The SEC censured and penalized Citadel Securities LLC over misleading statements the firm’s wholesale market making unit allegedly made to retail broker-dealers regarding the execution of retail equity trades sent to the unit under payment for order flow arrangements. Citadel agreed to pay $22.6 million without admitting or denying the SEC’s findings (In the Matter of Citadel Securities LLC, Release No. 33-10280, January 13, 2017).
During a conference call with reporters, the SEC’s Acting Director of Enforcement, Stephanie Avakian, said the Citadel matter was important for a number of reasons, including that it: involved retail order handling; implicated pricing and latency differences between the data feeds used to obtain pricing information; established the SEC’s ability to investigate algorithmic trades; and reaffirmed to investors that the SEC will conduct enforcement throughout markets, including retail markets.
SEC focus on algorithms. According to the SEC’s order, Citadel’s wholesale market making unit, Citadel Execution Services (CES), made written and other representations to CES retail broker-dealer clients, although CES had no direct contact with the retail customers whose orders were the subject of the SEC’s investigation. Specifically, the SEC alleged that CES defined "market orders" in a particular way and told clients that it would internalize or route orders to obtain the best bid or offer from available data feeds (e.g., securities information processors (SIPs) feeds or direct depth of book feeds).
The SEC’s press release and agency officials on the media call emphasized that internalization means the market maker takes the other side of the transaction or trades against the order. The SEC suggested that retail investors and broker-dealers proactively seek explanations from internalizers about how prices are determined.
In the Citadel matter, CES used a pair of algorithms to make decisions about whether to internalize or to route orders to the market. The algorithms were designed to account for differences between SIPs and depth of book feeds, including latencies due to SIPs’ physical locations, the time needed to consolidate data, the existence of separate execution feeds, and the lack of odd lot data.
CES’s FastFill strategy would immediately internalize a marketable order at the SIP price when the price from a depth of book feed was better than one from the SIPs. These orders typically received some form of price improvement, but not enough to eliminate the unfavorable result. Price improvement was primarily aimed at getting or retaining retail broker-dealer clients.
CES’s SmartProvide strategy functioned similarly, but with emphasis on scenarios where the SIPs had better prices than the depth of book feeds. In these Instances, the algorithm routed a non-marketable order to the market. Together, the two algorithms handled a comparatively small portion of CES’s total order flow. The SEC targeted CES’s use of the algorithms from the end of 2007 until January 2010, but CES no longer uses the algorithms embodied in FastFill and SmartProvide.
Censure and penalty. Citadel was charged with willfully violating Securities Act Section 17(a)(2), which prohibits "any person in the offer or sale of any securities" from "obtain[ing] money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading."
The firm will pay disgorgement of $5.2 million (with prejudgment interest of nearly $1.5 million) along with a civil money penalty of $16 million for a total of $22.6 million. In reply to a reporter’s question, Robert Cohen, Co-Chief of the Market Abuse Unit within the SEC’s Enforcement Division, explained that the censure of Citadel is a statutory remedy, but declined to comment on what might be the consequences of the censure for Citadel.
The case is No. 33-10280.
Companies: Citadel Securities LLC
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