OTC Market Maker pockets $8500 off Institutional Error
At 10:06:29 yesterday morning, an institution sent a sell order for approximately 14,000 shares, causing the stock of AHGP (Alliance Holdings) to fall $1.44. One minute later it appears the same institution sent a buy order for a similar amount of shares, causing the stock to spike back up over a dollar. An OTC market maker was quick to capitalize on the opportunity. We would like to thank Nanex for bringing this trade to our attention.
Here is the chart:
It is safe to say that whatever institution sent those orders, they were probably done in error, as the institution lost a significant amount of money in this one minute time period. However, the more concerning issue to me is how this order was handled. It is apparent that this order was handled by an OTC market maker, because the back part of the order was executed off-exchange.
Here is the trade executions from the original sell-order:
As you can see the stock quickly fell from a price of 44.54 to 43.10 as a result of the institutional 14K share sell order. But take note of the last few executions. There are four separate trades executed off-exchange and reported to the FINRA trade reporting facility (designated FINRA TRF on the tape). The four trades I wanted to highlight are:
Time Price Size Market Center
10:06:29 43.10 200 FINRA TRF
10:06:29 43.101 2104 FINRA TRF
10:06:29 43.101 700 FINRA TRF
10:06:29 43.10 1600 FINRA TRF
These trades were executed by an OTC market maker, as they were printed off-exchange. The total number of shares purchased by the OTC market maker here is 4604 shares.
Now take a look at the sequence of trades from the institution’s 14K share buy order:
Again, if you look at the last part of the tape, there are two executions at 10:07:33 reported to the FINRA TRF.
Time Price Size Market Center
10:07:33 44.959 829 FINRA TRF
10:07:36 44.96 4200 FINRA TRF
The total number of shares sold by the OTC market maker is 5029 shares. Assuming they may have had 425 shares on their books from earlier (because the buy order and sell order doesn’t perfectly match up), the OTC market maker just made a cool $8500 for their handling of these two orders. The OTC market maker makes this money by playing a game where they allow the initial part of the order to move the price, and then take the back part of the order for themselves.
Here is the way the game was played. (Again, this is all just derived from the tape, so there is no actual proof that this occurred in this situation, but knowing how OTC market makers operate, the example from yesterday is pretty straight forward).
The OTC market maker received the institutional order to sell 14K shares from some retail brokerage (they actually buy this order flow from the brokerage house – called payment for order flow).
They then allow the first 10K shares to sweep the book lower (trade out the limit buy orders on the book), and move the price of the stock to where they would like to be a buyer. They then execute the back part of the order (the last 4604 shares) for themselves, purchasing the stock at the lowest price.
They then received a subsequent buy order from the institution for 14,000 shares. They lick their chops, and allow the first part of the buy order to move the price higher, and then sell their own stock (that they just purchased a minute earlier) at the highest price, selling 5029 shares.
Their toll for providing this service to the market (not counting the extra 625 shares that were sold at the top) was $8563 (4604 shares x $1.86).
This money comes directly from the institution that sent the buy and subsequent sell orders. Now you might say the institution deserves to lose that money for sending such stupid orders. That may be true, but why shouldn’t the back part of that order be allowed to naturally interact with the other limit orders on the order book?
There was a market participant bidding for 1900 shares at $43.10 prior to the institutional sell order being entered into the market. Of those 1900 shares, it appears that participant got filled on zero. This is because the OTC market maker chose to step in front of that person’s limit order and take the remaining 4604 shares for themselves. The OTC market maker executed the back part of the order at the expense of the limit order trader, and left that trader unfilled.
Now it should be noted that the OTC market maker did nothing illegal here. This execution tactic is perfectly within the rules defined by the SEC, as OTC market makers are allowed to purchase order flow and trade against it. But why do we need a middleman pocketing $8563, by stepping in between a natural buyer and a natural seller? Secondly, what point is there to providing liquidity when there is a privileged participant capable of stepping in front of your order at the moment it is about to be executed?
This practice discourages displayed liquidity providers. If we started eliminating some of these predatory practices, our markets would have much more liquidity. If we had more liquidity on the books for issues like this, the institutional orders wouldn’t have nearly as much price impact. Perhaps then, these types of institutional errors wouldn’t prove to be so costly.
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