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


by Pam Martens and Russ Martens, Wall St For Main St:

The 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.”

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