One Year Later, BATS Is Doing Just Fine

BATS, an upstart electronic exchange, is stealing market share from the NYSE and Nasdaq—despite mistakes that could have killed it
BATS Global Markets CEO Joe Ratterman Photograph by Scott Eells/Bloomberg

CEO Ratterman at BATS HQ outside Kansas City
Photograph by Ryan Lowry for Bloomberg Businessweek

Long after the markets closed on Jan. 9, Joe Ratterman, the chief executive officer of BATS Global Markets, was in his office trying to figure out how to keep a small computer error from killing his business. His programmers had just discovered a glitch in the company’s code that, over a period of four years, had caused hundreds of thousands of transactions to be bought and sold at the wrong price.

BATS is an acronym for Better Alternative Trading System, and BATS Global Markets operates the third-largest electronic stock exchange in the U.S. It has been stealing business from its much older rivals NYSE and Nasdaq since it opened in 2006. On a typical day, BATS handles about 12 percent of the stock traded on public markets in the U.S., some 750 million shares. It’s managed this with just 160 employees and a headquarters far from Wall Street, or any other financial center, in a two-story office complex along an interstate in Lenexa, Kan., a suburb of Kansas City.

Despite its ascent, BATS does not have a lock on the loyalty of the financial markets. No one does. As irregularities at futures trader MF Global and many banks and hedge funds have proved again and again, trust is everything, and once it’s gone, a financial firm can collapse overnight.

Sitting at his desk, Ratterman pored over the detailed report revealing that, since October 2008, BATS had averaged about 410 mistakes per day, which might cost market participants an estimated $420,000 overall. It was a tiny sum by Wall Street standards, and on its own was no threat to the future of a healthy company. But BATS was still recovering from a near-death experience.

Less than a year before, on March 23, 2012, BATS planned to start listing corporate shares on its exchange, as NYSE and Nasdaq do, and hold its own IPO. To mark the big step forward, BATS would be the first listed company on its own exchange, ticker sign BATS. Underwriters had valued the company at $810 million in 2010, and it was ready to offer $100 million in shares.

As the offering began to move into the trading process, a bug caused the BATS platform to stop taking incoming orders on symbols ranging from A to BF, including BATS and Apple, whose shares fell to a low of $542 before trading was halted. (Although Apple is listed on the Nasdaq, like all stocks it trades on many exchanges, and that meant the mini crash was felt throughout the markets.) Compromised trades caused BATS’s own shares to drop from $16 to less than a penny.

Ratterman ended up withdrawing the IPO that morning. What was supposed to be a banner moment instead suggested BATS was not ready for the big leagues and reinforced popular fears about electronic trading in general. The new markets seemed so fast and massive and complex that even the systems’ builders couldn’t control them—not even when they were taking themselves public. Such meltdowns prompted MIT researcher Lynne Markus to warn of the potential for a trading disaster akin to the mortgage crisis and spurred the Securities and Exchange Commission to set up a new monitoring system for computerized traders. And now there was a problem with BATS’s trading system again.
For a lord of finance, Ratterman is unusual. At 46, he has a shaved head, wears square-rim glasses, and sports classic, laid-back programmer garb—polo shirt, jeans, and business casual sneakers. He’s also a devout Christian, who spends his spare time driving around Kansas City dropping off food and blankets for the homeless. He does have a private plane, in the mode of a master of the universe, but he flies it himself, and not to Cannes, but to a home in Wyoming. He’s also dedicated to an extreme level of transparency that’s helped BATS do more than survive disaster under his leadership; it’s prospered. BATS earned about $100 million before interest, taxes, and other non-cash items in 2012. (Ratterman’s compensation in 2010, according to the company’s SEC filing, was $2.48 million.)

After processing the exchange’s second embarrassment in less than a year, Ratterman decided to inform his customers immediately. He helped draft a detailed explanation that was released at 6:40 p.m. EST, with an exact time frame for the errors and an estimate of incidents along with a timeline for patching the problem. By the next morning it was all over the financial news. The blowback was intense, as expected, but Ratterman absorbed it with a calm that was either admirable or oblivious. This magazine had scheduled an interview with him that day; instead of canceling, he met the reporter after spending hours fielding calls from other media outlets. “It’s odd, but we’ve actually made the system better by finding this,” he said late that afternoon. His gaze fell on a tiny Yoda figure perched at the edge of his desk. “We are on an evolutionary path that is toward the better, not worse.”

