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ConvergEx took no principal risk, didn't make markets, didn't hang on to shares, etc.: there's no actual trading profit here. It's just gouging profit.



ConvergEx took no principal risk, didn't make markets, didn't hang on to shares, etc.: there's no actual trading profit here. It's just gouging profit.

The Securities and Exchange Commission settled fraud accusations on Wednesday against ConvergEx, a group of brokers that, in the SEC's words, "held themselves out to the public as a unified conflict-free agency broker that charged explicit commissions for equity order execution." Surprise! Most of those words were false!

The basic deal was that you hired ConvergEx to do some pretty boring but big equity trades,1 and ConvergEx would do your trades for you on a purely agency basis and charge you a fixed stated commission. So you'd be like, "buy a million shares of Facebook," and ConvergEx would go buy a million shares of Facebook for your account and say, "okay we filled you at $55.05" or whatever and then charge you a penny a share for their trouble.

But in fact what would happen is that ConvergEx would secretly use a Bermuda affiliate broker-dealer (ConvergEx Global Markets Limited, or CGM), which would buy the shares at, say, $55.02, and then sell them on to the client-facing ConvergEx entity at $55.05, and ConvergEx would go to the client and say "okay we filled you at $55.05, so pay us $55.06 with the commission, thanks." ConvergEx called the extra three cents "trading profits," which is a little euphemistic,2 or "TP," which is not. "It was not uncommon for the amount of TP to be several times the amount of commission that the customer had paid," says the SEC.

CGM often took TP when customers were asleep during market trading hours because of time zone differences. On the other hand, CGM did not take TP from customers who actively monitored executions throughout the day through the receipt of real-time trade information.

Likewise, CGM, with the knowledge and approval of its senior management, did not take TP on trades if customers, prior to trading, requested a "€œtime and sales"€ report that would detail the times of execution and prices received on the individual executions underlying a customer's order, and thus expose any TP taken by CGM.

The CGM Division also suspended the practice of taking TP at times when it knew customers were scrutinizing their executions, in order to impress those customers and secure future business. In at least one instance, CGM suspended the practice of taking TP when a customer requested time and sales reports to analyze execution prices and then resumed taking TP after they were told that the customer was no longer conducting the analysis.

By Matt 'The Explainer' Levine.

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