Study of brokers' potential conflict of interest in routing limit orders leaked to Wall Street

A new academic paper about potential conflict of interest in large retail brokers' routing of limit orders has stirred controversy on Wall Street and caught regulators' attention -- even before the paper has been submitted to a journal.

While some in the industry have compared the study's possible impact to an earlier one that reformed Nasdaq trading, the authors caution that the paper is not yet final and the findings should be taken in proper context.

The authors, professors at Indiana University's Kelley School of Business and the University of Notre Dame Mendoza College of Business, found that some large retail brokers regularly route clients' limit orders to the exchange that pays them the highest rebates. Under certain circumstances, this can lead to some clients' trades not being executed at the best possible times -- or not being executed at all.

"Certain brokers, led by Ameritrade and including E*Trade, Scott Trade and Fidelity, were bifurcating the order flow -- sending market and limit orders to different exchanges -- but seemed to send all their limit orders to one place," said Robert Jennings, the Gregg T. and Judith A. Summerville Professor of Finance at Kelley.

"Brokers were paid for almost every order received; the conflict of interest occurs because some exchanges will pay brokers more to route limit order flows there, even if the chance that the limit order gets executed is lower on that exchange than somewhere else."

U.S. equity exchanges typically charge traders taking liquidity -- such as market orders -- and pay traders making liquidity -- such as limit orders. The payments, or rebates, are funded by take fees, so exchanges with the highest liquidity rebates also have the highest take fees. Brokers can generate revenue from customers' order flow.

According to the paper, "Can Brokers Have It All? On the Relation Between Make Take Fees & Limit Order Execution Quality," study results also indicate that, under some market conditions and for certain stocks:

-- Fill rates for displayed limit orders are lower on exchanges with higher fees. -- Limit orders executed on venues with high fees take longer to execute than those with low fees. -- On average, limit orders executed on venues with low/negative take fees are more likely to fill at the most opportune time for the limit order customer.

"Our results suggest that order routing decisions have an important impact of at least some measures of limit order execution quality and routing decisions based primarily on rebates/fees appear to be inconsistent with best execution," Jennings said. "Even if fees/rebates are passed directly through to the investor, the decision to use a single venue that offers the highest liquidity rebates does not appear to be consistent with the objective of obtaining best execution."

Paper leaked to financial community; FINRA asks brokers for data

The authors presented the paper to relevant industry representatives, including several brokerages, the Securities and Exchange Commission and the National Association of Securities Dealers. This common practice is generally accepted by all parties to be a confidential forum to test and refine study hypotheses and findings.

However in this case, the paper was leaked to the broader financial community without the authors' knowledge or permission. This led some to suggest the paper's impact could equal that of a 1994 study by Bill Christie of Vanderbilt University and Paul Schultz of Notre Dame showing implicit collusion among Nasdaq market makers; it led to sweeping reform of Nasdaq market (and a billion-dollar legal settlement).

The paper's leak -- and the Financial Industry Regulatory Authority's subsequent request for routing data from the 50 largest brokers -- has the authors concerned that the findings about brokers' maximizing liquidity rebates might be oversimplified.

Routing limit orders to maximize make rebates reduces fill rates, produces less profitable limit order executions -- and might be inconsistent with a broker's fiduciary responsibility to obtain best execution, the authors concluded.

"This is a classic case of adverse selection. If there's really bad news about the stock, everybody gets filled. If there's good news about the stock, then only the places where the order gets filled first get filled," Jennings said. "We are not alleging that the use of such rebates is illegal or that it violates securities laws, but there is a need for further transparency for consumers."

The authors expect to publish the revised and final version of the paper in the near future, after incorporating feedback they received.

"Given the competitive nature of the retail brokerage business, if brokers can get exchanges to pay for their orders, they could charge lower commissions," Jennings said. "Thus, customers may be slightly better off; if the payment was eliminated, commissions might have to be higher."

Commissions may be based on the total revenue that brokers receive, "but lower commissions do not compensate those investors who miss out on profitable limit order executions," Jennings and his colleagues concluded. "Brokers cannot have it all."

Jennings co-authored "Can Brokers Have It All?" with Robert Battalio, a professor of finance; and Shane Corwin, an associate professor of finance, both at Notre Dame. Battalio earned his doctorate at Kelley.

