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August 14, 2007

Citi Vaults to Top with ATD Buy

By Peter Chapman

Citi's acquisition of Automated Trading Desk last month propels it into the wholesaler big leagues.

Three years after it began building a wholesaling operation servicing retail broker-dealers, Citi has decided to muscle its way to the top by paying nearly $700 million for one of the four largest wholesalers. The big trading house has become a dominant wholesaler of executions of options and over-the-counter equities, but is not a force in national market system stocks.

"We weren't a player," said Kevin Murphy, Citi's head of U.S. broker-dealer sales, "because we didn't have the modeling capability that the top-tier players have. So we are really excited about the opportunity to add a top-tier electronic execution platform to our existing options and distressed business."

Citi began its push into the equities wholesaling business in 2004 with the build-out of an OTC desk and the hiring of broker-dealer sales executives. It augmented that effort last year when it bought TD Waterhouse's capital markets group. Still it never gained the heft it sought in trading national market system stocks.

With the ATD acquisition, Citi gets access to proven and sophisticated trading technology and a new customer base. ATD is the third- or fourth-largest wholesaler, behind Knight Capital Group and UBS. It competes with Citadel Execution Services for the No. 3 spot.

Wholesalers are broker-dealers that execute trades for retail brokers. When it comes to NMS stocks, the business has become automated. Orders are directed to sophisticated market-making systems and either executed or routed away to other venues for execution. Orders are generally small, in the hundreds of shares.

Citi lacked the technology to compete against the four dominant shops. "Our automated market-making platform is one of our true strengths," said Steve Swanson, ATD's chief executive. "They did not have that." ATD's predictive modeling technology predicts stock prices 30 seconds or so in advance. The technology, developed from the market microstructure theories of ATD's founders, is crucial to the profitable off-loading of positions.

What Citi does have, though, is order flow. Its Citigroup Smith Barney unit is one of the industry's largest sources of retail flow. Citi currently internalizes nearly half of its Nasdaq inflow (those orders of fewer than 10,000 shares) and routes away the rest to wholesalers, according to a recent Rule 606 filing. It sends over half of its New York Stock Exchange-listed flow to the NYSE and the rest to wholesalers. Citi will likely internalize more of its Smith Barney flow now that it owns ATD, according to Murphy.

ATD will operate autonomously from its headquarters outside Charleston, S.C. It will also not have to adopt the Citi way of doing business, according to Murphy. The set-up mirrors that of Citi's options market-making operation, which Citi bought from Knight in 2004. Options is run out of Minnetonka, Minn., and Chicago.

With the ATD acquisition, Citi also gets a small OTC wholesaling business, which will be folded into Citi's increasingly dominant trading operation. Since acquiring the TD Waterhouse unit a year ago, Citi has rocketed to the top of the pack in the business of trading OTC Bulletin Board and Pink Sheets securities for broker-dealers. It has nudged aside UBS as the No. 2 player, trailing only Knight.