Securities Price Shopping

We've all heard about how Michael Lewis' book (Flash Boys) has brought a flurry of attention to the (real) movements of stocks, but his work seems also to have spurred on a host of other initiatives that were already in the works.

Importantly, the "authorities" have been paying attention to the all-important consideration of pricing (of securities).  In short, we think it's problematic that each party (fund, company, investor) gets to price its own assets. Two different banks can hold the same amount of the same investment, have the same auditor and the same regulator, and price the investment yards apart -- based on the application of different assumptions. We have a number of solutions to this problem, but have been arguing for pricing transparency (where are these prices coming from, and upon what assumptions are they based) for many years.

The SEC had previously found troubling pricing practices ("violations of law or material weaknesses in controls") in the world of private equity.  Now it has announced it found serious deficiencies in valuation processes used by hedge funds:

...regulators have discovered some funds engaging in what he called "flip-flopping," boosting valuations by changing the way they measure holdings several times a year. In some instances, the funds chose the measurement with the highest value or intentionally classified certain assets in a way that gave the fund manager more flexibility to inflate the price of the fund's holdings. (Source WSJ)

FINRA recently fined Citi upon finding that "one of Citigroup's trading desks employed a manual pricing methodology for non-convertible preferred securities that did not appropriately incorporate the National Best Bid and Offer (NBBO) for those securities." According to FINRA, "Citigroup priced more than 14,800 customer transactions inferior to the NBBO." FINRA also notes, as if it comes straight out of Flash Boys which focuses on exchange execution and the NBBO, that...

"Citigroup priced more than 7,200 customer transactions inferior to the NBBO because the firm's proprietary BondsDirect order execution system (BondsDirect) used a faulty pricing logic that only incorporated the primary listing exchange's quotation for each non-convertible preferred security."

For a list of pricing "issues" and disagreements, click here. For our other coverage on high frequency trading (HFTs), click here.

Meanwhile, we've been tracking dark pool trading flow after the recent investigations.  In an earlier blog we tabulated recent trading levels, showing the reported, dramatic, drop in trading at Barclays' dark pool.  Since then, the flow within Barclays' has stabilized and gone up just a touch in August, while overall ATS trading levels have stabilized somewhat.  This is despite any seasonality component, with general trading levels on exchanges down roughly 9.5% since June (i.e., comparing August to June).