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U.S. investigates market-making operations of Citadel, KCG

62 points by randomname2 10y ago

chollida1 10y ago
I consider this to be a big deal. Most people don't realize that retail orders( orders from an ordinary person) almost never reach an exchange. Funds like Citadel and KCG pay the banks and brokerages( Schwab, Vanguard, etc) hunderes of millions per year to get their order flow. Here's a reuters article about Schawb's pay for order flow: http://www.reuters.com/article/schwab-ceo-proposal-idUSL1N0O12EC20140515 http://www.reuters.com/article/schwab-ceo-proposal-idUSL1N0O... > Trading companies, including market makers such as UBS , KCG Holdings and hedge fund Citadel LLC, are willing to compete for retail investors' orders because they are considered "dumb money" that shows the professionals where markets are headed. > In reporting first-quarter earnings last month, Schwab said that it expects to earn about $100 million this year from selling client orders, the first time it gave out a specific number, and higher than the estimate it had given a few weeks earlier to Reuters. and here is the breakdown of their order flow: https://www.schwab.com/public/schwab/nn/legal_compliance/important_notices/order_routing.html https://www.schwab.com/public/schwab/nn/legal_compliance/imp... The funds then get a free look at these orders where if they are beneficial to them they can fill the order, or if they aren't, then they can pass the order onto an exchange. If you thought flash orders were bad, these are much worse and flash orders were discontinued years ago. If you thought HFT funds were bad then consider atleast HFT funds have to put their orders out to the market and take the risk that they'll get rolled over when the market moves. ie they put their money where their mouth is and they compete every day on a level play ground with the rest of the market makers. These internalizers often hold orders up for up to a second, before they choose to fill them or let them go and when you consider that the IEX delay of 350 micro seconds, not milliseconds, is considered contentious you get a good idea of just how scummy things have gotten. in an unrelated piece of news Reuters today wrote a piece showing the top paid hedge fund managers. Citadel's founder Ken Griffin can in first, taking home 1.7 Billion last year. This is really the DOJ taking on the biggest players on wall street. http://www.reuters.com/article/us-hedgefunds-compensation-idUSKCN0Y11D1?feedType=RSS&feedName=businessNews&utm_source=Twitter&utm_medium=Social&utm_campaign=Feed%3A+reuters%2FbusinessNews+%28Business+News%29 http://www.reuters.com/article/us-hedgefunds-compensation-id...
- rayiner 10y ago
  > These internalizers often hold orders up for up to a second, before they choose to fill them or let them go and when you consider that the IEX delay of 350 nano seconds, not milliseconds, is considered contentious you get a good idea of just how scummy things have gotten. Do you mean microseconds? Because 350 nanoseconds is only long enough for light to travel about 250 feet in fiber.
  - chollida1 10y ago
    yes sorry, I've already updated it.
- tcoppi 10y ago
  I'm not sure how paying for order flow is still legal. At this point it is basically brokerages offloading their fiduciary obligations(for money!) to legalized front-running operations. As the article says, these operations are basically operating as exchanges, and they probably need to be regulated as such.
  - kasey_junk 10y ago
    I think that more information being available about order flow practices is all-in-all a good thing, and I encourage the relevant regulatory authorities to watch it like a hawk. That said, I much prefer my free trades from Robinhood that are the outcome of payment for order flow, than I did the $25 it used to cost me to trade. For the kind of trading I do, it is a much better deal to let the internalizers capture the spread (even if it is not the true spread) than it is to not have internalizers.
    - tcoppi 10y ago
      I agree, this is definitely a double-edged sword. Hopefully the outcome of this investigation is more transparency and fairness for retail traders, without completely destroying the execution cost reduction that has been made possible by them.
- 10y ago
matt_wulfeck 10y ago
If I'm buying with limit orders, can someone explain how I'd get a bad deal on one of these exchanges?
- kasey_junk 10y ago
  The internalizer could price improve you to an "incorrect" NBBO price and pocket the difference.
- chollida1 10y ago
  It's a good question. If you are a retail trader, you should almost always use limit orders. You can never get a worse fill than what you ask for but the internalizer can make money off your order and you can miss out on market moves that occur in the second after you place your order. if you are fine getting price that you put your limit order in for then as far as you are concerned, you'll be fine. As with all things market micro structure related, nanex.net has a good writeup on this. I'm not sure how often this scenario occurs as I've never worked for an internalizer but its http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-to-Know.pdf http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-... Check out the section called "Marketable Limit Orders". > For example: the Wholesaler receives a retail order to buy 2000 shares at $10.03 or better (lower) when the SIP shows a total of 2000 shares offered at the best offer price of 10.01. 1. Wholesaler buys 300 from one exchange at $10.01, and immediately, 1700 shares that were available on other exchanges disappear, causing the best offer price to move to $10.02. 2. Wholesaler buys 400 at $10.02, and again, sell orders on other exchanges disappear, causing the best offer price to move to $10.03. 3. Wholesaler sells short remaining 1300 shares at $10.0290 to retail investor, providing a $0.0010 price improvement relative to the $10.03 SIP offer price at time of execution. 4. Within seconds, stock reverts back to $10.01 offered. 5. Wholesaler covers short by buying 1300 shares at $10.01. > By quickly influencing the price of the stock, perhaps by less optimal routing, then directly filling the order at an execution price away from the original NBBO at time of Order Receipt, the Wholesaler profits from the $0.019 change on 1300 shares ($24.70), less any "price improvement" given to the retail investor, less the $4.00 Payment for Order flow paid to the Retail Broker (2000 shares x .0020 per share) and $6 in exchange fees (maximum SEC fee $0.0030 per share x 2000 shares).
atemerev 10y ago
HFT is nothing new. It is just the automated version of regular market making. As long as there are several MMs, they will compete for execution speed.
randomname2 10y ago
Is there any reason the DOJ should not subpoena the code here?

