`Partisan-Driven Solutions.' Virtu CEO Takes Some Swings at SEC Agenda
Also, Bair and Hoenig pan FDIC merger proposal; Senate report on hedge fund use of AI sparks quick pushback from industry
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Friday Q and A: SEC Chair Gary Gensler’s rules have provoked an unprecedented howl of protest on Wall Street. But most of the resistance to his agenda is marshaled through industry trade associations here in Washington, allowing regulated companies and their executives to keep a safe distance from the fray.
Doug Cifu, the CEO of Virtu Financial, doesn’t play that game. Over the past few years he’s emerged as one of Gensler’s biggest, and most outspoken, critics. That’s partly out of necessity – the SEC’s proposed overhaul of the stock market’s plumbing targets market making firms like Virtu and Citadel Securities that execute the bulk of trades made by retail investors today. But it’s also because Cifu, a native New Yorker and former corporate lawyer, enjoys mixing it up and being the industry’s resident loud person.
We spoke with Cifu earlier this week, looking to get a better insight on how market participants see the Biden administration’s regulatory push. He was happy to oblige, even though he has been a bit busy dealing with other pressing matters like the National Hockey League playoffs. More on that below, as well as his unvarnished thoughts on Gensler’s policies, the SEC’s recent court losses and what the agency’s main courtroom antagonist Eugene Scalia should name his boat. What follows is our conversation, condensed and edited for clarity (as well as, for those who know Cifu, excising a few F-bombs).
Capitol Account: When we asked people what to talk to you about, most wanted to know about your other job as co-owner of the Florida Panthers. They seem well on their way to winning the Stanley Cup – for the first time. How are you feeling?
Doug Cifu: It's a great change of pace. I'm really happy. Over the last 10 years I've met hundreds and hundreds of fans – I'm a little bit out there – and you know what it's like with sports. Imagine…you’ve never won a championship…We sucked for so long. When we bought this team, it was a disaster. It was really a labor of love and a lot of money.
CA: Were you a hockey fan before you became an owner?
DC: I was probably more of a professional football fan. I've always been a sports fan, but I didn't know the whole NHL.
CA: What’s it like having an ice hockey team in sunny Florida?
DC: As a former lawyer, the structure of the league is great for a small market team. Give Gary – I want to say Gary Gensler, don't give Gary Gensler credit for anything other than creating bipartisanship in Washington. [NHL Commissioner] Gary Bettman has done a really good job allowing the bottom half of the league to survive and to be competitive.
CA: Speaking of Gensler, it’s been a bit quiet at the SEC on the rulemaking front, especially on the market structure proposals that you have been vocal about. Does that make you worried about a big rush coming this summer?
DC: It doesn't make me nervous at all. There's been such a rebuke of, I'll say, his overreach in many areas. And I think there's been a little bit of a pushback on his style. The overreach part is self-evident and it transcends market structure. He's been slapped down just last week with regard to the private funds.
CA: What did you think of that rule, which set up a new disclosure regime for hedge funds, private equity and venture capital?
DC: It was just classic big government, nanny state. Think about what [Gensler] was saying – that somehow Calpers and Temasek in their dealings with Carlyle and with AQR needed the government to prescribe what type of disclosures and contractual regimes they should have in their fund agreements. It was that absurd…This was a politically driven determination from the top.
CA: The industry, of course, quickly sued and it was struck down in a unanimous decision.
DC: For the [Managed Funds Association], it was a no-brainer for them to litigate. I know those folks pretty well because they represent a lot of our clients, and they're very sensible people. They're not lunatics like me. Their job is basically to lobby and whatnot, and stay behind the scenes. So for them to go out on a limb and actually litigate was a huge deal. They have to get the money, right? It's not like they've got millions of dollars sitting around. It's different if Citadel or we or Schwab sue. People will say it's obviously in our interest to do that and we have a lot more experience doing that.
CA: This is the second loss on a Gensler-era rule in the Fifth Circuit. Do you think that’s a trend?
DC: There's going to be more litigation. Gary Gensler is like the full employment act for Gene Scalia. That guy's going to name his next boat, “The Gensler” or “Arbitrary and Capricious.”
CA: What’s the takeaway from the financial industry perspective?
DC: I think the theme is that these are partisan-driven solutions, searching for problems…The way it's framed a little bit in some of the mainstream media is, Wall Street's pushing back. It's not Wall Street, it's just common sense. Users of the industry are saying, ‘These things don't make any sense, why are you proposing them? No one's asked for this. We don't need it. We think ultimately it will increase costs.’
