The Curious Case Of Latour Trading
The SEC fined another high frequency trading firm yesterday. While these settlements with exchanges, brokers and HFT firms seems to be occurring more frequently now, yesterday’s $16 million settlement with Latour Trading raises a whole new level of risk concerns.
Before we get to the details of the case, let’s talk about Latour Trading:
– Latour Trading has been a registered broker/dealer with the SEC since 2009.
– Latour is a high frequency, proprietary trading firm that has no customers. They are also a market maker in a number of securities.
– According to the SEC, in 2011, Latour “often accounted for 4%, and at times as much as 9%, of the trading volume in equity securities for the entire U.S. market”.
– According to BrokerCheck , Latour is registered with all the 11 stock exchanges BUT is not a FINRA member.
– Latour’s clearing agent since 2009 has been Wedbush Securities. Wedbush has just been charged by FINRA for systematic market access violations, anti-money laundering and supervisory deficiencies.
– Latour is wholly owned by Tower Research Capital Investments LLC.
– Tower Research is run by Mark Gorton. Back in 2011, Gorton’s other company, LimeWire, reached a settlement for $105 million with the four largest record labels for copyright infringement
– Tower Research is a member of the Modern Markets Initiative (MMI), the HFT lobby organization.
This case is about a high frequency trading firm who blatantly disregarded Rule 15c3-1, the Net Capital Rule, which is one of the most important rules a for broker/dealer. The net capital rule was put in place so regulators could monitor the financial health of brokerage firms. According to the SEC:
From at least January 2010 through at least December 2011 (the “relevant period”), Latour consistently conducted a securities business while miscalculating the amount of net capital it had and thereby failing to maintain the required minimum net capital by millions of dollars. The firm operated without maintaining its required minimum net capital on 19 of 24 reporting dates during the relevant period. At end of day on those 19 reporting dates, the firm maintained net capital deficiencies in amounts ranging from approximately $2 million to as much as $28 million.”
“Latour’s net capital violations resulted from multiple flaws and errors in the firm’s haircut calculations, including the use of hypothetical positions (positions the firm did not actually hold) to create hedges for certain positions and a computer programming error. As a result of these flaws and errors, Latour regularly understated its required haircut deductions in its net capital computations by tens of millions of dollars. On one occasion, Latour understated its haircuts by nearly $40 million. Because of these understatements, Latour’s net capital violations also resulted in violations of the broker-dealer books and records and financial reporting rules.”
While some reporters like Matt Levine of Bloomberg have already sought to trivialize this case and make it seem like it was just a calculation error when netting positions, we think this case demonstrates the fact that there is an enormous amount of risk embedded in our equity markets that is going unchecked by regulators. We find it hard to believe that Latour was unknowingly reporting incorrect net capital calculations. In their case, the SEC details how Latour would often enter creation/redemption orders for ETF’s with their clearing agent after-hours or even on the weekends and then mark their month end FOCUS report as if they had executed the trades earlier:
“Latour also improperly treated after-hours orders to create or redeem as executed trades. For instance, on Friday September 30, 2011, Latour emailed its clearing firm/AP at 6:38 p.m. to redeem 28 units or 1.4 million shares (worth approximately $158 million) of SPY. The clearing firm responded at 6:45 p.m. that it would enter the order on Monday morning. Latour calculated its September 30th haircuts, however, as if its after-hours order had been executed that day. “
But what we find even harder to believe is that this went on for two years. Why didn’t any of the exchanges/SRO’s that Latour is a member of identify these net capital violations? Were these exchanges looking the other way since Latour was a very large customer that had jumped to the number one program trading volume firm in late 2011? If Latour was a FINRA member, would they have had a better chance at identifying these violations? Doesn’t it make sense for firms that are doing as much business as Latour (at times, they represented up to 9% of all equity volume) to be required to register with FINRA?
While supporters of Latour Trading may claim that no other firm was put at risk since they have no customers, we think that our entire market was put at risk by Latour. By exposing themselves to excessive risk, Latour also exposed their clearing firm, Wedbush Securities, to excessive risk. Wedbush in turn could have exposed numerous other firms (anybody remember Adler Coleman? ). We wonder if there are any other proprietary trading firms currently out there doing the same thing that Latour did? One interesting note is that Latour was playing these net capital games during the time of the Flash Crash on May 6, 2010. We wonder if they had anything to do with the violent moves in the market on that day?
While HFT firms often claim they give the market the gifts of added liquidity and tight spreads, they usually don’t tell you about that other gift they give to the market – systemic risk. As we saw with the $440 million Knight Capital debacle, it doesn’t take long for a firm to self-implode. The market got lucky with the Knight event since it was self-inflicted and contained, but we may not be as lucky the next time one of these lightly capitalized, overly exposed HFT firm has a “software bug”. We are very concerned that the market is starting to overlook these infractions since they are occurring so frequently. We are concerned that the market is normalizing these deviant events.