In the last several years, TD Ameritrade has made several fortunes by routing its customers' stock purchase orders to a high-frequency trading hedge fund called Citadel, now suspected of, but not proven to have engaged in illegal "front-running." (Note: evidently front-running, though illegal if done by humans, is somehow within the law if done by computer algorithms. The Justice Department is now evaluating whether computer-implemented front-running constitutes illegal inside trading.) From the New York Times Magazine adaptation and condensation of Michael Lewis' new blockbuster exposé, Flash Boys: A Wall Street Revolt:
...“You could see that something had just changed,” Gitlin says. “You could see that when you were trading a stock, the market knew what you were going to do, and it was going to move against you.” But what Katsuyama described was a far more detailed picture of the market than Gitlin had ever considered — and in that market, all the incentives were screwy. The Wall Street brokerage firm that was deciding where to send T. Rowe Price’s buy and sell orders had a great deal of power over how and where those orders were submitted. Some exchanges paid brokerages for their orders; others charged for those orders. Did that influence where the broker decided to send an order, even when it didn’t sync with the interests of the investors the broker was supposed to represent? No one could say.
Another wacky incentive was “payment for order flow.” As of 2010, every American brokerage and all the online brokers effectively auctioned their customers’ stock-market orders. The online broker TD Ameritrade, for example, was paid hundreds of millions of dollars each year to send its orders to a hedge fund called Citadel, which executed the orders on behalf of TD Ameritrade. Why was Citadel willing to pay so much to see the flow? No one could say with certainty what Citadel’s advantage was.
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