Welcome back to the channel everyone today, dave lauer, a former citadel trader, was speaking about dark pools and payment for order flow on cnbc, with melissa lee and actually exposed citadel and ken griffin live on air, so stay tuned and let's make some money, but guys before. I dive into the video i just want to give a massive shout out to the 3 300 of you that currently ding that notification bell, because you guys are always the first to watch a new video as soon as it's released so guys be sure to drop A like down below subscribe to the channel and ding that notification bell, if you haven't already so that you don't miss another video, just like this one, and now i want to dive straight in with the key information. So let's hear what dave, lauer and melissa lee had to say: yes says: the sec needs to do much more to level the playing field. Let's bring in dave lauer former citadel trader and ceo of urban ai dave great to have you with us thanks so much for having me on the list.

I appreciate it. It's nice that gensler is engaging with the twitter community, but i know from looking at the twitter community's comments about what gensler said today that there is a lot of skepticism about whether or not the sec can or will in fact do anything um. From your perspective, what do you think is the number one thing that the sec should be focused on when it comes to this particular matter of routing order flow to wholesalers, as opposed to lit exchanges yeah, i i appreciate the skepticism. You know i've been sort of in this conversation now for almost 10 years, and i've heard about holistic reviews of market structure and - and you know the need to study, and i i feel like it's uh, you know something that we hear a lot of and we See little action and i i think the most important thing that we should be focusing on from a market structure perspective is the fact that almost half of all trading is happening off exchange uh and in some retail heavy names you're, seeing more than 70 of the Volume executed in these internalizers or wholesaling systems and that's damaging the markets, it's widening spreads and it's a significant information advantage for all for those two firms citadel and virtue who operated due fact, a de facto duopoly in the internalization market.

So i think that we should be looking at better disclosures uh and i think we should be looking at rules similar to other countries. You know this isn't a controversial thing: canada, europe, the uk, australia, all have very strong rules that prevent the internalization and off exchange execution of small orders, while preserving that function, functionality for institutional orders, david's karen thanks for being on. So just so, i understand clearly when you talk about disclosure, are you saying, make the dark pools transparent and that that should help solve the problem? Well, i would like to see more transparency, but i think we've done a good job there. I you know when i think better disclosures, i'm thinking around short positions and derivatives, that type of thing, the issues around failures to deliver and naked shorting.

I think we need much better disclosures in that area, which is a major area of concern uh and then, in terms of off exchange trading. I think we should require material price improvement for small orders for off exchange trading and in saying that, i'm only echoing what citadel said in a comment letter in 2004, where they made the identical arguments that i'm making here. Someone argued dave, though, that with um payment for order flow effectively, but but the notion that that retail orders retail trades are routed to internalizers and wholesalers instead of lint markets that they are getting better pricing. Is there they're getting better pricing relative to a wider spread, and this is so important to understand uh the way that we route orders for retail? It means that those orders do not go to lit markets and by taking those orders away from lit markets.

You widen the spreads because everyone wants to trade against those orders. Those orders are profitable for market makers, so all i'm arguing is that we should have open competition for order flow. That should not be a controversial thing in in you know. Capitalist markets get get that those orders onto exchanges, let all the market makers compete for them.

You would tighten spreads and you would still get price improvement and size improvement for those retail orders. So i i'm convinced that net net we would see far better execution quality. Even for retail, let alone for institutional asset managers who would benefit from those tighter spreads by 25 or more so, basically, what you're saying is that that, right now the system is such that you might get a better price, but that's like saying you're getting something at A 20 discount after it's already been marked up 40 or something like that or you right i mean exactly. Basically, it looks better, but it's really not because that spread is so wide.

That's right and if you look at other markets around the world, they actually have lower execution costs than the us. If you compensate for the fact that the u.s market is much bigger and you control for company size, but i've seen reports that show that execution costs in markets with less off exchange trading uh are lower and that's what we should aspire to in the us. Dave great to have you with us thanks for joining us thanks thanks for having me dave lauer. I personally think that was a brilliant interview, dave lauer, literally voiced, so many of our problems live on cnbc.