Source: Indiana University

Defects in solar cells made of silicon identified

Sergio Castellanos wants continue researching, work in an industry and does not rule out to eventually move to another country. Credit: Image courtesy of Investigación y Desarrollo

Since he was a teenager, engineer Sergio Castellanos had the desire to study abroad to prepare and do research in the best laboratories, particularly on solar energy. With six years of stay in the United States, first at the University of Arizona and now at the Massachusetts Institute of Technology (MIT) in Boston, his dream has come true:

"Working on defects found on silicon and their impact on the efficiency of solar cells made with this material."

This research is carried out to obtain his doctorate from MIT.

"Dislocation is a defect that occurs at high temperatures, of 500 ° C onwards. In my research I analyze these defects and their impact on the efficiency of solar cells made from silicon, since this material is used in over 90 percent of solar panels worldwide ."

The Mexican researcher in Boston explains that the harmful part of the dislocation is interacting with other defects such as metallic impurities within the material of solar cells; they tend to reduce efficiency by -for example- interacting with electrons.

"When having a dislocation is very easy for impurities to settle into a defect in the material. Therefore, in my research I analyze at an early scale what kind of dislocations will be more harmful to the cells, meaning, which ones will interact more with impurities because not all do likewise, hence not all dislocations are equally harmful."

The proposal of Sergio Castellanos at the MIT is to apply a method in wafers of polycrystalline silicon before being processed into solar cells. This method involves using a chemical treatment in order to view the dislocations and analyze the geometric variation on the surface. After making crystallographic analysis as well as X-rays for determining the distribution and concentration of metal impurities, a correlation is made with the geometric appearance of the surface and then, just by looking at the surface, one can deduce what the electrical behavior within material will be.

"The goal is to identify which areas of the material will be more likely for electrons to recombine before being extracted by contacts, becoming less efficient cells."

A little bit of history

When the native of Hermosillo, Sonora (northern state of Mexico), was in high school, he applied for the Massachusetts Institute of Technology (MIT) and was not admitted. He told himself he would not be discouraged because surely the opportunity would could come later. He decided to study mechanical engineering at the Technological Institute of Hermosillo and two years in his parents supported him to finish his degree abroad.

He was transferred to the University of Arizona where he finished his degree. At the university, he became involved in several projects on the subject of energy, as was the case with hydrogen cells, a solar car and installing solar panels.

The Mexican says he enjoyed doing research and started looking for projects and teachers who worked in that area. He spotted four scientists, but wanted to go to MIT because "for any engineer to be in this school is a dream. I had practice in energy research during my bachelor's and for my doctorate I looked for subjects in this area. I applied at several universities and at last I was admitted at MIT in Boston."

His research in solar cells is in the last stage, and once completed in the next year he will make it available to other researchers. This work was presented at various conferences and has received good reviews in terms of utility.

To "finish the tale" on solar cells, the Mexican will complete his studies in six to eight months, and is more than satisfied with the subject that has developed during his research.

Sergio Castellanos wants continue researching, work in an industry and does not rule out to eventually move to another country. In the remaining months he will define his next step. (Agencia ID)

Source: Investigación y Desarrollo

Credit score can also describe health status

It appears the same behaviors that ruin credit ruin health too. Credit: © Ivelin Radkov / Fotolia

A credit score doesn't just reduce a person's entire financial history down to a single number and somehow predict their credit-worthiness.

It might also be saying something about a person's health status, too, according to a new analysis from a long-term study of the physical and mental health of more than 1,000 New Zealanders who have been monitored continuously from birth to age 38.

The latest paper from the study, appearing this week in the Proceedings of the National Academy of Sciences, has found a strong relationship between low credit scores and poor cardiovascular health.

This doesn't mean that poor financial management hurts your health, post-doctoral researcher Salomon Israel of Duke University is quick to point out. It's that the sort of personal attributes that can lead to a poor credit score can also contribute to poor health.

This and other studies from the Dunedin Multidisciplinary Health and Development Study in New Zealand have found that self-control, planning ahead and perseverance are attributes that predict both better financial status and better health.

