Technically Speaking, May 2008

David Krell is the founder and Chairman of International Securities Exchange Holdings, Inc. (ISE) located at 60 Broad Street in lower Manhattan. We met in his expansive corner-window office overlooking the Hudson and East Rivers with a direct view both of the Statue of Liberty and the World Trade Center landmark. David has served in many capacities for the Market Technicians Association and along the way has been innovative in developing new business in new markets. He gives us the benefit of his wisdom and insight. 

Molly Schilling (MS): Are you still involved with the MTA?

David Krell (DK): I’m an MTA member, and I try to help as often as I can, in any way that I can. I’ve been a Director on the Board, I’ve been President, and have served as head of a number of committees for many years. I have a natural love for the organization and try to offer anything I can do to help.

MS: What drew you into Technical Analysis?

DK: Did it take me a while to get involved? No. I started in Wall Street in 1971 as a fundamental analyst. And there was a fellow working in the company that I worked for, who was then part of what the MTA was just starting in the early 70s, and he was one of the formative members of the MTA. And he got me involved in technical analysis, and then with the MTA, and that’s when I left fundamental analysis and became much more involved in technical analysis, because typically the fundamental analyst thinks about a company and rather than the stock.

MS: And so that just made sense to you back then…

DK: That’s right. This company, ISE, has been public for 2½ years. I’ve been in meetings with fundamental analysts who cover this industry and cover this company, and it seems to me that they could use some technical analysis to help them. It would serve their purpose very well.

MS: Tell me about your company.

DK: The ISE is an exchange started in May of 2000, as the first fully electronic options exchange in the United States, with a much different market structure. And within a relatively short period of time, within three years, we became one of the most successful markets. In 2005, we became the largest stock options exchange in the world. 

MS: Quite a development.

DK: We were also one of the first security exchanges to go public, and now the stock is traded on the US market. Our volumes have exploded since last summer. To give you an example, the November 2007 monthly average of the volume and options market for ISE was about 70 percent higher than it was in November of 2006. We’ve had record volumes since August.

MS: Do you think the volatility will more or less continue?

DK: That’s a function of how quickly these other, more fundamental issues are resolved. As long as there’s uncertainty, whether it’s income security, or equity security, and that uncertainty was the original reason why options were created and produced back in the early 70s to control risk and now to increase your exposure at certain times.

MS: Do you have a trading platform for your clients?

DK: Yes. We decided to harness the computer and in 2000 it was a question of whether the computer was feasible as opposed to a trading floor. So we at the ISE don’t have a trading floor perse. All of our activity is done on a computer, so if you want to buy a contract on Microsoft, you send an order over through your broker the same way you would have done ten years ago and that broker sends the order out electronically to us and we execute it, and send it back electronically. We’ve found it’s just much more efficient. It’s faster, it’s lower cost – there are lots of benefits. We were the catalyst for change in our industry.

MS: Were you inclined toward the market when you were a young boy?

DK: Yes, I was interested in the markets. My father was an investor, and when I was in high school, I had a summer job and saved $500 and invested it in a mutual fund because he thought that would really be helpful to me. That was in the late 1960s and I learned a great deal from that experience. I still have the stock certificates. After college, I got an MBA in Finance.

MS: And what do you do when you’re not focused on your work? How do you manage life and work and is it a difficult balance?

DK: Well, I don’t think it’s difficult, work has to be fun. I look forward to going to work and making a contribution, making a difference and helping investors manage their money in a more efficient way. And managing a company. We started ISE ten years ago, in 1997, with 2 people, and now we have about 240 people employed here and we’re the largest exchange. So that gives me a sense of satisfaction as well.

MS: Was it scary when you started? 

DK: Very, very scary.

MS: What was it like that first year?

DK: Well, there were just two of us to start, and until late 1998, for more than a year, there were only four of us working on this project. Then in November of ’98, we announced the project. That’s because we needed to hire other people. Nobody knew what we were doing and we wanted to keep it quiet during the planning stage when we were beginning to specify the system requirements coding of the system, which was all electronic and writing the new rules as a new exchange. So, there was a lot of work involved in starting a new exchange.

One of the thing is we discovered early on was that the SEC had not registered a new exchange in 27 years. So we had to be very creative. We had to hire the right people. We already knew a lot of people in the business, and they believed in us. We launched in May 2000, not an ideal time. Up until then, everyone had been very concerned about Y2K. We had a hard time in 1999 getting anyone’s attention. It felt like “By the way, here we are. We’re a new exchange. Could you please connect us to your system?” The last thing they wanted was somebody else calling on them. So that was a difficult period.

And the stock market really topped out in early 2000, March 2000. The winds weren’t really in our sails. We were competing against four bitterly entrenched, very large exchanges that had been in existence for decades. To them, we were the newcomer, with a whole new and different approach to market structure – an automated exchange, electronic. There was a lot of resistance to this change, which is one of the things that I find fascinating about Wall Street. How much resistance there is to change. Very few people want to change anything.

MS: That’s interesting.

DK: They’re very confident in what they do, successful in how they do it, and any time you make a change you’re taking a risk. So, most brokerage firms don’t want the risk of changing their trading or their trading systems. We had to convince  people through example, and through providing a better solution for them, that they should change. They didn’t meet us with open arms.