He spoke about how citadel and virtue are the two major players in the market: pretty much controlling all the volume, how 70 of retail orders are going through the dark pool and not going through lit exchanges. He spoke about payment for order flow and how it doesn't incentivize market makers to give the best execution price. It gives customers a 25 discount after a 40 markup. But what did he mean when he spoke about citadel wanting to ban payment for order flow and ban dark pools in a letter from 2004? Well, i managed to do some digging and found that exact letter.

So, let's go through it together, guys before we dive any deeper. I've got a quick message from the sponsor of today's video gsx is a new cryptocurrency. That's revolutionizing the industry. The problem with most cryptocurrencies is volatility.

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It is thus crucial that the commission implement reforms that will further this trend. Specifically, the firm quote rule would best serve liquidity and transparency if it applied to all listed option order types up to the displayed size of any quo. The practice of payment for order flow, creates serious conflicts of interest and should be banned. Internalization without meaningful price improvement reduces competition limits.

Price discovery leads to market fragmentation and should be banned. The commission should not yet require the listed options market to quote in decimals, because decimalization would overload systems already pushed to their limits and lead to less transparent and shallow markets. Now the firm quite raw and decimalization aren't really too applicable. At the moment.

The firm quote rule is where market makers have to execute the price at which a trader places their limit order and decimalization is basically making market makers quote prices in more decimals than before. Maybe three decimals instead of two decimals, for example. However, let's take a look and see what citadel had to see about payment for order flow citadel group urges the commission to ban payment for order flow. This practice distorts order.

Routing decisions is anti-competitive and creates an obvious and substantial conflict of interest between broker-dealers and their customers, bearing in mind that citadel are the ones writing this letter and completely agree that payment for order flow is anti-competitive. Broker deal is accepting payment for order flow. Have a strong incentive to root orders based on the amount of order flow payments which benefit these broker-dealers, rather than on the basis of execution quality which benefits their customers. Furthermore, the parties making such payments, either voluntarily or through an exchange-mandated program, are forced to find other ways to recoup the amounts of such payments, whether through wider spreads or a reduction in benefits that otherwise could and should be provided to customers.

I guess the video absolutely took the viewpoint if you can't beat them join them and overtake them and become even bigger than they are payment for order flow is a practice that, on its face, is at odds with a broker-dealer's obligation to its customers. A broker-dealer has a fiduciary obligation to obtain the best execution reasonably available for its customers orders under prevailing market conditions. We do not believe that a broker dealer that accepts payment for order flow and does not pass such payments onto its customers, either directly or through reduced execution fees or commissions, can consistently fulfill its best execution obligations in practice. The conflict of interest caused by payments for order flow may lead broker dealers to execute customer option orders at a defensible price rather than aggressively pursuing the best possible price and seeking price improvement opportunities gradually.

This results in the erosion of market efficiency and wider bid and ask spreads, even in cases where execution price may not be affected. Public customers whose order flow is being sold to the highest bidder may be left with the perception that they could have gotten better execution. In the absence of these payments, because payment for order flow creates fundamental conflicts of interest that cannot be cured by disclosure, the commission should ban payments for order flow altogether. It is crucial.

This ban include not only exchange sponsored programs, but also payment for order. Flow arrangements entered into privately between order flow providers and market centers individually negotiated payment for order flow arrangements, lack transparency and are more difficult to police. For this reason, a ban of only exchange sponsored payment fraud of her arrangements would be worse than the status quo. From the isc and cboe, because these markets have multiple independent, quoting firms bearing in mind ken griffin literally wrote this letter himself in 2004.