CA: Gensler is looking to reduce investor costs in his market structure overhaul. But financial firms have argued that American markets are in great shape and retail traders have never had it so good.
DC: We make markets…There's not a country that we don't touch and don't operate in. And without exception, there's not a single jurisdiction [outside the U.S.] that has such ready access to 10,000 listed companies and ETFs for a zero commission – at a bid-offer spread that, for every conceivable security you want to purchase, is generally like less than a penny. That’s really unique…And none of that was accomplished by regulatory fiat.
CA: The SEC has adopted one of the four market structure proposals it issued at the end of 2022, a non-controversial disclosure rule. Of the three that are pending, Gensler seems most eager to set a new federal standard that defines the “best execution” of a trade. Brokers don’t like this because Finra, the industry self regulator, already has its own.
DC: I think he was annoyed that Finra got all the cases and all the publicity. It's a bit of a slap in the face to [Finra CEO Robert] Cook, who's a pretty decent guy and a quasi public servant who does a pretty good job. One, it was just a political land grab. And then two, this is one of these Gary's trying to be too smart by half.
CA: How so?
DC: He's going to try to put something through that has enough ambiguity in it that somebody who was inclined, like a Gensler, could look at it and say, `Maybe it's not consistent with the federal best-ex standard to send orders off-exchange to a wholesaler. Maybe it's not consistent with this new federal best-ex standard that a retail broker gets paid a rebate by a wholesaler.’
CA: Gensler has said this is too important just to leave to the self-regulator.
DC: I don't think that there's stuff going on in best-ex land that Finra doesn't surveil and enforce today. There's enough market pressure that Schwab and Fidelity and Robinhood and Morgan Stanley E-Trade have huge market power over the wholesalers, and can extract really good best execution for their clients. They don't need the federal government to assist them in that. All this is, is a gotcha.
CA: Gensler often notes that firms like yours are sitting in the middle, taking a cut of transactions and driving up costs for investors.
DC: Correct. He has a couple fundamental views. One is that the disintermediation of the old [stock trading] model – it was not a good thing. That the nanny state needs to be there to protect retail investors, they're too dumb to figure this out on their own. And two, that any industry participant, but particularly market makers…is friction in the market, and we don't provide any service…That is just so antithetical to the way markets have actually worked for a couple hundred years. Market makers have been around for a long time.
CA: Another issue that Virtu and other firms have raised is that Gensler doesn’t really understand your business.
DC: The first Zoom we did with him, it was painfully obvious that he was really out of his depth. He just did not understand the plumbing of the equity markets. And I don't blame him, he didn't work in that [area]. I didn't know it before I started Virtu and had been doing it for 16 years. But more than that, he was so biased against what we were saying that I [realized], this guy is irredeemably trying to impact what we do. I don't want to get dramatic and say it's an existential crisis for Virtu, et cetera. But it was like, he's now my enemy…Therefore I have to go and be the person that disagrees with him publicly. And say the emperor has no clothes.
CA: How did you win that job?
DC: Because Citadel is politically way too Republican. Ken [Griffin] is the largest Republican donor, and they'll be kind of dismissed. I can go on CNBC every time Gensler goes on CNBC, which I did in the early days, and I can give interviews like this. I can say whatever the hell I want because my partner backs me up and I have facts and data on my side.
CA: Do you think there has been more industry criticism of the SEC than in the past?
DC: I might have been the loudest, and one of the first people to object, but if you look at what's happened in the last three years everybody's come out of the woodwork. For conservative – I don't mean politically – big corporate organizations to very publicly criticize the SEC is kind of unique.
CA: Last year the SEC brought an enforcement action against Virtu, alleging the firm made misleading disclosures to investors about walling off sensitive information. You refused to settle. What can you say about the case?
DC: It’s like a plaintiff's law firm wrote the complaint. This is the U.S. government, these are our paid representatives, and they're acting like somehow through intimation we did something inappropriate with respect to our clients. That's why I didn't settle it. You can quote me on this, and I've said it publicly, I'm not going to pay ransom to Somali pirates. That's how they acted.
CA: Didn’t Virtu self-report what happened to the SEC?
DC: We didn't acknowledge that there was a violation. But we said, `Here's the situation, we had passwords that were shared. There's zero evidence that anything was ever used inappropriately.’ It should have been, as I've said, a speeding ticket. It should have been a very low six-figure kind of settlement.
