Updated with correction
Recent settlements over market makers providing misleading information on equity trades have put institutional investors on notice that they need to take a closer look of how their trades are routed, sources said.
The fines against Citadel Securities along with Deutsche Bank Securities and Credit Suisse over misleading trade execution show that investors and regulators “aren't taking (brokers') word any more” on best execution, said Peter Maragos, CEO of agency brokerage Dash Financial LLC, New York.
“This should be a call to action for both asset owners and institutional investors,” David Weisberger, managing director and head of trading and quantitative services at IHS Markit, New York, said of the Jan. 13 announcement that Citadel Securities would pay $22.5 million to settle Securities and Exchange Commission charges that it misled other brokerages in getting the best market price on retail orders.
IHS Markit is among a growing number of firms — including Trade Informatics LLC, LiquidMetrix and Babelfish Analytics, even market makers like J.P. Morgan Chase & Co. — that are providing trade order routing transparency for institutional clients.
“In the institutional world, there's virtually no scrutiny of routing, so what do you think is actually going on?” said Mr. Weisberger. “In retail, with a halogen light shining down, this still goes on. There's no data on fill rates and other information on the institutional side that provide the basis for market comparison. If you think Citadel is doing it, there are hundreds of institutional brokers with no scrutiny of their routing.”
That lack of scrutiny, sources said, can open the door to trades being routed to exchanges and dark pools based more on rebates and lower fees than on best execution. In Citadel's case, algorithms did not take the other side of the orders, called internalization, at the best price observed — but reported to clients that it did.
Many money managers aren't doing their due diligence on routing, said Rob McGrath, former global head of trading at Schroders PLC, New York. “Some of the bigger guys are on top of this, but only a handful; the majority aren't,” said Mr. McGrath, who left Schroders in July and is now consulting with financial technology developers on trading applications.
Mr. McGrath said the issue with many money managers isn't ignoring transparency but rather knowing what to look for. “It's not popular to say, but it's because they don't know what they don't know,” Mr. McGrath said.
“They (managers) don't know the questions to ask, and the brokers certainly don't make it easy on them. The idea is that if people can just tell you enough to satisfy you, that's what's happening. If you know what to ask for, you'll get it, he said.”