Conflicts of interest were the watchword of the day in Capital Hill testimony on high frequency trading today, as exchanges and dark pools were questioned about their practices.
Bradley Katsuyama: HFT a national threat
Testifying before the Senate’s Permanent Subcommittee on Investigations, appropriately under the Homeland Security and Government Affairs banner as HFT is considered a national security issue, was Bradley Katsuyama, founder of the IEX Exchange and hero of the book Flash Boys. Katsuyama wastestifying in the first panel, separated from protagonists in the second panel, including Joseph Ratterman, the CEO of BATS Global Markets. Readers will recall the last time these two met on a CNBC stage fireworks ensued.
Katsuyama, for his part, issued a bevy of memorable one liners, such as calling the HFT storm “a principle based issue that comes down to the foundation of why markets exist,” referring to the core regulatory principle that all market participants have equal access and conflicts of interest are not predominate. A simple principle, but when considering high frequency trading, one that easily gets muddied in the dash for HFT cash.
While Katsuyama waxed poetic on issues of market fairness and design intent, it was a little mention from US Senator Carl Levin that might have been the real undercover news.
Levin revealed that an executive at Vanguard Group had determined that receiving payment for order flow could be construed as illegal and thus the brokerage firm does not accept it. Apparently Levin didn’t have the wrong people in front of him, because Joseph P. Brennan, the head of Vanguard’s Global Equity Index Group, appeared clueless about the details of this key corporate decision.
TD Ameritrade’s order flow revenue
As previously mentioned on ValueWalk, TD Ameritrade Holding Corp. (NYSE:AMTD) generated $236 million in 2013 in payment for order flow revenue. Vanguard is one of the larger players in the stock market and could garner an equal among if it sold its order flow, and thus forgoing a “free” revenue stream is significant, giving additional weight to the argument that payment for order flow might be a conflict of interest.
In the testimony TD Ameritrade Senior Vice President of the Trader Group, Steven Quirk, appeared to have difficulty under Levin’s glaring questions. Quirk maintained the brokerage firm always sought the best execution price for their clients regardless of trading venue. Levin then countered that the lion’s share of “non marketable” order flow went to the dark pool trading venues that offered the highest rebates. Levin then asked Thomas Farley, the newly appointed President of the NYSE Group, if at all times when TD Ameritrade Holding Corp. (NYSE:AMTD) routed orders to the dark pools that paid the highest rebate if it was due to NYSE offering a higher stock price at the time, which he said was not the case. This seemed to indicate the NYSE had competitive markets but didn’t receive the non-marketable order flow from TD Ameritrade due to not paying the highest rebates.
Senator Levin closed the testimony by indicating that the markets must rid themselves of conflict of interest in order to be considered fair.
Ultimately the stock market like what it heard, as TD Ameritrade Holding Corp. (NYSE:AMTD) was up near 4.5 percent at mid afternoon trading, as were many of the trading venues.