Citadel CEO Ken Griffin: Are Markets Fair To Retail Investors?

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CNBC exclusive: CNBC transcript: Citadel Founder & CEO Ken Griffin speaks with CNBC’s “Squawk Box” today about receiving perrsonal identifying information from retail investors and if the markets are fair to them.

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Q4 2020 hedge fund letters, conferences and more

Citadel CEO Ken Griffin: We Receive No Personal Identifying Information From Retail Investors

Griffin On Whether The Markets Are Fair To Retail Investors

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ANDREW ROSS SORKIN: In the House Financial Services Committee hearing that captured the attention of Wall Street and Main Street, the heads of Robinhood, Reddit, Melvin Capital and our next guest were grilled over the GameStop saga and how they've handled the Reddit rally. Joining us right now is Ken Griffin, he is the founder and CEO of Citadel and we're thrilled to have him on the program this morning. Lots of questions I know you answered a lot of them yesterday but hopefully we can get through a couple of them today. Thank you for joining us. The big question and here's where I want to start if we could, Ken, seems to be the debate still around this idea of payment for order flow. The idea that, effectively, your firm pays Robinhood – it's actually where they get a majority of their revenue from – to execute trades and therefore, the public perception is that you wouldn't be doing that if there wasn't a benefit to you at the expense of the retail investor. Can you explain the economics of payment for order flow from your vantage point?

CITADEL CEO KEN GRIFFIN: Certainly. Andrew, thanks for having me here today. And happy birthday. It's 29 this year is that right?

SORKIN: A little bit older. By about fifteen years. Thank you.

CITADEL CEO KEN GRIFFIN: All right, you'll catch me eventually. So, it's a pleasure to be here. Yesterday was an important hearing in that we were – I was hoping going to find some understanding of what happened in GameStop, and the other talks over the course the last couple of weeks. We spent a huge amount of time on a long-standing commercial practice referred to as payment for order flow. In the United States, retail brokerage firms are permitted to collect payment from order flow from market centers to whom they send orders. Now, over the course last 20 years, as the CEO of Robinhood testified, the regional brokerage firms have become extremely focused on putting various market makers in competition to execute their orders. They will set a payment for order flow rate, say, you know, you pay us X amount per share. And they charge generally speaking the same rate to each market maker. And then we're going to route the order to the market maker that provides us with the best execution. Now, the upshot of this is that the retail investor has a better execution than they can on exchange across the orders that we execute for them. And for the regional brokerage firms, they have an important source of revenue that helps to fuel their business model. And one of the key driving changes of the last few years has been Robinhood's push to zero commissions that has spread across the industry for the benefit of all investors. Now as I testified yesterday, there are reasons that payment for order flow exists. First and foremost is that exchanges are simply not as competitive as we can be off exchange in the processing of retail-sized orders. One of the reasons for this is a regulatory mandate that exchanges have to trade in one-cent wide increments. We can trade tighter than a penny and share the value that we are still able to capture with the retail investor, and with Robinhood and other retail brokers, in the form of payment for order flow. So as I said yesterday, one of the ways that we can reduce the amount of payment for order flow is by permitting exchanges to be more competitive. That would change the industry in a important way going forward if this is an area of undue concern. What I will say is that last year, collectively, the market makers delivered about $3.7 billion of price improvement to retail investors. And through the payment for order flow –



SORKIN: Ken, let me just ask you a question about this though, and I want to raise a letter which I know you're familiar with that was written by your general counsel – your former general counsel I should say – back in 2004. And maybe I imagine your thinking has evolved on this, but back then he wrote, “Citadel Group urges the commission” – this was a letter to the SEC, “to ban payment for order flow. Payment for order flow is a practice that on its face is at odds with a brokerdealer’s obligation to its customers. We do not believe that a broker-dealer that accepts payment for order flow and does not pass such payments on to its customers (either directly or through reduced execution fees or commissions) can consistently fulfill its best execution obligations.”

GRIFFIN: Andrew, do me a favor. Read the front of that letter. What is this letter in reference to?

SORKIN: This letter was in reference to payment for order flow rulings around best execution at that time.

GRIFFIN: No. In the U.S. options market – and that's an incredibly important distinction – in the U.S. options market, every single options trade must be executed on exchange. And the context of this letter has been the introduction of the very negatively impacting price improvement auctions, which discourage market makers from putting their best foot forward, each and every day in the U.S. options market, until they receive an order from a retail brokerage firm that they then take into a price improvement auction. And so what's interesting is, back at the time that this letter was written, we were witnessing a dramatic transformation of the U.S options market, one that has been incredibly good overall for investors, but one that has been in some sense, taken somewhat off track by the introduction of price improvement auctions. That's why when you type in a given symbol on your on your Bloomberg, or on the internet, comparable price for an option the market could be 10,15 cents wide. It's because the existence of the price improvement auctions. Now for equities trading on exchange, the issue here is that the exchanges cannot be as competitive as we can be off exchange – online options we are able to trade off exchange that's a very important distinction.

SORKIN: So, the other big issue, though, that investors and there's a public perception that you get to see the flows. That you get to see information. And that even if you're not front running your investors, which is illegal, that the data unto itself has value. How do you use that information?