CA: It sounds like that didn’t happen.
DC: They asked for a ridiculous amount, which I'd rather just pay my law firm because I know I'm going to win. And I could talk to my clients about it. The SEC has this policy that if you settle, you have to agree upon a statement. And you can't disagree.
CA: It’s called no admit, no deny.
DC: I'm not going to agree to that. Not only were they asking for ransom, they were trying to impact my institutional business. Rather than settle, I went to all of my big clients and I said, `Here's exactly what happened. I'm going to send you what our brief is going to be.’ Every one of them said, `All right, we get it. You guys are honest dealers. We really appreciate the candor. We're going to keep trading with you.’
CA: You said earlier that Gensler has spurred bipartisanship in Washington. What do you mean?
DC: I met this congressman named Ritchie Torres, who represents probably one of the poorest districts in the country and his background and his political views could not be any more different than mine. He’s an openly gay man of color who grew up in the South Bronx. I'm a married white guy, grew up in middle class Long Island and went to Ivy League schools. I don't believe in socialism and Ritchie kind of does. We get along great because we bonded over Israel and, more importantly, his disdain of Gary Gensler.
CA: Torres has raised questions about the impact of some of the SEC’s proposals on young minority investors who’ve put money in the market via mobile apps.
DC: Think about the groups and the individuals in society who were under-banked and under-brokered 30 years ago…You had to go to some white guy in Ridgewood, New Jersey who worked at Morgan Stanley, and you paid $500 a trade to get quarter-wide spreads. That was just unavailable to lower socioeconomic, which tended to be minority, communities. This was Ritchie’s point, which I’m now stealing. His point was the Robinhoods of the world and the Schwabs and the Fidelitys and the Webulls have empowered the under- brokered.
CA: Where are you on the political spectrum?
DC: I'm a registered Democrat. If you look at my political donations, they're all there. I gave, God help me, money to [Sen. Charles] Schumer and to Clinton – Hillary…I'm a socially liberal guy. I've probably given a lot more money to Democrats than I have Republicans over the years.
CA: Looking at regulation more broadly, how do Wall Street executives view the Biden administration team?
DC: People are scratching their heads saying, `Man, this is complete regulatory overreach.’ Look at what Lina Khan's done at the FTC. I used to be an M&A lawyer, and I talked to a lot of my old friends and competitors. Every transaction now you’ve got to sit there and do this analysis: Is this activist person going to come in and try to sue and stop these acquisitions? I'm sure there's plenty of CEOs and strategy people that look at transactions that might be in the best interest of their companies and say, `We probably shouldn't do this because we don't want to get challenged, and we don't want to waste the money.’ Just think of what that does to innovation and investment.
CA: Is regulation an important issue to voters?
DC: I think it actually is. The entire crypto industry, to the extent there is such a thing, has rallied for Trump. There's a guy running for Senate in Massachusetts who's actually a pretty sensible, smart guy, against Elizabeth Warren — just because of her anti-crypto stance. I don't know if that [affects] 1,000 votes or 500,000 votes. I don't know if it's Pennsylvania, New York or wherever it is. But it's clearly impactful…Secondly, it’s not necessarily market structure, but climate disclosure, the proxy advisor [rules] – all of that is really anti-business at the end of the day…I think it has turned off a lot of the business community.
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Merger Fail: Sheila Bair and Thomas Hoenig, the former chairman and vice chairman of the FDIC respectively, have never hewed strictly to Republican positions on bank policy. In fact, the pair have been among the rare conservative voices advocating for hiking capital requirements. They also share many of Democrats’ concerns about too-big-to-fail banks fueling risks to the broader system.
Yet in a comment letter to the FDIC this week, Bair and Hoenig say progressives are wrong on a key piece of that debate: mergers. They argue the agency’s proposed guidelines for bank acquisitions will exacerbate, rather than ease, industry concentration.
CFPB Director Rohit Chopra, Acting Comptroller Michael Hsu and FDIC Chairman Martin Gruenberg backed the plan in March. The consumer bureau chief (who holds an FDIC board seat) has said explicitly the adjustments are designed to discourage “megamergers.”
In an interview, Hoenig summed up why he thinks his former agency gets it wrong: “You’re doing exactly what you think you’re not going to do – you’re helping the largest banks, protecting them, and you’re hurting the regional and smaller banks.” (Hoenig is an independent who considers himself a free-market conservative, while Bair is a Republican.)
