Citadel Securities vs. SEC Day One In Court Analyzed

What Is The Court Case about?

As covered in our previous coverage on this case surrounding D-Limit orders, the Securities and Exchange Commission (SEC) accepted a proposal to create D-Limit orders, as put forward by the Investors Exchange (IEX). The discretionary limit order, D-Limit, places a 350 ms delay on orders so that all market participants have a leveled playing field.

In turn, Citadel Securities have taken them to court over the proposed changes. Large institutions tend to have more resources than retail traders (high computing power and faster connections) to implement high-frequency trading ahead of other market players. According to a study released last year by the UK’s Financial Conduct Authority (FCA), the cost of latency arbitrage is quite exorbitant:

“Extrapolating globally, we find that the annual sums at stake in latency-arbitrage races across global equity markets are about $5 billion per year.”

Citadel Securities’ Attorney Denies Latency Arbitrage Exists

Designated as Case#: 20-1424 Citadel Securities LLC v. SEC, the hearing was held at the US Court of Appeals for the District of Columbia Circuit. Attorney Jeffrey Wall, representing Citadel Securities, answered a three-judge panel: Judges Rao, Walker, and Sentelle.  You can listen to the audio transcript here, starting at the 55:00 mark.  

The court session started with the US Circuit Judge, Justin Walker, asking the Citadel Securities representative, Jeffrey Wall, whether latency arbitrage even exists.

To this, Wall responded that the court “doesn’t have to get into it“. The judge then noted his confusion about Citadel Securities, recognizing the existence of latency arbitrage.

“I couldn’t tell from your brief whether your client acknowledges its existence even. And if you don’t acknowledge its existence, it’s hard to make the argument that the algorithm and the speed bump are not sufficiently tailored.”

Attorney Wall responded that there is a reason to be “extremely skeptical“. He noted that 10 years ago, latency arbitrage could be argued for. Today, it is not likely that it even exists as such because:

“Look, there are a lot of dogs that ought to be barking if this is the phenomenon that they say it is.”

An important thing to note for the background of this case is the SEC’s MIDAS system, which allows the regulatory agency to reconstruct order books on the fly for specific timeframes.
On a daily basis, MIDAS sifts through 1 billion records covering records, covering:

• Orders on national exchanges
• Modifications or cancellations of those orders
• Trade executions against those orders
• And even off-exchange trade executions, i.e., dark pools, officially designated as Alternative Trading Systems (ATSs)

Wall noted the absence of any analysis of that data to show where latency arbitrage is present, which includes Citadel Securities’ direct competitors such as XTX Markets. In short, the brunt of Wall’s argument is that the court only needs to agree that:

“All the court needs to say is…look, they took there to be a problem because they took these numbers, and so there is a lot of trading when the signal is on. And the numbers are meaningless because it’s large trades that are turning on the signal.”

Essentially, Wall argued that IEX (Investors Exchange that proposed D-Limit orders) misinterpreted what is going on because it has a low, 2% market share. Furthermore, Wall argued that implementing the D-Limit order is tantamount to tinkering with the market.

“Once an order hits the exchange, you can’t tinker with it.”

Once again, Wall argued that IEX’s proposal is making the market unstable by creating equity prices that are “phantom”. Going even further, he argued that IEX is doing this to bring orders to its own exchange for larger profit gains, describing IEX as a rogue element that is “reaching in and repricing the quotes themselves; that’s sort of a novel thing”.

How Does The SEC Defend Itself?

Stephen Hall, the Legal Director of Better Markets, who was representing a non-profit advocacy group, supported the SEC’s decision to integrate D-Limit orders at the behest of IEX. Hall framed the lawsuit as an attempt by Citadel Securities to maintain its domineering position among market makers.

“Citadel is fighting desperately in court to protect its ability to generate near-certain profits — to print money in effect — through their privileged data access and sophisticated trading technology,”

Furthermore, Judge Neomi Rao countered the argument that the SEC has failed to provide sufficient grounds to make the case for latency arbitrage.

Multiplayer gamers will know that geographic latency is a matter of physical reality. Therefore, if all else is equal – computing power and connection – geographic latency would still be a factor.

Accordingly, judge Rao stated the following: “All quotes have some geographic latencies, so you can’t take immediately to mean it, to literally mean there’s no geographic delay whatsoever “.

Judge Rao then concluded that if geographical latency exists, the D-Limit rule is aligned with the previously established de minimis time delay interpretation in 2016.

“Once you take into account the premise that there is some geographic delay, the question is — is this de minimis IEX delay any different? Then, it’s not. It’s the permission founded well within the same kinds of geographical latency limitation that all other protected quotes is. So, it’s quite simply consistent.”

With that said, the bulk of arguments revolved around the potential SEC infringement of the Administrative Procedure Act, binding the SEC with requirements to put forward new rules.

The Case Achieved Record Viewing Figures Across Multiple Platforms

The court hearing stream proved popular online with thousands tuning in live to hear the case — perhaps a testament to the public’s interest in this story since the beginning of the year.

Such a conclusion would clear up the mess enacted on January 29 when multiple brokerages decided to restrict the trading of popular meme stocks, such as GME and AMC. Yesterday, at Yahoo Finance’s All Markets Summit 2021: The Path Forward, Gary Gensler reiterated that retail brokers made the wrong call:

“Restrictions on trading that fateful Friday in January was not good for the retail investors that wanted access to the markets,”

However, the SEC’s report issued on October 18, 2021, did acknowledge that GameStop was a unique event, unlikely due for a repeat:

“GME experienced a confluence of all of the factors that impacted the meme stocks: (1) large price moves, (2) large volume changes, (3) large short interest, (4) frequent Reddit mentions, and (5) significant coverage in the mainstream media.”

If the SEC successfully defends D-Limit orders against Citadel Securities, this may be the compromise needed to avoid banning the PFOF model altogether. No doubt, it could severely impact Robinhood and other brokerages that rely on zero-commission trading.

Do you think all market participants have equally powerful computers and fast connections in order to eliminate latency arbitrage? Let us know in the comments below.

The post Citadel Securities vs. SEC Day One In Court Analyzed appeared first on The Tokenist.