So to answer you specific question, the first year was really a very rough one. I always say everybody views ISE as a great success. Everybody reads ISE as an overnight success. And I say it’s an overnight success that took three years. 

MS: A big long overnight…

DK: That’s even better.

MS: What was it that you really felt that consolidated your vision?

DK: When you’re starting a new business, you have to believe in what you’re doing. You have to be very passionate about it and you can’t believe everything that you hear from others who don’t want to change their businesses, who feel endangered. You have to compartmentalize their resistance. You have to believe that what you’re doing is good.

Every time we would sit around the table, I would always ask the following questions: “What’s good for the American investor? Is this change a good thing? Or is that new functionality a good thing? Is it going to make it better, the markets tighter? Is it going to be better liquidity? Is it going to be faster? Is it going to be less costly?” Those are the questions, because at the end, that’s how you differentiate your business.

People buy their newspaper in the same place. They don’t change their behavior. They buy their coffee every morning from the same vendor, typically. It’s a behavioral issue. And so unless you can convince them with overwhelming evidence that you have a much better cup of coffee, or a better way of doing it, they’re not going to change. And that’s what we had to do.

MS: So was your working model more nuanced than just “going electronic”?

DK: When I speak to technology people, their assessment usually is “Well, you succeeded because you were electronic,” and my answer to that is, it’s only partially a factor. We succeeded because we had good ideas. Moving through an electronic system made it possible to deliver all the other goods.

For example, we created a different market structure than the other exchanges. I won’t go into detail about that, it’s complicated. We brought in new liquidity providers that made deep and liquid markets. We automated the whole process to make it cheaper for the online brokers, because they were giving their customers much lower commission rates and they were concerned about not having too many intermediaries in the trading process. And they’re expensive. So we eliminated a lot of those steps for them, and made it cheaper and faster for them, and more accurate. There were lots of things we did, and electronic trading was just the vehicle that delivered those goods.

MS: You were involved in getting the CMT recognized as equivalent to a CFA for a Series 86 exemption by the regulators.

DK: I worked closely with Ralph Acampora and a number of other people within the MTA to have the CMT recognized, just as the CFA designation is recognized, as a qualified standard. I had worked with exchanges and with the SEC in developing my business, and I was able to help as we worked for more than a year with the New York Stock Exchange and their regulatory division, and the NASD and its specialists and examinations to vet the CMT exam as a valid criteria, benchmark, for technical analysts to use.

MS: As a CEO, what keeps you up at night?

DK: One of the things that keeps me up at night is the systems’ integrity, and not just ours, but those around us. When I walk in the street and see construction workers digging, my blood pressure always goes up when I see a street feeder dug up, or somebody with a jack hammer who could cut into one of our cables. But, at the same time, that’s why we have multiple data centers. We have multiple service providers for networks, for communications coming in. We were operational all through 9/11. We operated through that catastrophe.

We have our own generators, and power supply. As an exchange, you have to have all those critical support systems to make sure that your downtime is measured in seconds, and not in minutes or hours.

MS: What was it like when 9/11 happened?

DK: I was sitting right here, watching CNBC.

First of all, I heard it, and the building shook a little bit. My first reaction was, “Oh, one of those little airplanes made a wrong turn.” Then when they said it was much bigger, I had to start thinking about how we were going to open the market. We have a system, a hotline, connecting all the exchanges, and we immediately got on the hotline, asking them how we’re going to open the markets, because that’s our first responsibility.

But when the second plane hit, we knew it was much bigger. We have a business continuity plan that we put into place at the very beginning. We have a whole data center backing up this facility in New Jersey. We sent a whole group right away over there. And then, just before 10:00, the buildings started falling down. You see how close that building is over there (pointing across the street)? You could not see that building. It was a fog.

We got down to the lobby level, the whole building, we stayed together. We grouped by where people lived. New Jersey people, Long Island people, the Connecticut people, the Westchester people, and we slowly directed them out, with a group leader, and everybody got home, thank god.

And I stayed. My partner was actually across the street, and I stayed here that whole time, because I knew that if I were to leave, I might not be able to come back. My wife was also here. The next morning we came back in here. The street was full of snow, the ash was about three or four inches high. My wife and I were together, and I put her in our command center, and I put her headphones on her, and I said, “Just answer the phones,” because I had to talk with the other exchanges and plan with the SEC about reopening the markets.

So I was on those hotlines and she was answering the phones, because we had members all over the country who were calling in. They wanted to know where things stood. My wife is a first grade teacher, but she did real well here that day.

MS: It must have been an astonishing event.

DK: Oh it was terrible. I mean, that first week of being here, I never left, except for one day when the National Guard and the police forced us, when they were afraid that one of the buildings would collapse, so they forced us out. But I came back the next day. There were only soldiers on the street. On every corner, there were half a dozen soldiers with machine guns, and – scary. But when you operate a business that you have responsibility for, you have to be there.

MS: David, it’s been a pleasure to meet you and to visit with you in this wonderful office.

DK: Thanks, Molly.