In Class Book

It was in the late 1980s that Ken Griffin set his sights on what Citadel Securities would eventually become. An early trade with Susquehanna Investment Group paid out less than the young Griffin was expecting. One version of the story has him sitting on the telephone in his Harvard dorm room, complaining to the Susquehanna trader and vowing to start a competing business to change the entire market, according to former employees and acquaintances.

Whether apocryphal, few would dispute that Griffin — the founder of Citadel Securities and its related $35bn hedge fund Citadel — has fulfilled this vow.

The initial ideas that would evolve into Citadel Securities took life in the early 2000s on a separate floor of the hedge fund’s old Chicago headquarters. Since then it has grown into one of the largest trading houses in the world, involved in roughly one in four of all US stock trades and nearly 40 per cent of all those involving individual retail investors.

This year, it took in outside investment for the first time. Venture capitalists Sequoia and Paradigm bought 5 per cent of the company for $1.15bn, valuing it at $22bn. The new investors are expected to advise on expansion into new markets, including cryptocurrencies, and the deal is seen as a precursor to Citadel Securities eventually filing for an initial public offering.

Should it take that path, it would bring it on to the same public equities markets that it now dominates. It would also put it even more firmly in the crosshairs of the Securities and Exchange Commission. The US regulator has homed in on Citadel Securities’ dominance as a market maker, the term for trading houses that sit in between transactions both buying and selling to investors.

A public listing would also open it up to the Reddit traders who targeted Citadel Securities in 2021 as they waged a self-styled war against establishment players and financial behemoths.

“What Citadel Securities offers is the value of consistency,” says Chris Nagy, founder of the advocacy group Healthy Markets Association. “They are market dominators. But there is no such thing as a free lunch.”

Yet this colossal enterprise is still far from being a household name and was until recently seen as something of a Wall Street outsider, having pioneered an electronic overhaul of trading which has displaced the traditional banking model of financial markets that preceded it.

“We have accomplished a lot and there has been a lot of winning but I don’t think there is any point where we would say we have won,” says Matt Culek, chief operating officer of Citadel Securities. “There is always more to do, always more to build, always more to achieve.”

Playing to win

When he joined Citadel in 2004, Matthew Andresen was given the book Good To Great by Jim Collins, about how companies excel. Other new starters received Hardball by George Stalk and Robert Lachenauer, which carries the tagline: “are you playing to play, or playing to win?”

It was part of an effort by Griffin to imbue a mentality of relentless, almost military style improvement in his staff, according to multiple past and present employees. Some hated it, contributing to periods of high turnover. For others, Griffin is the ultimate leader.

“A little part of me still misses it,” says Andresen. “Ken has a way of getting more out of you than you knew was there.”

Andresen joined as co-head of a small group with Jason Lehman, which had already begun developing the quantitative and predictive trading tools necessary to become a fully electronic market maker in equity options.

The business moved to a sectioned-off room on the 37th floor of Citadel’s headquarters on Dearborn Street in Chicago, separated from the rest of the hedge fund by a double height wall of sheet rock. It is the same office it occupies today, only now it takes up 10 floors and employs 1,200 people globally.

Lehman and Andresen helped build Citadel’s systems, connecting them to major US exchanges on one side, and on the other hundreds of brokerages to connect with investors. The two remain partners today at their own trading company, Headlands Technologies.

“Citadel was always an excellent, world-leading quantitative shop in terms of research acumen,” says Andresen. “What Ken felt had changed was that markets were becoming more electronic and technology driven. Then it’s more about technology and research prowess rather than about knowing people and being part of the club.”

That core thinking remains at Citadel Securities today and has been at the heart of a revolution in the way financial markets function, spreading from derivatives to stocks and currencies and into fixed income, such as US government debt.

Superfast, cheap communications technology has overlapped with a regulatory drive for more competition and transparency. The company’s eager embrace of the changes allowed it to adapt far quicker than the investment banks that once attempted to keep it out of their club.

“The banks have been left behind,” Griffin told a conference in Florida in 2018. “When Citadel [Securities] trades more than Goldman Sachs in the equity market every day by a multiple, that’s a tough place for Goldman Sachs to be.”

Around the time that the 2008 financial crisis almost sank the hedge fund, Citadel Securities was spun off having experienced rapid growth in just a few years.

Peng Zhao, who joined Citadel in the mid-2000s and has run Citadel Securities since 2017, says Griffin’s influence is evident through the culture of the business, even if the founder is no longer involved in the “day to day” running of a company in which — according to regulatory disclosures — he owns a stake of at least 75 per cent.

“We don’t try to be all things to all people and we don’t apologise for that,” says Zhao. “Much of how I approach things, much of how I value things . . . I learned from Ken.”

One way Citadel Securities trades in equity markets is by paying brokers like Robinhood a fee to receive retail investors’ orders, competing with the likes of Virtu — the publicly traded market maker — and Susquehanna to trade those orders at or better than current market prices. It’s a controversial practice known as payment for order flow.

Once the order is received, it offers the market maker unique information unavailable to its rivals. It is able to use this, alongside a broad array of other market data, to compute how best to price trades and maximise profits.

This greater certainty of profitability reduces its risk. With less risk it is able to reduce the cost of trading for retail investors as well, taking less profit on each individual trade so that it can build market share. Many brokers now offer commission-free trading, in part because of the market maker’s ability to still turn a profit from tiny margins.

