Can the sell-side absorb any more scandals?

Another week and another broker is forced to face up to regulators over problems with its equity business.

This time it’s Citi, which has seen one of its equity trading units fined US$5 million over a failure to protect confidential trading information.

This latest regulatory action in the wake of the New York Attorney General’s court action against Barclays for creating misleading marketing materials that understated the amount of high-frequency trading (HFT) going on in its pool.

Incidentally, Barclays filed a motion to have the suit thrown out of court at the end of last week, the same week it saw its LX dark pool’s standings plummet from being the second largest in the US to being twelfth largest.

And earlier in July, Goldman Sachs was ordered to pay US$800,000 to the Financial Industry Regulatory Authority for failing to execute trades in its dark pool at the best price available, though it seems the problem was related to systems problems rather than any deliberate attempt to undermine clients.

In the latest case against Citi, its LavaFlow subsidiary, which runs an alternative trading system, it was found that an affiliate running a smart order router (SOR) on LavaFlow was given access to information about individual orders, rather than aggregate data.

US regulator the Securities Exchange Commission (SEC) said the situation had enabled the SOR to execute trades on over 400 million shares over a three-year period.

The SEC has been more willing to intervene in equity markets of late, seeking to restore investor confidence in market structure following the flash crash of 2010 and subsequent technology failures, rogue algorithms and growing public concern stemming from the publication of HFT exposé ‘Flash Boys’ earlier this year.

However, while fines and legal action might prompt the sell-side to make reforms, in the long run the events of recent months have further sapped the buy-side’s trust in brokers.

With many saying the buy-side is already becoming much more empowered and independent from the sell-side in recent years, brokers simply cannot continue to operate in ways that undermine their client base. The institutional investors simply don’t need to rely on them as much as they used to, and dealing with brokers that fail to take proper care of their interests is likely to be scrutinised more closely than in the past.

The sell-side desperately needs to change its ways, but for some the reputational damage of recent scandals could be the final nail in the coffin for their institutional trading business.