broad sense, Flash Boys hasn’t altered the trajectory of the stock market in a meaningful way. Despite all the public outrage, Lewis’ book hasn’t impacted investor behavior. The S&P 500 is actually up a few ticks since the book was released.
But companies that have anything to do with high-frequency trading are considered toxic right now. Eventually, the dust from Flash Boys will settle and the outrage will subside. And it will be obvious when that happens. The share prices for companies such as KCG Holdings and CME Group will begin to rise again.
Though we may never see Virtu Financial on a public exchange.
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