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February 1, 2012

Cover Story: Full Disclosure

Buyside Seeks More Information From Brokers About Their Order Routing Practices

By James Armstrong and John D'Antona Jr.

As buyside traders hit the send button, they can take comfort in the fact that their orders are flying out at the speed of light. But to where? To an exchange? A dark pool? How many venues does that order hit before it actually gets filled? And more importantly, who sees the order, and is there leakage of information that could negatively affect the price of the stock for the buyside?

Trading algorithms and smart order routers have given the buyside increased control over their orders, but now many on the buyside want more information. They are asking what happened to their orders before they got filled. And if they're being exposed to toxicity in certain venues, they want that to stop -fast. 

Kevin Cronin, Invesco

What's at stake? A lot. According to Kevin Cronin, global head of equity trading at Invesco, it is necessary to know where your orders are routed to fulfill your fiduciary responsibility as a money manager. That's because the way brokers route orders may or may not be consistent with what is best for clients, said Cronin, whose firm runs $271 billion in equities worldwide.

The current lack of transparency poses a problem, say many on the buyside.

"We get some data on order routing but would like more data and transparency regarding this process," said William Quinn, senior equity trader at San Francisco-based money manager HighMark Capital Management, which manages $5 billion in equities.

Other buysiders said the same thing. Dennis Fox, head trader at Munder Capital Management in Birmingham, Mich., said he gets some information about where his orders go. But it is not enough for him and his firm with $16 billion in assets. Fox wants greater clarity about his brokers' routing practices. And the sellside is keenly aware of this demand.

"Clients are wanting to know more and do more," said John Goeller, managing director within global execution services at Bank of America Merrill Lynch. "They're becoming more sophisticated. It's a natural evolution."

For their part, brokers are flexible to client demand. They can route orders to certain venues first, and route to other venues not at all. But Goeller said it's a function of asking. It can be difficult to show empirically that information leakage is coming from a particular venue, so if the buyside suspects they're being gamed, they have to speak up, he said.

Goeller and others on the sellside often welcome questions about a trade, since those queries provide a chance to ensure that both the broker and the client are on the same page. He knows that there's often an important subtext when customers ask about order flow. They want to know what brokers did with their orders, but they also want to know that the broker is someone they can trust.