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 US Federal authorities are investigating the market-making arms of Citadel LLC and KCG Holdings Inc. reported Reuters.

According to people familiar with the investigation, information from Citadel and KCG related to the firms’ execution of stock trades on behalf of clients has been subpoenaed by the Justice Department.

According to the people familiar with the inquiry, to see whether they are giving customers unfavorable prices on trades in order to capture more profit on the transactions, authorities are examining internal data concerning the firms’ routing of customer stock orders through exchanges and other trading systems. U.S. brokers are legally required to seek the “best execution reasonably available” on orders under Securities and Exchange Commission rules. This is done to ensure that all customers get a favorable price and a swift trade. A number of high-speed trading firms that pay retail brokerages to sell them their flow of customer orders for stock trades are being looked into by the Justice Department. This segment of the industry is known as wholesale market making.

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

The sources told Reuters that the Justice Department authorities who previously investigated banks for alleged wrongdoing in the market for residential mortgage-backed securities were the ones who were driving this inquiry as well. Investigators had to master some of finance’s most complex markets in order to make the previous cases which yielded billions of dollars in penalties. The current undertaking presents similar technical challenges.

What sort of evidence the federal investigators may have compiled in their inquiries is still unclear. And it is possible that no cases will result from the investigations.

There were no comments to Reuters queries from a spokesman for KCG and a Justice Department spokesman.

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

“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. We cooperate fully with such requests, but as a matter of practice, we simply don’t confirm any particular inquiry,” said Katie Spring, a spokeswoman for Citadel.

(Adapted from Reuters)

Categories: Economy & Finance