In 2018, Griffin argued this also created safer markets. “We are able to understand the price of literally thousands of securities simultaneously and where should price be on any one security given the mosaic,” he said. “A number of banks that don’t have the capabilities that we have in artificial intelligence, machine learning, [and] modern predictive analytics can’t maintain price integrity in periods of chaos.”

Yet, some argue that through speed and now dominance Citadel Securities has helped create an unlevel playing field, something Griffin has previously denied. However, even some of its fiercest critics accept that since the company started, US equity trading has been opened up to a broader audience with a lower cost of trading, even if they disagree with how it has been done.

“It is a win at all costs mentality,” says one industry veteran. “[Griffin] firmly believes the fastest firms should win . . . The problem with that is that any one who is slightly slower loses . . . The fastest firm winning means that you are winning by an asymmetry of information that you gain with that speed.”

S&P Global Ratings noted in December that Citadel Securities’ “complex systems and algorithms” created elevated operational risk, even if it has “strong risk-management capabilities”.

Citadel Securities settled charges with US regulators for $22m in 2017 that it misled brokers over how it priced their trades between 2007 and 2010. In July 2020, US industry watchdog the Financial Industry Regulatory Authority, fined it $700,000 for trading ahead of customer orders. In March 2021 it paid $275,000 for reporting errors and two days after Christmas it paid a further $225,000 — split across 13 exchanges — related to poor risk management resulting in “erroneous trades”. In each case it neither admitted nor denied wrongdoing.

Jamil Nazarali, head of business development at Citadel Securities, says there is a stark difference between Griffin’s willingness to tolerate trading risk compared to regulatory risk. “We have so little tolerance for regulatory risk,” he adds.

Clashing with the ‘Redditors’

Early in February 2020, before Covid-19 had been defined as a pandemic, the S&P 500, America’s benchmark stock index, was trading close to an all-time high. By the end of March, Citadel Securities had set up a quarantined office in the ballroom of the Four Seasons hotel in Palm Beach, Florida in response to the crisis.

The sheer volume of trading — both as markets fell in March and as they rose through the recovery — created a windfall for Citadel Securities, which profits more from the volume of trading rather than the direction it is going in. The company ended 2020 with net trading revenues of more than $6.7bn, according to people familiar with its performance.

Just a few weeks later the company was thrust into the national spotlight. A surge in trading, fuelled initially by retail investors on social media, boosted a handful of unfashionable listed companies. The sheer amount of trading in so-called “meme stocks” such as retailer GameStop and cinema chain AMC caught many brokers off guard. Some, notably Robinhood, were forced to curb trading to cope with the demand flooding their systems.

Private investors, many of whom congregated on sites like Reddit, watched as stock prices fell while they were unable to trade. Their anger turned to the markets’ biggest wholesale broker — Citadel Securities.

At a Washington hearing into the “meme stock” episode, Griffin made little secret of his company’s success from the stock market fever. On one day alone, Citadel Securities traded 7.4bn shares for retail investors, more than the entire industry’s average daily volumes in 2019, he said. Citadel Securities ended 2021 with record trading revenues, surpassing 2020, says Culek.

This success helped make it an outsized villain in the minds of retail investors — especially those on sites like Reddit.

Some investors accused brokerages of conspiring with the market maker to prevent them from trading shares. In the aftermath of the meme stock mania, Griffin told the House financial services committee that Citadel Securities had not pressured Robinhood into restricting trading, nor had it had any prior knowledge that the broker was going to do that.

A subsequent SEC report came down on Citadel Securities’ side. Nevertheless it has led to closer attention from Gary Gensler, chair of the SEC, who is concerned over the dominance of Citadel Securities and a few other firms including Virtu, warning that healthy competition in the markets may be at risk.

“Market share by volume traded is not necessarily a proxy for power,” says Culek. “That’s a proxy for winning most frequently in fair competition.”

Gensler, however, appears to be unconvinced. He told the US Senate banking committee in September that payment for order flow, together with exchange rebates, “may present a number of conflicts of interest”. He later hammered home his point telling CNBC that when trading is bought and sent to wholesalers, “they have information that the rest of the market may not have, at least for a short period of time. And even milliseconds matter in these markets”.

Publicly, Griffin appears unmoved by Gensler’s stance. “If you’re going to tell me that by regulatory fiat one of my major items of expense disappears, I’m OK with that,” said Griffin in October, referring to payment for order flow.

“Citadel [Securities] is a convenient piñata,” says Doug Cifu, chief executive of Virtu. He believes much of the interest in the company and Griffin by both retail investors and politicians stems from politics, noting that Griffin is one of the largest Republican donors in the country.

Yet, there may be scope elsewhere for Griffin and Gensler’s interests to align.

The deal with venture capital groups Sequoia and Paradigm is seen to be more about strategic direction than the cash involved. Paradigm, for instance, specialises in helping disruptive crypto companies.

Gensler is considering new regulation to bring oversight to the crypto market, and Citadel Securities — despite Griffin being critical of the market in the past — has a record of profiting from regulatory change. “As that regulatory certainty comes we expect to be a major market maker [in crypto],” says Nazarali.

It marks the latest chapter in a story that stretches back 30 years.

Susquehanna declined to comment on the original trade that riled Griffin all those years ago, though Jeff Yass, the company’s founder, made light of it a few years ago, saying that if he had known what Griffin and Citadel Securities would become he would have made sure the young upstart was paid more, according to people familiar with the joke.

“Citadel Securities is the Amazon of the stock and options markets,” says Yass, likening the two for both having high volumes and low prices. “They’ve saved the investing public untold billions of dollars.”

Additional reporting by Miles Kruppa in San Francisco and Eric Platt in New York