62 points by randomname2 10y ago

I consider this to be a big deal. Most people don't realize that retail orders( orders from an ordinary person) almost never reach an exchange. Funds like Citadel and KCG pay the banks and brokerages( Schwab, Vanguard, etc) hunderes of millions per year to get their order flow. Here's a reuters article about Schawb's pay for order flow: http://www.reuters.com/article/schwab-ceo-proposal-idUSL1N0O12EC20140515 http://www.reuters.com/article/schwab-ceo-proposal-idUSL1N0O... > Trading companies, including market makers such as UBS , KCG Holdings and hedge fund Citadel LLC, are willing to compete for retail investors' orders because they are considered "dumb money" that shows the professionals where markets are headed. > In reporting first-quarter earnings last month, Schwab said that it expects to earn about $100 million this year from selling client orders, the first time it gave out a specific number, and higher than the estimate it had given a few weeks earlier to Reuters. and here is the breakdown of their order flow: https://www.schwab.com/public/schwab/nn/legal_compliance/important_notices/order_routing.html https://www.schwab.com/public/schwab/nn/legal_compliance/imp... The funds then get a free look at these orders where if they are beneficial to them they can fill the order, or if they aren't, then they can pass the order onto an exchange. If you thought flash orders were bad, these are much worse and flash orders were discontinued years ago. If you thought HFT funds were bad then consider atleast HFT funds have to put their orders out to the market and take the risk that they'll get rolled over when the market moves. ie they put their money where their mouth is and they compete every day on a level play ground with the rest of the market makers. These internalizers often hold orders up for up to a second, before they choose to fill them or let them go and when you consider that the IEX delay of 350 micro seconds, not milliseconds, is considered contentious you get a good idea of just how scummy things have gotten. in an unrelated piece of news Reuters today wrote a piece showing the top paid hedge fund managers. Citadel's founder Ken Griffin can in first, taking home 1.7 Billion last year. This is really the DOJ taking on the biggest players on wall street. http://www.reuters.com/article/us-hedgefunds-compensation-idUSKCN0Y11D1?feedType=RSS&feedName=businessNews&utm_source=Twitter&utm_medium=Social&utm_campaign=Feed%3A+reuters%2FbusinessNews+%28Business+News%29 http://www.reuters.com/article/us-hedgefunds-compensation-id...