GRIFFIN: So, I think there's been a number of misperceptions about the data that we receive from the retail brokerage community. In fact, a prominent US Senator asked us specifically about what personal identifying information do we receive from retail investors. The answer is none. We receive an order, and as the party that has to execute that order, what we look at at the moment of receipt, is what are the various options that we have to achieve the best execution for that order. And you're exactly right. We are not permitted to trade in front of that order any execution that we can achieve in the context of the market. For fulfilling that order, we must provide back to the retail investor, sometimes even with a price improvement that we add on at the moment of execution. So the big picture is this conspiracy theory that we somehow or another are like some of the big tech giants that have access to personal identifying information, it's just flat out false. We have a price, quantity, a limit. That's what comes to us in an order from a retail broker.

SORKIN: Right. Let me ask you a maybe more meta question about all of this, which is, do you believe that the markets unto themselves are completely fair and when I, when I say fair, do you believe that my mother has the same opportunity to make money in the market, as you do.

GRIFFIN: So, it's all comes down to a matter of horizon and strategy. It's like asking if I went and play golf this weekend with Tiger Woods, would I win. Of course not. But there are various ways to compete with Tiger Woods off a golf course and do very well. I'm not gonna play him on his game, on his course. Your grandmother might be very aware of a change in technology or otherwise that will impact our economy. She might look at the car you drive five years and go, hmm, Andrew bought a Tesla. And I think EVs (electric vehicles) are the futures of America, the future of America and I'm going to buy Tesla stock. And if she bought Tesla stock five years ago, she would have made a lot more money than we made at Citadel. So, I never underestimate the skill of the American retail investor at understanding emerging trends, where real wealth is created and their ability to take advantage of that wealth transformation.

SORKIN: One of the big issues that this GameStop mania brought to bear is the issue of shorting, and in particular the issue of short selling beyond the float, beyond where you have situations where a stock is being, being shorted more than 100% of the shares that are available. Can you explain to the public, how that could happen, and whether you think it's right?

GRIFFIN: It's a great question and one that has quite a bit of misinformation. When you short a stock, you have to borrow from somebody else. And that's typically from a pension plan or an endowment that holds the stock at a custody bank. As the short seller you then sell that share of stock that you just borrowed into the market. If the share’s bought by another institution that institution is again in a position to lend that share back out. Now why did institutions lend the shares? They can earn a very, very high rate of return on security like GameStop in the middle of the recent events, you know there were days when borrowing GameStop would cost a short seller an annualized fee of somewhere between 25% and 50%. That's real money to whether it's an ETF holder or pension plan with respect to lending those shares.

SORKIN: And let me ask you a separate question that, that maybe relates to the larger picture of Citadel right now, which is you control and you talked about it yesterday more than 50% of the retail volume. Is that good for the markets when you think about competition?

GRIFFIN: So, we control, and we don't control let's just be clear, we execute about 40% of all the retail order flow the United States every day. And we do it because we offer the best execution quality to American retail investors of any of our competitors. If they decide that by legislation we should, we should eliminate competition as the basis for which business is done in America, then clearly, we'd be in a position to do less business. But we are always advocates for markets that have a level playing field, that are transparent and where the winners and losers are determined on the basis of their ability to compete. We think it's such a world that our team that works incredibly hard. I mean my guys put in just absolutely insane hours in the course of the last two weeks to make sure that we were resilient and stable in the height of the trading frenzy. We think in a world where competition dictates how business is done that we're well positioned to do well for our customers and to do well for our shareholders.

SORKIN: What do you think the implications are of the social media enabled, what you've seen happen in the Reddit community, and what it could do to short selling in the light. For example, do you think that there'll be a lot less short selling in the future?

GRIFFIN: There's no doubt in the foreseeable future the amount of short selling will be reduced by the events of the course of the last couple of weeks. There's just no doubt. What I will say is that it's unclear the power of the Reddit community. That, that will play out over time, as we've seen them converge around other securities, other situations and the price impact that they have as a community. I think the GameStop situation is incredibly unique in that it was such a heavily shorted stock and there were some real potential drivers for change. As you know, the founder of Chewy recently joined the board. He had a fantastic reputation and building Chewy. There's an opportunity for change at GameStop that will unfold over the months and years to come. I think it's a very unique situation and I'd be very hesitant to draw any significant conclusions from the events in the last few weeks and GameStop,

SORKIN: Given all the conspiracy theories though that were raised on social media and the implications of that I'm curious in retrospect, you obviously made a big investment in Melvin, in the middle of this, Melvin Capital. Do you think that was a mistake?

GRIFFIN: No, I think Gabe Plotkin is one of the finest investors of his generation.

SORKIN: But, but, but given what the public perception became around this idea that that Citadel was behind Plotkin on one side behind Robinhood on the other. In retrospect, do you think it created a perception of a conflict?

GRIFFIN: If I had to run my business to the possibility of an insane conspiracy theory emerging at any point in time, I would have no business.

SORKIN: Before I let you go, I do have to ask you one question that's maybe a little bit off topic but it's something we've been talking about virtually every day on this program for the last several months and that is as an investor, Bitcoin, how do you think about Bitcoin today, are you invested in Bitcoin.

GRIFFIN: I just don't spend much time thinking about cryptocurrencies.

SORKIN: Really?

GRIFFIN: No I don't, you know, I don't see the, the economic underpinning of cryptocurrencies. I understand how to value stocks, I understand how to think about currency exchange rates around the world. I don't know how to think about what is effectively a digital token.

SORKIN: It's a longer conversation. Ken, I want to appreciate, and thank you for being here today especially after you got grilled yesterday, and thank you for taking our questions this morning and I hope to come on back, and we can do this again for some more time. So, thank you.

GRIFFIN: Andrew, absolutely. Thank you so very much.

SORKIN: Appreciate it. See you, Ken. Thanks.