A SEC probe into high frequncy trading firms, and more attention from a pesky New York Attorney General — last week all of that seemed like a slight bump in the road for the upcoming IPO of one of the most powerful high frequency trading firms in the world, Virtu.
Valued at as much as $US3 billion, the company was hoping to raise $US100 million in its IPO — maybe even $US200, or $US250 million this month. The word was that this would turn CEO Vicent Viola, a former Nymex Chair who owns 70% of the company, into a billionaire over night. Private equity firm Silver Lake has a $US250 million stake in the company.
This week things are looking different.
All of financial news is debating high frequency trading thanks to Michael Lewis’ new book, “Flash Boys: A Wall Street Revolt.” It’s about a group of Royal Bank of Canada traders who realise they’re getting cheated by high speed trading robots, so they go rogue and create their own exchange where investors can be safe. It’s called IEX.
Since then, the FBI has said that it will join financial regulators like the CFTC in probing HFT practices.
That’s why, according to the Wall Street Journal, Virtu is going on a “charm offensive.”
The firm is touting its partnership with IEX, and CEO Brad Katsuyama said Virtu is one of the “good high-frequency traders.”
But that doesn’t change what Virtu itself wrote in its IPO prospectus:
“Regulatory and legal uncertainties could harm our business. These uncertainties could increase our costs and inhibit our plan to provide liquidity in new securities and other financial instruments as new regulations cause migration of certain products to electronic trading.
“We are subject to risks relating to litigation and potential securities law liability, which could increase our costs and negate any competitive advantage we have based on our low-cost structure.”
Lewis says that high frequency trading firms have “rigged” the market against regular investors. That has specific meaning when it comes to these investigations and Virtu.
The CFTC, specifically, is looking into Virtu’s trading from 2011 to November 2013. The prospectus says that the probe has to do with Virtu’s “participation in certain incentive programs offered by exchanges or venues during that time period.“
A French regulator is also looking into the work of one of Virtu’s subsidiaries.
And then there’s transactions fees. This has been floated around in the United States as a way to stop HFT firms from spitting out quotes that they never mean to fill — something the FBI is investigating — but it’s far from being a rule.
The European Union, though, voted introduce a financial transaction tax in February 2013.
And Virtu isn’t Teflon The company usually makes $US1-2 million a day trading, but running an HFT firm is expensive.
From Virtu’s prospectus:
In 2013 the firm made $US664 million in revenue, but $US476 million of that went to operating expenses. The firm ended up taking in $US182 million, a nice increase from 2012 $US87 million number.
It’s a nice cushion to be sure, but now that so many regulators are looking into Virtu’s business model it may not seem like enough.
In a worst case doomsday scenario, the firm could end up paying out lawsuits, or having to create a new infrastructure to deal with regulation. All the sudden, that’s all on the table when last year there was barely a table.
It could put a sizable dent in $US182 million, especially since compensation expenses jumped from $US46 million in 2011 to $US78 million. You gotta keep your traders, and Virtu says in its prospectus that it wants to expand, which means hiring more and more.
And if you’re public, you have to deal with quarterly reports and public disclosures read by potentially skittish investors.
Virtu said that any change in government liquidity requirements could hurt the firm as well.
So it’s a shifting landscape, and investors don’t love “shifts” or “uncertainty” or “surprises”…
We’ll see how this goes.