On the same day that Senator Elizabeth Warren demanded answers on Robinhood’s ties to Citadel Securities and its affiliated hedge fund, the Chicago-based firm officially launched a legal war Tuesday against the Securities and Exchange Commission.
In previously unreported court documents, Citadel Securities asked a court to overturn the SEC’s bipartisan approval of a trading method launched by IEX Group, the exchange made famous by Michael Lewis’ book “Flash Boys.”
The timing of Citadel’s 77-page court filing Tuesday was unrelated to the recent market turbulence. Citadel Securities filed its intention to sue in October and the two sides agreed last fall to a February 2 deadline for a brief.
Known as D-Limit, IEX says the order type is designed to help protect investors from predatory trading strategies. Short for discretionary limit, IEX says D-Limit acts like a regular limit order except when the exchange’s algorithms predict a price is about to change. A limit order is an order to buy or sell a stock at a determined price or better.
However, Citadel Securities is arguing D-Limit does the opposite of protecting investors. In 77 pages of court documents filed Tuesday, Citadel Securities accused the SEC of having “ignored” evidence that retail investors would be “harmed” by the D-Limit order. The firm cited its own analysis that found more than half of its trading activity on IEX was on behalf of retail investors, not for its own profit.
Citadel Securities, a major source of revenue for Robinhood is owned by billionaire Ken Griffin.
To make its case about how retail investors can be harmed by D-Limit, Citadel Securities compared it to shopping at a store.
“Imagine a grocery store that has deliberately installed extra-long conveyor belts on its checkout lines,” the company argues in the filing. In theory, the store could use that extra time to determine if any items have sold out at rivals’ stores.
“If so, the store’s computers quickly raise its own price before your item reaches the cashier,” the filing says.
The SEC did not respond to a request for comment. IEX said it looks forward to responding to the Citadel Securities filing and pointed to public trading data that it says shows D-Limit delivers better trading results and pricing to investors.
‘Predatory’ trading strategies
The claims by Citadel Securities come despite the fact that last year Republicans and Democrats at the SEC unanimously approved the rule, which was also backed by large pension funds and asset managers like T. Rowe Price.
D-Limit was even blessed by Better Markets, the tough-on-Wall-Street nonprofit run by Dennis Kelleher, who was on President Joe Biden’s transition agency review team.
IEX’s D-Limit, along with the exchange’s other technology, can “protect investors against predatory” trading strategies, Lev Bagramian, senior securities policy advisor at Better Markets, told CNN Business in an email.
Kelleher said D-Limit would shield investors specifically from Citadel Securities — and by extension hurt the firm’s booming revenue.
“Presumably that’s why Citadel vehemently opposed IEX’s D-Limit order type,” Kelleher said.
IEX was founded in March 2012 by former Wall Street executive Brad Katsuyama, a central character in Flash Boys, which made the case that high-speed traders are preying on mom-and-pop investors. IEX was approved as an exchange in August 2016.
“Despite the current environment,” Katsuyama told CNN Business in a statement, “Citadel has followed through on their attempt to reverse the SEC’s approval of an innovation that is designed to protect all investors from predatory trading strategies.”
A Citadel Securities spokesperson pointed to an October statement in which the firm said the SEC “failed to properly consider the costs and burdens imposed by this proposal that will undermine the reliability of our markets and harm tens of millions of retail investors.”
Although D-Limit won unanimous support from the SEC, some companies warned the agency in comment letters not to approve the rule.
Nasdaq, a rival exchange to IEX, slammed D-Limit as “nothing more than a thinly veiled attempt by IEX to bolster its dismal market quality for displayed orders.”
Elizabeth Warren raises questions about Robinhood, Citadel
The lawsuit comes as scrutiny intensifies on Citadel Securities in the wake of the Reddit-driven market volatility and Robinhood’s controversial decision to temporarily suspend purchases of GameStop (GME), AMC (AMC) and other stocks backed by WallStreetBets.
Treasury Secretary Janet Yellen summoned federal regulators to look into the market turbulence this week and lawmakers have called for an investigation.
Robinhood, which championed the free-trading business model that is now common in the industry, has repeatedly said that its trading restrictions on GameStop were driven by soaring financial requirements during the market volatility, not at the behest of Wall Street firms hurt by the GameStop rally.
But Warren, a Democrat from Massachusetts, said Robinhood’s trading limits on small investors “raises troubling concerns about its relationship with large financial institutions that execute its trades.”
Specifically, Warren pointed to Robinhood’s ties to Citadel Securities.
‘You’re the product’
Like other brokerages, Robinhood gets paid to route orders to market makers, a controversial practice known as payment for orderflow. In December alone, Robinhood generated about $12.4 million by routing orders to Citadel Securities, according to disclosure forms.
Critics say it is only free to trade on Robinhood because the app sends orders to market makers, enabling them to trade ahead of those retail flows.
“With anything that’s free, you’re the product,” Mark Yusko, CEO of hedge fund Morgan Creek Capital Management, told CNN Business earlier this week.
Another entity owned by Griffin, the hedge fund Citadel, provided a $2 billion bailout to GameStop short-seller Melvin Capital Management after its bets blew up.
Both Citadel Securities and Citadel the hedge fund denied any role in Robinhood’s decision to stop purchases of GameStop.
In a statement, Citadel Securities said it has not “instructed or otherwise caused any brokerage firm to stop, suspend or limit trading or otherwise refuse to do business.”
The SEC clash isn’t the only time Citadel has been in the headlines recently with a regulator. Last year FINRA, Wall Street’s self-regulator, fined Citadel Securities $700,000 for trading ahead of customer orders. FINRA said that over a two-year period Citadel Securities delayed certain equity orders from clients — while continuing to trade those same stocks in its own account. Without admitting or denying the findings, Citadel accepted and consented to the FINRA action.