Outside the glass walls of his office, the trade operations floor was empty, an expanse of unoccupied computer terminals and darkened wall monitors. About 40 workers had been sent to a remote location to test the company’s backup systems in case of a natural disaster. Ratterman holds such emergency drills monthly, and decided not to cancel that either. He was determined not to let a little meltdown ruin anything. “It’s not the most pleasant thing to have to deal with when you tell on yourself,” he said. “But I’ve conducted as much normal business as I could today, so I’ll go out with my wife and have a nice evening.”
Last year, a few days after BATS withdrew its IPO, Peter Buckley, a former board member who’d personally invested $150,000 in the exchange, sent Ratterman a framed print of a Union Jack with the slogan “Keep Calm and Carry On.” It now hangs in Ratterman’s office. It’s a kind gesture, though Ratterman hardly needs reminding. Michael Richter, a current board member, says BATS’s board was disappointed but never considered ousting the CEO. “This wasn’t a case of bad judgment or that we lost confidence in his ability to manage,” he says. “We fumbled the ball and the clock ran out. We are still a championship team.”

Some of that is due to Ratterman’s willingness to take blame and his ability to turn mistakes into advantages, starting with the letter of apology he wrote after the failed IPO. “I basically came right out and said we screwed up and we expected better of ourselves and we will do better,” he says. He’s also careful to explain that he always saw the broader consequences as minimal. “We just walked away and decided to come back another day,” he says. “I probably wouldn’t want to go through it again if I didn’t have to, but I don’t see how it impacted our business for the negative at this point.”

Two days after the IPO flop, co-founder Dave Cummings wrote a letter to the industry advocating that BATS push forward with the offering even if it meant settling for a lower price. Cummings noted that this was his individual opinion, not the company line, but the notice hit at nearly the same time as Ratterman’s mea culpa, making it appear as if the former CEO and current board member might be trying to publicly dictate the next course of action. Ratterman kept calm and carried on. “People see it as, you know, Dave—that’s just his unfiltered style,” he says. “I would not have put out the letter that he did for my purposes. The letter that we put out was the right one.” He’s since said the company has no immediate plans to go public.

Ratterman did agree to step down as board chairman but says he would have done so anyway in order to give the board independence if BATS had gone public. Richter, who notes that an internal subcommittee also investigated the IPO failure, agrees: “The board has not taken any significant redirection,” he says, meaning Ratterman still has the board’s confidence.

Even without BATS shares trading on the market, Ratterman has found a way to pay his investors. In August he issued $100 million in dividends, then secured a loan to pay out an additional $300 million in December. Ratterman and most employees with shares received an undisclosed payout, though 97 percent of the money went to larger investors. The result, says Richter, has been “highly satisfactory.”
When Ratterman was 9 years old, his father, a maintenance worker at Hallmark Cards, died in a water-skiing accident, leaving his mother, who worked in the accounting department of an industrial gas company, to raise him and his younger brother. During high school in Kansas City, Mo., in the early 1980s, Ratterman taught himself programming on an Apple II. He graduated from the University of Central Missouri in 1988 with a double major in mathematics and computer science. He once considered becoming a math teacher but changed his mind after a field trip to a troubled school. “I got a sense of what it is like to be a teacher when nobody wants to be taught,” he says.

Ratterman spent the next decade and a half climbing the corporate ladder at Bridge Information Systems, a financial information provider that has since been acquired by Thomson Reuters, and then LabOne, a health screening and diagnostic testing company later bought by Quest Diagnostics. By 2004, Ratterman realized he missed the securities industry, so he earned his Series 7 brokers’ license, among others, and went to work for Tradebot Systems, an automated trading firm that would ultimately lead to the inspiration for BATS.

Tradebot operated out of a small brick storefront with green awnings in what Ratterman calls “Mayberry,” a quaint little shopping district in North Kansas City. Cummings, a former programmer turned day trader at the Kansas City Board of Trade, founded Tradebot in 1999. In June 2005, Cummings, Ratterman, and 11 other Tradebot employees leased an adjoining storefront and outfitted it with whiteboards to draw up their own exchange. Cummings became BATS’s first CEO. Ratterman, then chief operating officer, replaced him in July 2007 before BATS registered with the SEC as a formal exchange. (Cummings continues to represent Tradebot on the board of directors; he declined to be interviewed for this story.) Although the early founders won’t disclose how much they initially invested, rent was inexpensive—about $10 per square foot—and employees don’t need much to live well in the Midwestern city. They built their initial platform for less than $10 million, Ratterman says.

