Citadel is growing in the stock market-making industry, just as big banks exit it and regulators rev up their scrutiny.
The Chicago-based company, best known for its separate hedge fund operation, said yesterday that it acquired Citigroup’s stock market-making unit, which executes orders for everyday investors trading through such companies as Scottrade.
Chicago-based Citadel is already one of the biggest companies in the highly competitive trading arena, but adding the Citibank operation lets it increase its share against rivals like Bats and KCG Holdings. For Citadel’s billionaire owner, Ken Griffin, expanding that Citadel Securities unit means more profits for himself that don’t have to be shared with hedge fund clients.
“One of the things about this business is that there’s a lot of economies of scale, so your costs are not that much different whether you trade a billion shares or 1.1 billion shares,” said Jamil Nazarali, who oversees the Citadel Securities unit. “It makes sense for us to continue to grow.”
Nazarali declined to say in an interview how much Citadel paid for the Citigroup unit or how much in annual revenue or profit it generates.
In market-making, Citadel matches buy and sell orders in markets all over the world, including stocks, options and treasuries. The market-makers profit from the difference between the prices at which they buy and sell the stocks. In the wholesale market, the market-makers service retail brokers including Scottrade, TD Ameritrade, E*Trade and Charles Schwab, but they also handle orders for the banks and other customers.
Citadel had the biggest share of wholesale retail volume for the fourth quarter, followed by KCG and UBS, according to the New York industry research firm Tabb Group. Citigroup had about seven percent for the quarter.
Citadel began building the business in earnest about five years ago. In that wholesale arena, market-makers like Citadel, KCG and Bats have historically paid the brokers a fee to buy their retail order flow.
That practice has raised questions about whether customers of those retail brokers are getting the best prices, given market-makers are willing to pay for the flow. Indeed, recently there have been reports that the Department of Justice and some state regulators are investigating whether Citadel and KCG are providing the best possible prices.
“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,” Katie Spring, a spokeswoman for Citadel, said in a statement after the reports emerged last week. “We cooperate fully with such requests, but as a matter of practice, we don’t confirm any particular inquiry.”
The company contends that it has improved order execution for retail customers by tightening the spreads between buy and sell orders and by using its high-speed technological expertise on behalf of those everyday investors.
Still, some people involved in the industry remain skeptical. “It begs the question: are they using those retail orders in any way to benefit themselves,” said Edward Siedle, a former SEC lawyer who now investigates money managers for his Boynton Beach, Florida-based Benchmark Financial Services firm. “That’s a legitimate question to ask.”
The question was also asked of the big banks in the wake of the financial recession because they were acting as brokers in one part of their business and as market-makers for their own accounts in another part, creating potential conflicts of interest. The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 made that set-up more costly and complicated so many of them, like Citigroup, have exited it.
A company like Citadel that owns a hedge fund business also faces potential conflicts vis-a-vis the clients in either business, but Citadel said it keeps the businesses completely separate for the most part, aside for their common ownership in Griffin.
Whether it’s separate enough to best serve everyday investors and satisfy regulators is likely to be determined by the investigations underway.