Wednesday, May 11, 2016

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

A bit tardy on this but wanted to have it on the blog for future reference.
We've pondered, from time to time, where the SEC was on HFT as it relates to the '34 Act, the Securities and Exchange Act, section 9 and to 15 U.S. Code § 78i - Manipulation of security prices, specifically:
...(a)(2)To effect, alone or with 1 or more other persons, a series of transactions in any security registered on a national securities exchange, any security not so registered, or in connection with any security-based swap or security-based swap agreement with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.
Got it?  The entry of orders for the purpose of other than actually transacting in the security at the given price -- that is, to induce others to trade, to raise or lower the price, to do anything other than to actually transact -- is illegal.
The Federales would probably think I'm misreading the law, at least they haven't moved on the basis of the Exchange Act, but they are moving elsewhere.

From Reuters, May 10:
Federal authorities are investigating the market-making arms of Citadel LLC and KCG Holdings Inc, looking into the possibility that the two giants of electronic trading are giving small investors a poor deal when executing stock transactions on their behalf.

The Justice Department has subpoenaed information from Citadel and KCG (KCG.N) related to the firms' execution of stock trades on behalf of clients, according to people familiar with the investigation.

Authorities are examining internal data concerning the firms’ routing of customer stock orders through exchanges and other trading systems, to see whether they are giving customers unfavorable prices on trades in order to capture more profit on the transactions, according to the people familiar with the inquiry. Under Securities and Exchange Commission rules, U.S. brokers are legally required to seek the “best execution reasonably available” on orders, a standard meant to ensure that all customers get a favorable price and a swift trade.

The Justice Department has looked at a number of high-speed trading firms that pay retail brokerages to sell them their flow of customer orders for stock trades. This segment of the industry is known as wholesale market making.

The documents subpoenaed from KCG related to the firm’s market making activities from 2009 to 2011, according to a person familiar with the KCG probe. In 2012, the head of KCG’s electronic trading group, which included its wholesale market making arm, Jamil Nazarali, left the firm to join Citadel. Since then, Citadel’s own wholesale market maker has grown substantially under Nazarali.

The inquiry is being driven by Justice Department authorities who previously investigated banks for alleged wrongdoing in the market for residential mortgage-backed securities, these people said. Making those cases, which yielded billions of dollars in penalties, required investigators to master some of finance’s most complex markets. The current undertaking presents similar technical challenges.

It isn’t clear what sort of evidence the federal investigators may have compiled in their inquiries. And it is possible that no cases will result from the investigations.

A spokesman for KCG declined to comment, as did a Justice Department spokesman. In an August 2015 filing with the SEC, KCG disclosed the existence of a Justice Department probe but provided no details.

A spokeswoman for Citadel said she could neither confirm nor deny the firm’s involvement in the investigations, but said Citadel cooperates fully with any requests from enforcement agencies.

“As one of the largest market-makers and providers of liquidity in the U.S., we regularly receive inquiries from and work closely with a number of regulators and others regarding our business and market practices,” said Katie Spring, a spokeswoman for Citadel. “We cooperate fully with such requests, but as a matter of practice, we simply don’t confirm any particular inquiry.”

One person familiar with the inquiry said that based on the tenor of the discussions with investigators, Citadel expects the probe will conclude with no action recommended.

KCG’s shares opened 4 percent lower on Tuesday after Reuters reported the Justice Department probe. In afternoon trading, the stock was at $13.24, off 23 cents on the day, or 1.7 percent.

If authorities do move ahead, they would be marching forcefully into the debate over high-speed trading. Critics have alleged that firms with the fastest trading technology are using speed to manipulate stock prices, giving investors a raw deal. The industry counters that its technology delivers cheaper and more transparent trades to investors....MORE
We last visited Citadel in February's "Ahem. The Art Market May Still Be Alive: Speculation That Citadel’s Kenneth Griffin Spent $500 Million On a 2-Piece Private Sale":
Still alive or we just saw top-tick.