ConvergEx Charged by SEC / DOJ


Yesterday the SEC announced that it had charged ConvergEX with fraud for deceiving customers about commissions.

“ConvergEx brokerages sent customer trades on an unnecessary journey through its offshore affiliate so they could take extra fees behind customers’ backs,” said Stephen L. Cohen, associate director of the SEC’s Division of Enforcement.  “Brokers who seek to enhance their bottom lines through deception about their compensation are violating the law and the trust of their customers.”

You can read the details here.

Essentially, one division of ConvergEx had created a system where large institutional orders were routinely routed through a Bermuda subsidiary for a period of five years (between 2006 and 2011), which took trading profits on those orders, passed the executions back to the US-based ConvergEx subsidiaries with markups that reflected the undisclosed trading profits, and then those executions were delivered to the clients with a commission attached.

The subsidiaries involved were New York based G-trade Services LLC (GTS), Bermuda-based ConvergEx Global Markets Limited (CGM) – a wholly owned subsidiary of GTS, and New York based ConvergEx Execution Solutions LLC (CES). The institutional business that was disadvantaged was order flow from transition business. It should be noted that the vast majority of ConvergEx’s institutional business is not involved in the activity that resulted in the SEC/DOJ actions. On page 4 of the SEC order, footnote 4 explicitly states:

These proceedings do not involve the following businesses of CES, G-Trade or their affiliates: U.S. Program and Sales Trading, Options Services, Prime Services, ATSs, Commission Management and Recapture Services, Clearing, or Technology. These proceedings also do not involve orders executed through ConvergEx’s electronic Direct Market Access (“DMA”) platform.

The CGM behavior was wrong, and the details of that division’s actions demonstrate dishonesty of a most sad sort. In some stated incidents,  the SEC noted that the commissions charged to the clients were $93,000 and $33,000  – while ConvergEx’s CGM division also took trading profits in addition to those commissions of $543,000 and $283,000, respectively.

The details went like this:

1)      ConvergEx agreed to execute large baskets of order flow for clients, including order flow on US listed stocks.

2)      ConvergEx assessed the customer’s ability to detect fraud and dishonest markups, including whether the customers had the capability to see real-time fills and executions. If the clients were not sophisticated enough to see the fills real time, and detect markups, then ConvergEx would route the orders to Bermuda-based CGM.

3)      CGM would execute the orders, inter-positioning itself in the process. Buy orders were sometimes given the high price of the day, and sell orders the low price of the day, despite the actual fills related to the execution of the orders. The difference would be classified as TPs (trading profits).

4)      The fills, including the markups reflecting CGM’s trading profits, were passed back to the client, and a commission tacked on to add insult to injury.

5)      If the clients asked to see times and sales data, questioning the executions, then falsified data was created that backed into the poor fill prices. If the clients asked to get real time fills, ConvergEx told those clients that it would take a while to implement – perhaps a year; during that year ConvergEx continued to willfully “milk the cow”.

6)      CGM traders, when asked how much profits they could take on the orders routed to it, were told by management to take “as much as possible”.

7)      Cost analysis was performed of the higher clearing costs involved by routing orders from NY to Bermuda and back, and customer orders were not directed  to CGM unless there was an opportunity to take trading profits.

Again, what kind of institutional business was affected? Transition business. Was it all transition business? No – it was only transition business where clients had no access to real-time executions and fills (FIX Tag30 – for example); in other words it was the transition business of clients with the least sophistication, who did not have the means to monitor their trades, and who consequently placed the greatest amount of trust into ConvergEx to treat them honestly and fairly. If you have been trading through ConvergEx’s DMA platform, or with their sales and trading desks, you were not affected. This misconduct was isolated to a subset of the transition business.

Could this happen to any of us? All of us would like to think that the answer is decidedly no. However, we do know that we all should be looking at our routing with more scrutiny in general. We should all insist on complete disclosure of order routing and execution practices, and from all venues we deal with. We should all understand how customers are segmented within the dark pools we trade in, as well as the order types allowed, and the order matching engine priorities.

Complexity again is our enemy, and we are reminded yet again why simplicity in order routing, execution, order matching is the best way that we can protect ourselves from the labyrinth that is our modern capital markets.

At this point I suppose we all wish Eric Noll good luck in his new clean up role at ConvergEx. They will need an executive with the ability to steer though troubled times.