rayiner 10y ago
> These internalizers often hold orders up for up to a second, before they choose to fill them or let them go and when you consider that the IEX delay of 350 nano seconds, not milliseconds, is considered contentious you get a good idea of just how scummy things have gotten. Do you mean microseconds? Because 350 nanoseconds is only long enough for light to travel about 250 feet in fiber.
- chollida1 10y ago
  yes sorry, I've already updated it.
tcoppi 10y ago
I'm not sure how paying for order flow is still legal. At this point it is basically brokerages offloading their fiduciary obligations(for money!) to legalized front-running operations. As the article says, these operations are basically operating as exchanges, and they probably need to be regulated as such.
- kasey_junk 10y ago
  I think that more information being available about order flow practices is all-in-all a good thing, and I encourage the relevant regulatory authorities to watch it like a hawk. That said, I much prefer my free trades from Robinhood that are the outcome of payment for order flow, than I did the $25 it used to cost me to trade. For the kind of trading I do, it is a much better deal to let the internalizers capture the spread (even if it is not the true spread) than it is to not have internalizers.
  - tcoppi 10y ago
    I agree, this is definitely a double-edged sword. Hopefully the outcome of this investigation is more transparency and fairness for retail traders, without completely destroying the execution cost reduction that has been made possible by them.
10y ago

matt_wulfeck 10y ago

If I'm buying with limit orders, can someone explain how I'd get a bad deal on one of these exchanges?

kasey_junk 10y ago
The internalizer could price improve you to an "incorrect" NBBO price and pocket the difference.
chollida1 10y ago
It's a good question. If you are a retail trader, you should almost always use limit orders. You can never get a worse fill than what you ask for but the internalizer can make money off your order and you can miss out on market moves that occur in the second after you place your order. if you are fine getting price that you put your limit order in for then as far as you are concerned, you'll be fine. As with all things market micro structure related, nanex.net has a good writeup on this. I'm not sure how often this scenario occurs as I've never worked for an internalizer but its http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-to-Know.pdf http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-... Check out the section called "Marketable Limit Orders". > For example: the Wholesaler receives a retail order to buy 2000 shares at $10.03 or better (lower) when the SIP shows a total of 2000 shares offered at the best offer price of 10.01. 1. Wholesaler buys 300 from one exchange at $10.01, and immediately, 1700 shares that were available on other exchanges disappear, causing the best offer price to move to $10.02. 2. Wholesaler buys 400 at $10.02, and again, sell orders on other exchanges disappear, causing the best offer price to move to $10.03. 3. Wholesaler sells short remaining 1300 shares at $10.0290 to retail investor, providing a $0.0010 price improvement relative to the $10.03 SIP offer price at time of execution. 4. Within seconds, stock reverts back to $10.01 offered. 5. Wholesaler covers short by buying 1300 shares at $10.01. > By quickly influencing the price of the stock, perhaps by less optimal routing, then directly filling the order at an execution price away from the original NBBO at time of Order Receipt, the Wholesaler profits from the $0.019 change on 1300 shares ($24.70), less any "price improvement" given to the retail investor, less the $4.00 Payment for Order flow paid to the Retail Broker (2000 shares x .0020 per share) and $6 in exchange fees (maximum SEC fee $0.0030 per share x 2000 shares).

atemerev 10y ago

HFT is nothing new. It is just the automated version of regular market making. As long as there are several MMs, they will compete for execution speed.

randomname2 10y ago

Is there any reason the DOJ should not subpoena the code here?