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 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."