The ex-regulators’ feedback echoes PNC CEO Bill Demchak’s critique of the OCC’s separately proposed merger guidelines back in April. In a sign of the angst the efforts are provoking in the industry, the executive took the unusual step of writing personally to assert that the plan would allow the largest banks “to continue to grow unchecked.”
In their letter, Bair and Hoenig take aim at the FDIC’s idea of applying “special scrutiny” to deals that result in banks with more than $100 billion in assets. That isn’t justified, they contend, because firms of that size pose little risk of exacerbating concentration. (A $100 billion bank represents only about 0.4 percent of the industry’s $24 trillion in assets, they point out.)
They also pan the FDIC’s push to give itself more discretion in how it screens deals, arguing that would make the process “increasingly arbitrary and uncertain.”
Bair and Hoenig maintain that the revisions would cement the position of the largest banks by making it tougher for regional lenders to become big enough to compete with their giant rivals. Banks seeking to grow through mergers “should not be held to a higher standard,” they write. “To do otherwise will lead to a two-tier banking system in which the largest are protected from new entrants and allowed to grow ever larger and systemically important while the second tier are throttled from competing at a higher level.”
The two also find fault with the FDIC’s recommendation that a merger must result in a financially stronger bank. That could discourage healthier institutions from buying ailing ones, potentially leading to more bank failures. “Encouraging bank M&A has been an important, and essential tool, used by the FDIC and other bank regulators in stabilizing the banking system,” Bair and Hoenig note.
For their part, liberals have argued that the solution to having “too big to fail banks” isn’t to create more of them, which a regional bank “megamerger” could effectively do. “To level the playing field and reduce concentration creep, we should continue to reduce the ‘too big to fail’ subsidy,” Chopra said in a March speech. “There are many ways under existing law to reduce these subsidies to ease the pressure to consolidate.”
Hedge Funds and AI: Senate Homeland Security Committee Chairman Gary Peters dropped a report today concluding that the use of artificial intelligence by hedge funds “increases risks to investors and financial markets”, drawing a quick rebuke from the industry.
Peters is one of a number of senators looking to advance AI legislation at the moment, so far to limited effect. The findings – from the panel’s Democratic majority – don’t break a ton of new ground. The “risks” section, for example, mostly cites concerns raised by other sources rather than highlighting new evidence of potential threats. The document talks about the use of AI-generated content for market manipulation and notes the danger of supercharging “herding behavior,” where disparate investors crowd into the same trade and drive huge market swings.
The committee staff did talk to six hedge funds – Renaissance Technologies, Bridgewater, Citadel, AI Capital Management, WorldQuant and Numerai – to get a sense of how they are relying on the technology at the moment. Some have been using forms of automation for quite some time. Each told the panel that they generally “do not use [machine learning] for conducting actual trades in the market independently of human involvement,” the report says.
Yet the firms appear to be exploring new use cases, including with “generative” systems like GPT. Bridgewater said that it “is actively exploring other potential [machine learning] applications and has been developing proprietary methods for years [and] expects that it will soon launch a small size allocation to one of its broader investment strategies” based on the technology.
The report stresses that there is currently “little government oversight over how these systems are developed.” Its recommendations give a sense of where lawmakers, or perhaps regulatory agencies, might head if they decided to start clamping down on AI-driven trading. For example, the study emphasizes that hedge funds don’t have a uniform definition of AI, let alone consistent safety practices. It recommends standards around internal risk assessments, third-party audits and investor disclosures about the use and testing of AI systems. The report suggests that there’s more regulators could do to apply their existing authorities to AI, including at the SEC and CFTC.
Peters issued this statement:
“As hedge funds and the financial sector at large increasingly use AI to inform trading decisions, it is critical that there are safeguards in place to ensure the technology is being used in a way that minimizes potential risks to individuals and to market stability itself.”
Here’s a response from Bryan Corbett, president of the Managed Funds Association:
“Alternative asset managers use technology to generate returns throughout the economic cycle for their investors, including pensions, foundations, and endowments. This partisan report fails to recognize long-accepted current market practices which serve investors and enhance market efficiency. It does not accurately portray how the alternative asset management industry uses emerging technologies like AI. The overtly-political report spreads misinformation about an entire industry, is not representative of the industry today, and sets back public discourse around an important topic.”