Weekend Economists Commemorate the Dark Knight July 25-27, 2014

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21. Citi Wasn't So Clear on What 'Hidden Orders' Meant

http://www.bloombergview.com/articles/2014-07-25/citi-wasn-t-so-clear-on-what-hidden-orders-meant

Coincidence or not, ever since "Flash Boys" came out four months ago, alleging that U.S. equity markets are rigged by high-frequency traders and crooked dark-pool operators, there's been a whole lot of regulatory attention paid to high-frequency traders and crooked dark-pool operators in U.S. equity markets.1 New York Attorney General Eric Schneiderman has been on quite a tear, going especially hard after Barclays's dark pool. The Securities and Exchange Commission has upped its game, fining Liquidnet $2 million for using dark-pool customer data to pitch issuer business. Even Finra has gotten involved, fining Goldman Sachs $800,000 for messing up the clock on its dark pool.

Here's another one! It's a $5 million SEC settlement with LavaFlow Inc., a big stock trading venue owned by Citigroup. LavaFlow is not a dark pool; it's an electronic communications network (ECN) that displays orders. (Basically: It's a stock exchange within Citigroup.) But it allows subscribers to submit various sorts of non-displayed orders,2 which are, you know, not supposed to be displayed. And the problem was with those non-displayed orders.

LavaFlow had an affiliate called Lava Trading,3 whose main business was running a smart order router called ColorBook. From the SEC's order:

Lava Trading’s flagship product was ColorBook, which was software that provided smart order routing services to over 100 registered broker-dealers that principally used ColorBook to route their customers’ orders to execution venues. ... An “order router” is an application that generally allows an end user to submit an order to an execution venue. A “smart order router” applies preprogrammed analytics that carry out an execution strategy for order flow provided to the smart order router.

The point here is that, if you just want to buy some stock, that's a weirdly hard thing to do. You can't just go to the New York Stock Exchange and say "buy 100 shares of IBM," because IBM shares are traded on a bunch of different exchanges and ECNs and dark pools, and you want to buy them at the lowest price offered on any of those venues. Or maybe you don't -- maybe you prefer convenience to getting the lowest price. But that doesn't matter, because Regulation NMS says that your broker can't buy you 100 shares of IBM at $195 on the New York Stock Exchange if someone is offering 100 shares for $194.95 on, say, the LavaFlow ECN.4 So you're forced to deal with all the venues anyway.