Look at how the tables have turned internalization citadel group urges the commission to ban the increasingly common listed options, market practice of order. Internalization at prices not meaningfully better than the market prices. Basically citadel group themselves are saying that they urge the commission to ban the second book where a price can potentially be different to the market price. If an order flow provider is willing to beat the best price by the allowable, quoting increment after an order is exposed to robust public price discovery, then the order flow provider should be allowed to internalize the offer.

There is, however, no justification for allowing an order flow provider to internalize any portion of a customer's order if the order flow provider simply matches the best market price. Basically, citadel themselves is saying: market makers can't hold on to a transaction and either decide to take the other side of a trade if they can't find someone better and offer a lower price. Similarly, an order flow provider should not be allowed to internalize a customer order. If the order flow provider simply beats the best price market price by a penny, where the option is quoted in nickels or dimes price improvement that is not meaningful, does not justify internalization price improvement is a smaller increment than the allowable.

Quoting increment is not meaningful because there is no way to know whether the market would have been willing to trade at the improved price. Internalization allows a broker-dealer to view a customer's order and determine if the broker-dealer wishes to match or cross some or all of the order by matching or providing minimal price improvement over the market without exposing the order to a robust and transparent price discovery process. Basically, internalizers shouldn't be allowed to hide a transaction and push it through the dark pool, instead of putting it on the lit exchange and exposing it to fair price discovery procedures. This practice substantially reduces the opportunity for investor orders to interact and contributes to harmful fragmentation of the market, basically completely splits the market between a lit exchange and a dark pool, rather than it being fair and together an appropriate price discovery taking place.

This reduced order. Interaction. Also interferes with the process of price discovery and detracts from a market participant's ability to provide best execution as a result of internalization orders remaining in the market is subject to an incomplete price discovery process which causes the display prices to be unreliable and impairs market transparency. Basically saying that, because of dark pools, the amc price currently isn't accurate or reliable, because there's been no appropriate price discovery.

Given that investors, especially retail investors, rely on displayed quotations in making investment decisions displayed quotations should represent the entire market supply and demand at any. Given time, moreover, because internalization provides order, flow providers with a guaranteed source of order flow, it also eliminates the need for them to compete aggressively for orders on the basis of their displayed quotations. Instead order flow providers can simply match market prices. After the fact, price matching takes advantage of the public price discovery process, but does not contribute to the process.

Moreover, if a substantial portion of the total order flow in an option is being internalized, the ability of other broker-dealers to compete successfully for order flow on the basis of their displayed quotations is dramatically reduced. Maybe something such as passing 70 of transactions through a dark pool would count as reduced competition. Those market participants that are willing to participate in public price discovery by displaying firm trading interests at their best prices are thus not fully rewarded for their aggressive, quoting. This creates disincentives for vigorous price competition which can lead to wider bid and ask spreads less depth and higher transaction costs.

If this occurs, all orders are likely to receive inferior executions, not just those that are internalized guys i'll, be sure to leave the link to this article down in the description below. So you can see just how outrageous this article is and just how much citadel contradict themselves. I also just wanted to give you a quick update and a quick warning about robin hoods. Robin hood hit 80.

There is validity in the theory that it's being driven up by the hedges, to divert retail attention from amc but understand the game remain steadfast. The move in robin hood will seem minuscule in comparison to the move that is coming for amc guys. Please don't be distracted by robin hood. It may look appetizing running up 30, 40 50 in a day, but you know the hedges are just manipulating it and they're gon na bring it crashing back down.

On top of you, although saying that, obviously it's not financial advice, so you're free to buy robin hood if you want and make your own decisions guys be sure to leave a comment down below. Let me know what you think about citadel contradicting themselves and wanting to ban payment for order flow and internalization and dark pulls and what you think about dave lauer, exposing it live on cnbc guys. If you haven't already i'd, really consider checking out the patreon and the private discord and becoming part of the team, so you get urgent updates and news, and due diligence about amc like this before i even make a video linked in the description below and as always Guys, if you enjoyed this video, be sure to check out some of my others. Alternatively, subscribe to the channel and ding that notification bell, because that way, you'll be alerted.

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