What’s Going On Inside Your Wall Street Brokerage Firm?

By Pam Martens and Russ Martens: December 12, 2017

Wall Street Street SignThe Financial Industry Regulatory Authority (FINRA), Wall Street’s self-regulator with a long history of conflicts of interest, has released a summary of its findings from the examinations it conducts at the nation’s brokerage firms. As is typical of FINRA, the document released to the public is extremely light on details. (Almost half of FINRA’s Board comes from inside the industry, with current representation from JPMorgan Chase, Merrill Lynch, Citadel and Fidelity, to name just a few of the insiders.)

One area of the report did stand out, however. FINRA has expressed concerns about the fairness of the price you’re getting on the stock or bond trade you’re placing with your broker. In Wall Street parlance, this is known as “Best Execution.” The report explains:

“Best execution is a significant investor protection requirement that essentially obligates a broker dealer to exercise reasonable care to execute a customer’s order in a way to obtain the most advantageous terms for the customer…If a broker-dealer receives an order routing inducement, such as payment for order flow, or trades as principal with customer orders, it must not let those factors interfere with its duty of best execution nor take them into account in analyzing market quality…

“FINRA had concerns regarding the duty of best execution at firms of all sizes that receive, handle, route or execute customer orders in equities, options and fixed income securities. FINRA found that some firms failed to implement and conduct an adequate regular and rigorous review of the quality of the executions of their customers’ orders…

“As a result of such deficiencies, these firms failed to assure that order flow was directed to markets providing the most beneficial terms for their customers’ orders. FINRA notes that conducting a regular and rigorous review of customer execution quality is critical to the supervision of best execution practices, particularly if a firm routes customer orders to an alternative trading system in which the firm has a financial interest or market centers that provide order routing inducements, such as payment for order flow arrangements and order routing rebates.”

In the paragraph above, FINRA highlights firms that route “customer orders to an alternative trading system in which the firm has a financial interest.” An alternative trading system (ATS) is typically a Dark Pool operating inside the bowels of the largest Wall Street banks, e.g., Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley, Merrill Lynch, etc. Dark Pools function as thinly regulated stock exchanges with little to no visibility given to the public.

Because there is no public outcry as a result of this darkness, there has been little interest from the mainstream business press to cover this deeply conflicted part of the market. Wall Street On Parade has attempted to fill in the gaps in reporting on this issue. (See related articles below.)

FINRA is now asking us to believe that it wants to see “rigorous review of customer execution quality” done by the brokerage firms that are running Dark Pools. But here’s what happened in 2014 when FINRA had the chance to take a strong stand against Goldman Sachs for outrageous conduct in its Dark Pool known as Sigma-X.

FINRA’s Market Regulation staff conducted an investigation of Sigma-X from July 29, 2011 through August 9, 2011 – a brief eight trading days. The investigation resulted in findings that the Dark Pool had denied its customers a trading price equal to the National Best Bid and Offer (NBBO), which is what they are required to do under law, on 395,119 transactions.

Instead of rigorously reviewing its in-house trading practices for deficiencies, FINRA tells us that “from at least November 1, 2008 through August 31, 2011” Goldman Sachs only spot-checked 20 orders per week to determine if they were in compliance with the National Best Bid and Offer. That sounds like the precise opposite of “rigorous.”

FINRA apparently looked further to see if there was a pattern of bad trades. It explains in a footnote that it knows of two other dates when Sigma-X also failed to provide its customers with trades at the National Best Bid and Offer: 7,585 bad trades occurred on March 16, 2011 and 6,359 occurred on June 23, 2011.

Given what looks like a very serious pattern of wrongdoing, one would have expected a serious regulator to review the entire three year period in question and specifically define how much money this cost the investing public.

Instead, FINRA waited three years to release its findings from 2011 and then settled the matter for chump change. On June 3, 2014, FINRA levied a fine of $800,000 against Goldman Sachs, suggesting that the meager fine was because Goldman had “voluntarily” agreed to pay its fleeced customers $1.67 million in restitution. Of course, without the precise details on how many actual bad trades there were in the three year period, the public has no way to determine if $1.67 million was meaningful restitution or a wink and a nod to Goldman’s version of “rigorously” policing its internal Dark Pool.

Step back for a moment and think about this: FINRA, a self-regulator with deep industry ties has outsourced its monitoring function to the Wall Street firms themselves, asking them to “rigorously” police themselves while it provides only spot checks. This in an industry where everything from the interest rate benchmark Libor to foreign exchange to the metal markets have been rigged by colluding Wall Street banks in recent years. Some bank traders even formalized the name of their group, appropriately calling themselves “The Cartel” and “The Bandits Club.”

In 2012, Wall Street Journal reporter, Scott Patterson, released a 354-page book that took a hard look at U.S. market structure. It was titled: Dark Pools: High Speed Traders, A.I. Bandits, and the Threat to the Global Financial System. On page 339 of his book, Patterson writes in the notes section: “The title of this book doesn’t entirely refer to what is technically known in the financial industry as a ‘dark pool.’ Narrowly defined, dark pool refers to a trading venue that masks buy and sell orders from the public market. Rather, I argue in this book that the entire United States stock market has become one vast dark pool. Orders are hidden in every part of the market. And the complex algorithm AI-based trading systems that control the ebb and flow of the market are cloaked in secrecy. Investors – and our esteemed regulators – are entirely in the dark because the market is dark.” (The italics in this excerpt are as they appear in the hardcover book.)

In  2014, Wall Street veteran and bestselling author Michael Lewis published his non-fiction book Flash Boys and went on 60 Minutes to declare that the U.S. stock market is rigged. Since that time, the SEC has done essentially nothing to correct the rigged structure of trading. Traditional stock exchanges, that are supposed to be self-regulatory bodies, are still charging enormous fees to allow high-frequency trading firms to co-locate their computers next to the stock exchange computers to gain a speed advantage. The stock exchanges are still selling a faster direct feed of trading data to those who can afford the obscene cost of this data and trade ahead of the market on that data. Discount brokers are still selling their own customers’ stock orders to alternative trading systems run by some of the biggest Wall Street firms in an unseemly system known as “payment for order flow” that places a low to non-existent concern on best execution.

And to top it all off, FINRA has the audacity to be running a private justice system for these same Wall Street firms – allowing them to close the nation’s courthouse doors to both customers and employees seeking restitution and to level the playing field.

Is it any wonder that Americans no longer trust Wall Street?

Related Articles:

Are Big Banks’ Dark Pools Behind the Run-Up in Bank Stock Prices?

Another Wall Street Inside Job?: Stock Buybacks Carried Out in Dark Pools

Shades of 1930 in Wall Street Banks’ Dark Pools?

Citigroup’s Dark Pools: Here’s Why the Public Doesn’t Trust Wall Street

FINRA Bombshell: Biggest Wall Street Banks Are Trading Their Own Stock in Dark Pools

Citadel’s Dark Pool: SEC Draws a Dark Curtain Around Its Operations 

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