Churning Swindles on Garbage Stocks
September 27th, 2010Via: Reuters:
Some traders are manipulating U.S. stocks that are worth less than $1 by taking both sides of trades in order to earn big rebates, according to an official at Knight Capital Group Inc.
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At issue is whether an individual trader is using separate brokerage accounts to trade against himself, something known as a wash trade. Shares that regularly trade below $1, such as Sirius XM Radio Inc and Level 3 Communications Inc, are the typical targets, Nazarali said.
Exchanges charge fees to those that execute against standing buy and sell orders, something called a take fee, and pay rebates to those that provide standing orders that are executed against. This is known as “maker-taker” pricing.
While stocks are normally priced in penny increments, rules adopted five years ago allow exchanges to price sub-dollar stocks in one-hundredth of a cent. The fees and rebates, however, are based on penny increments for all stocks, including sub-dollar stocks — which creates a possible loophole through which traders can earn out-sized rebates.
A trader can, for example, send a “limit order” bid through one brokerage account, and a corresponding “market order” to sell that same stock in another account. After trading with himself, the trader earns the bid’s rebate and pays the smaller selling fee — which is usually fixed at retail brokers like E*Trade — and walks away with the difference.
In this scenario, market makers such as Knight would foot much of the bill.
