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Bloomberg: BoA's market-making unit for its Merrill Lynch wealth division gets suddenly scrapped

The news and data giant is reporting that heat from Flash Boys made the investment bank think twice about conflicts

Thursday, May 22, 2014 – 2:22 AM by Brooke Southall
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Tim Welsh: You know the gig is up. That's their core competency.

In an abrupt about-face, Bank of America has scrapped a unit built expressly for Merrill Lynch, according to an article today in Bloomberg.

The Charlotte, NC-based mega-bank is shutting down the market-making business after only a year, according to the New York-based reporters who cited two anonymous sources familiar with the situation.

Increasing regulation and Bank of America’s concern about perceived conflicts of interest killed the internal startup venture. The unit’s leaders — Jonathan Wang and Steven Sadoff — were told to seek other jobs internally, according to the Bloomberg article.

The conflict arose because a custodian like Merrill Lynch is supposed to offer best execution on behalf of its advisors. But if fatter trading spreads in market-making lead to high profits, then conflicts emerge. To get around these conflicts, Wall Street tends to favor third-party trading firms like Citadel Holdings Inc. and KCG Holdings Inc. There again, conflicts can arise for custodians that selling the orders to the third parties.

Preemptive action

Essentially, Merrill had taken these third-party operations in house by hiring seasoned veterans of Citadel and KCG. Wang was at Citadel from 2005 to 2011, according to his LinkedIn profile. Sadoff was executive vice president of global head of operations, services, and technology at KCG’s predecessor at Knight Capital Group Inc., from 2002 to 2013, according to his LinkedIn profile. Merrill Lynch poached him last year.

Merrill Lynch is only the most recent advisor custodian to take such preemptive action. Charles Schwab & Co. bought and ran trades through market-maker affiliate Mayer & Schweitzer Inc. starting in 1991 but sold it in 2004 after merging it with Soundview and renaming it Soundview Schwab Capital Markets.

“This was a huge issue when I got to Schwab in 1999,” says former Schwab executive Tim Welsh, president of Nexus Strategy LLC. “Schwab wisely got out of this part of the market.” With Schwab safely out of the fray, it has called on regulators to bring down the hammer on questionable trade-related practices. See: Chuck Schwab and Walter Bettinger issue call to squash flash traders but RIAs question hysteria over the issue.

E*Trade sold its market-making unit last year for $75 million. TD Ameritrade has taken some heat of late over its trading practices.

TD Ameritrade’s stance

TD Ameritrade takes the position it has been tarred unjustly for its trading practices — though it allows it accepts payments from third-party traders, a business practice that some critics call a form of kickback.

“The [third party market makers] that we work with are trying to make a market,” says Joe Giannone, spokesman for TD Ameritrade.

“They need volume in order to provide liquidity and stability, and they are willing to pay a premium to attract that order flow. We do receive payments from some participants, but it does not interfere with our efforts to seek the best execution possible for investor…our priority is to seek best execution for our clients. To do that, we first offer our clients choice, allowing them to direct equity limit orders and option market and limit orders. We do not internalize any orders. We turn all orders back to the market.”

He continues: “Next, we work with multiple market participants to route client orders, which encourages redundancy and competition, resulting in better execution quality for clients. We evaluate their stability, execution quality, and consistency every day in real time, and we demand price improvement when appropriate. We’re very proud of the fact that more than 90% of client market orders on listed stocks received price improvement last year. You can see details on these relationships that we disclose to the SEC on our public 606 reports.”

The flinch

Notwithstanding ongoing struggles by discount brokers to find the right trading recipe, Merrill Lynch’s flinch in this area is particularly telling, according to Welsh.

“I think the news is that Merrill Lynch is a capital markets player and they realized they’ll have a problem explaining [the activities of this unit to regulators and clients],” he says. “You know the gig is up. That’s their core competency.”

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Mentioned in this article:

Nexus Strategy
Consulting Firm
Top Executive: Timothy D. Welsh

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