Finance

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

Citigroup has been selling a lot of assets lately, so it's not too surprising that the bank just unloaded high-frequency trading pioneer Automated Trading Desk to Citadel. 

What is surprising, however, is that it took the firm so long to divest itself of a unit that caused many headaches and became more and more of an odd fit in the years since its purchase in 2007, when the $680 million acquisition was heralded with breathless optimism: "Citi intends to leverage its global capabilities and expand ATD's technology and trading expertise to markets around the world which are experiencing similar growth in trading volume and electronic execution."

The first headache? Well, that $680 million didn't quite turn out to really be $680 million. The payday was $102.6 million in cash and the rest in Citigroup shares. This was in June 2007, right before the financial crisis was about to do this to Citigroup's shares:

Before the Crash
Citigroup offered to buy Automated Trading Desk when its shares were trading near their peak
Source: Bloomberg
Note: Share price is adjusted for reverse splits.

ATD founder David Whitcomb was not too thrilled to be holding so many shares that were falling so fast, so he led a class-action lawsuit against Citigroup contending the bank concealed toxic assets from shareholders. The bank ended up agreeing to pay $590 million to settle the case. 

Then the regulatory headaches began piling up. Remember how that ATD trading expertise was going to be expanding to "markets around the world which are experiencing similar growth in trading volume and electronic execution?" Well that idea hit some bumps in the road. ATD closed operations in Canada, Japan and Australia in 2013 as declining trading volumes and regulatory scrutiny made this type of electronic market-making less profitable, as a Wall Street Journal article reported.

Throw in Dodd-Frank Act pressure to flee proprietary trading and activities that can require balance-sheet space, and add a generous serving of public outrage after Michael Lewis's "Flash Boys" book about high-speed traders, and you end up with a business that sticks out like a sore thumb in a too-big-to-fail bank. "Under increased regulatory pressure, Goldman Sachs Group Inc., Bank of America Corp., Credit Suisse Group AG and Wells Fargo & Co. have all squashed U.S. equity market-making businesses in recent years," as Bloomberg's Annie Massa reported.  

Another headache came last August when Citigroup agreed to pay $15 million to resolve Securities and Exchange Commission claims that it failed to properly enforce policies meant to prevent improper transactions, including 467,000 trades that were inadvertently routed to ATD on behalf of advisory clients. (Read Matt Levine here for all the pertinent details on why that's not allowed and how it ended up happening.)

That $15 million settlement is negligible to a bank of Citigroup's size, but the case perhaps highlights how a business like this could be more trouble than its worth, considering the regulatory risks and the stiff competition being put forth from the likes of dominant players such as Citadel and Knight Capital. And the regulatory headaches only stand to get worse, with recent reports that authorities are scrutinizing the market-making practices of both of Citadel and Knight.

While Citigroup can cut and run, it's clear Citadel has much more at stake: 

Where the Trades Go
Citadel Securities executes more than a third of trades made by retail investors and traders in the U.S.
Source: Citadel

The SEC has made it clear that it's considering cracking down on the practice of "payment for order flow," in which firms like these pay the Charles Schwabs and E*Trades of the world to send them all their orders so they can match buyers and sellers in their own off-exchange systems. Why would they pay for order flow? Well, the general thinking is that retail investors are known charitably as "uninformed" and uncharitably as "dumb money" who are profitable to trade with, especially when cutting edge, high-speed data processing is involved. The profits may be as low as fractions of a penny per share, but it adds up if turbocharged by enough volume. The SEC is looking at measures including prohibiting payment for order flow, having the payments passed on to traders, requiring better disclosure and improving best practices. 

All of this makes it clear why Citigroup would want to get out of this business. And why Citadel, one of the biggest players in the "payment for order flow" wholesale trading business, would want to go to the mattresses to defend it and expand it. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net