In Kansas, BATS has its own little bell
Photograph by Ryan Lowry for Bloomberg Businessweek

BATS’s business model was simple: match the big exchanges on speed, and kill them on price. When it first launched on Jan. 27, 2006, the company earned about 1¢ per 100 shares traded; competitors, trading at the same speed, were earning as much as 10¢ at the time. “We certainly had a slay-the-dragon mentality, but not a prideful one,” says Ratterman, who credits Cummings, his team, and God for his success. “We just said, ‘Hey, we have to go up and challenge these big guys.’ ”

Despite the location of its headquarters, BATS was from the beginning an insurrection founded in partnership with many of the traders and institutions that were frustrated by the NYSE and Nasdaq duopoly. Among the first investors were Getco, a high-frequency trading firm founded in Chicago, and Wedbush, a Los Angeles-based investment bank that represents other speed-trading clients. In 2006, Credit Suisse, Morgan Stanley, Lime Brokerage, and Lehman Brothers joined. To attract business, and more investment, Cummings wrote newsletters about BATS’s mission and e-mailed them to Wall Street brokers and analysts. (In one, dated February 2007, he reportedly called Nasdaq CEO Robert Greifeld “a bully” who treated his clients like “hostages.”) Deutsche Bank, JPMorgan Chase, Citigroup, and Bank of America Merrill Lynch have since signed on as investors. In all, BATS raised a total of $159 million in funding. According to SEC filings, nearly 32 percent of the company’s annual revenue in 2010 came from trades made by its investors and partners. “They had the advantage of having major market participants as owners, so they were really able to steal the march on some incumbents and become a major competitor in the trading landscape,” says Justin Schack, a partner at Rosenblatt Securities. By the end of last year, BATS averaged 713 million shares matched daily, a more than 825 percent increase from its first year of business. “We thought, ‘We know we have something good, we just need them to try it,’ ” Ratterman says.

They have begun listing some shares, as originally planned, though still not their own. Over the past year, BATS has recruited exchange-traded fund issuers such as ProShares and BlackRock’s iShares to host 18 securities on its exchange. “With ETF issuers, once you convince them that you have a program that works and they like it, they bring you product after product after product,” Ratterman says. “You work on creating a relationship, and that yields many securities.”

BATS is expanding into other markets, in the U.S. and abroad. Over the past several years, Ratterman has started a U.S. options exchange and entered the European equities market. In April, five months after acquiring Chi-X Europe, Europe’s biggest equities market operator, BATS finished converting it to its own technology platform. BATS Chi-X Europe ended the year controlling nearly 25 percent of the European market. As former board member Buckley says, “This is plug-and-play exchange building for these guys. They can do it anywhere.”
Two weeks after coming clean on its most recent error, BATS said that Ratterman’s initial estimate of losses was off. Rather than causing $420,000 in losses, the final tally was closer to $17,000 over 12,000 total incidents. In many cases, that means BATS will owe just a few dollars per customer.

According to spokesman Randy Williams, Ratterman was incapable of waiting for the final accounting before reporting the potential worst-case scenario. “He said, ‘We’ve got to let the customers know. I’m not going to be able to sleep if we don’t tell the customers,’ ” Williams recalls. “He’s not going to cheat anybody because it’s not in line with his faith.”

Ratterman says he’s relied more strongly on prayer to help guide business decisions since the IPO fiasco. “I had strong faith prior to this, but I wrongly always assumed that I’ve got the church and how I live in the community and that is all stuff that God cares about; He doesn’t care about the business,” he says. “That is not the way it is. He taught me that I have to rely on Him even to do this.”

After work one evening in mid-February, he climbs into a delivery truck, which he owns and which he calls “The Vittle Van,” to begin his rounds delivering clothes, blankets, and meals to the homeless. (Ratterman won’t share the charity’s name because he doesn’t want recipients to know that he’s the founder and not just “Joe,” a volunteer they see often.) Before hitting the streets, he stops at a makeshift storeroom set up in one corner of BATS’s gym to collect an assortment of coats, hats, gloves, blankets, and water bottles, along with 50 sandwiches delivered from a local sub shop. It’s dark and below freezing. His wife, Sandy, is seated by the van’s sliding door.

At each stop, Ratterman shakes hands with regulars, calling them by their first names and asking about folks he doesn’t see. “Our foundation isn’t about generating great metrics and getting headlines, it’s about meeting specific, targeted individual needs,” he says. To figure out what to stock onboard, he tracks the handouts at each stop—he can’t help but do an on-the-spot analysis. As he puts it, “Under bridges is a 100 percent hit rate of people in need.” Perhaps it is under those bridges that he finds the secret to his management style; after all, what is a computer meltdown in comparison?

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