By Pam Martens: June 24, 2014
It’s gotten to the point that to maintain an account on Wall Street you have to surrender to a no-law zone. Wall Street is the only industry in America that can force its customers’ claims into its own private justice system, effectively closing the nation’s courts to its customers, while imposing a system where case law and legal precedent can be ignored and the public and press are barred from observing the proceedings.
Under that shield from the courts and the full measure of the law, Wall Street rules itself much of the time. Just yesterday it was reported that after Wall Street firms pummeled their self-regulator with angry letters, the Financial Industry Regulatory Authority (FINRA) withdrew a proposed rule that would force brokerage firms to tell customers what financial incentives they had paid a broker to switch firms. Often those incentives require reaching set commission goals which can encourage brokers to churn accounts. The Public Investors Arbitration Bar Association (PIABA) filed a noteworthy letter explaining why customers are required to have this “material” information and what the proposed rule left out. As usual, the industry got its way.
Sometimes, the iron will of Wall Street is such that investors completely overlook the rights that they do still have. Let’s take a look at how millions of stock trading orders are conducted every business day on Wall Street between the retail client and their stockbroker.
Let’s say you call your broker to sell 100 shares of XYZ stock held in your account. The conversation typically goes something like this?
Broker: Shall I put that in as a market order or a limit order?
You: a limit order at $38.00, good-until-cancelled. (You could also enter the order just for the day.)
Broker: Do you want the proceeds to go into your sweep account or a check for the proceeds to be mailed to you.
You: Pay out the proceeds to me.
Broker: Okay, you want to sell 100 XYZ at $38 GTC, is that correct?
You: That’s correct.
Broker: The commission on that, if executed, would be $_____.
Broker: Okay, I’ve entered your order.
What’s missing from this conversation?
Here’s a hint. The broker has correctly allowed you to specify time and price parameters for your trade. But what else is very important for getting a good trade execution?
The broker did not ask you which venue you wanted to route your stock order and, according to many SEC Rule 606 reports, you did not know enough to speak up.
According to Morgan Stanley’s first-quarter 2014 Rule 606 report, 100 percent of the customer orders it received were “non-directed.” Without any direction from its customers, according to those same reports, it directed over 80 percent of all stock trades to (wait for it)…itself. (Read Morgan Stanley’s further disclosures here.)
Is Morgan Stanley a stock exchange? No it’s not. How is it able to both take your order and execute your order away from a stock exchange within the bowels of its own firm?
Morgan Stanley, according to the SEC, owns and operates multiple Alternative Trading Systems, where it is allowed to route your orders.
Does Morgan Stanley’s 16,000 financial advisors actually know their firm is routing your stock trade to itself? We don’t have the answer to that. You should ask your financial advisor.
According to Merrill Lynch, things are operating much differently with its customers’ stock orders, for some unfathomable reason. Merrill’s more than 15,000 financial advisors and/or its sharp customers are telling the firm where to route orders, according to its Rule 606 reports.
The Rule 606 Report for the first quarter of 2014 for Merrill Lynch shows that close to 100 percent of customers’ stock trades were directed to a specific venue — by someone. For stocks listed on the New York Stock Exchange Euronext, 36.87 percent of those trades went to the New York Stock Exchange for execution whereas none of those stocks at Morgan Stanley went to the New York Stock Exchange. For stocks listed on the Nasdaq Stock Market, Merrill routed 68.85 percent of those trades to Inet, a system owned by Nasdaq. (See the full report here; putting Merrill Lynch in the drop-down box.)
According to the SEC, your brokerage firm can pretty much do whatever they want with your order as long as they make the claim they provided you with best execution. The SEC’s web site says:
“Your broker may decide to send your order to another division of your broker’s firm to be filled out of the firm’s own inventory. This is called ‘internalization.’ In this way, your broker’s firm may make money on the ‘spread’ – which is the difference between the purchase price and the sale price…
“If for any reason you want to direct your trade to a particular exchange, market maker, or ECN, you may be able to call your broker and ask him or her to do this. But some brokers may charge for that service. Some brokers offer active traders the ability to direct orders in Nasdaq stocks to the market maker or ECN of their choice.”
All of this deregulation of markets was supposed to bring about better choices for the consumer – or so we were told. And, yet, here is the SEC telling you that you may be able to direct your order but may be discouraged from exercising your right by the imposition of a fee.
Today, there are 13 stock exchanges and over 45 Alternative Trading Systems (including dark pools which do not make stock bids and offers visible to the public) and the consumer is lost in this maze.
The stock exchanges are selling, for obscene monthly fees, the right for the Alternative Trading Systems and high frequency traders to co-locate their super computers next to the exchanges’ computers to gain a speed advantage, an early peek at orders and, potentially, front run them.
The dark pools are seducing retail brokerage firms with payment for order flow to get their customers orders directed to their dark pool – pulling liquidity from the stock exchanges. According to TD Ameritrade’s Rule 606 Report for the first quarter of 2014, it directed its stock trades in both New York Stock Exchange listed stocks and Nasdaq stocks in direct proportion to the largest amounts being paid to it in payment for order flow by three market venues: Direct Edge, Citadel, and Citigroup Global Markets.
The big Wall Street firms, which are doling out customer advice, making public buy and hold stock recommendations — which can dramatically move the price of stocks — are also trading customers’ stocks in the dark in their own in-house dark pools, which are, effectively, unregulated stock exchanges.
The mess has finally gotten the attention of the New York State Attorney General, Eric Schneiderman, who calls it “Insider Trading 2.0.” Last week the Senate Permanent Subcommittee on Investigations titled its hearing on the matter: “Conflicts of Interest, Investor Loss of Confidence, and High Speed Trading in U.S. Markets.”
The web of conflicts has become so ingrained and intertwined that according to Bloomberg News’ Keri Geiger and Patricia Hurtado, the FBI “has openly solicited traders and stock-exchange workers to blow the whistle on possible front-running and manipulation via high-speed computers.”
But be comforted. The SEC says you may be able to tell your broker where you want your trade executed; if you could possibly navigate this web of conflicts and find a venue in which you would have the confidence to direct your order.
UPDATE: This article previously referred to Inet as Inet ATS, Inc. because that is the title used on the Merrill Lynch Rule 606 report. Inet is the name of the matching engine used by Nasdaq. The SEC no longer shows Inet operating an ATS.