"What it comes down to is that people who don't take care of their money don't take care of their health," said study leader Terrie Moffitt, who is the Nannerl O. Keohane university professor of psychology and neuroscience at Duke. She said this study confirms what the insurance and financial industries may already understand.

Backtracking into the data on these study participants, the researchers found that about 20% of the relationship between credit scores and heart health was accounted for by the attitudes, behaviors and competencies displayed by the study members when they were younger than age 10.

"We're showing that these things take root early in life," Israel said.

Harvard economist David Laibson, who was not involved in the research, said the study "fundamentally transforms our understanding of the psychological factors that connect our health and wealth."

Lamar Pierce, an associate professor of organization & strategy at Washington University in St. Louis, agreed. "This study is important because it identifies common cognitive foundations long before financial and physical health problems emerge," said Pierce, who was not involved in this study. "It provides hope that early life intervention can impede the development of life-long patterns of illness and financial struggle."

Using a standard measure called the Framingham cardiovascular risk score, the Duke researchers estimated the "heart age" of their participants, based on blood pressure, cholesterol levels, blood sugar and smoking habits. At age 38, the participants' Framingham "heart ages" ranged from 22 to 85 years. Participants with higher credit scores had younger "heart ages." The components of the Dunedin study's human capital measure -- educational attainment, cognitive ability and self-control -- each predicted higher credit scores and younger heart age.

The idea of checking credit scores against the detailed personal data in the Dunedin study came from a conversation Moffitt had with her seatmate on a plane about a decade ago. When she told her travelling companion from the life insurance industry that she studied self-control and life outcomes, he said, "We do that too, but we use credit scores."

"The thing that's so compelling about credit scores is that they're both predictive and retrospective," said co-author Avshalom Caspi, the Edward M. Arnett professor of psychology and neuroscience, psychiatry & behavioral sciences at Duke. "They offer a window on the future, but also a window on the past."

In recent years, credit scores have been used for pre-employment screening and many other functions beyond their original intent, Israel said. This study seems to bear out their usefulness as a proxy for a person's reliability and steadfastness, and in turn how healthy they may be.

"Our findings suggest that life insurance companies that acquire an applicant's credit score are also indirectly acquiring information about that applicant's educational attainment, intelligence and personality, right back to childhood," the authors wrote.

The link might work the other way as well. In less developed countries where credit scores aren't available, a Harvard team has been experimenting with using a 40-minute personality quiz to assess candidates' credit-worthiness for microloans.

This research was supported by the New Zealand Health Research Council, US National Institute on Aging (AG032282, T32-AG000029), the UK Medical Research Council (MR/K00381X) the Jacobs Foundation and the Yad Hanadiv Rothschild Foundation.

Source: Duke University

Researchers develop a system to reconstruct grape clusters in 3D, assess quality

Antonio José Sánchez Salmerón, researcher at the Instituto ai2 of the UPV, explains that, today, grape classification is based on an inspection by a panel of experts, that award it score depending on a series of parameters that determine its quality. Credit: Image courtesy of Asociación RUVID

Researchers of the Universitat Politècnica de València (UPV) have developed software to help reconstruct grape clusters with three-dimensional computer vision techniques. The system helps to automatically assess different parameters that define the quality of the wine grape during harvest time.

During the work, the researchers of the UPV collaborated with the Research Centre of Vine and Wine related Sciences of the University of La Rioja, the Spanish National Research Council (CSIC, in Spanish) and the Government of La Rioja. The results of this work were released last September in the journal Food Control.

Antonio José Sánchez Salmerón, researcher at the Instituto ai2 of the UPV, explains that, today, grape classification is based on an inspection by a panel of experts, that award it score depending on a series of parameters that determine its quality. Moreover, different tests are performed in the laboratory in order to estimate the quantity of sugar, the pH, the total acidity and the phenolic quality.

"Among the factors that define the quality of a wine, one of the most important is the quality of the grape as the raw material, but this concept is difficult to assess, due to problems such as subjective parameters, the short period of time available in the field to do the analysis during harvest time, the lack of measuring instruments and their high price, as well as the mixing of good quality and bad quality grape in the trucks. The introduction of this 3D grape reconstruction system helps assess different quality parameters for a wine grape cluster avoiding these problems. One of these parameters is the average size of the grape, which is a very important factor as it establishes the ratio between the quantity of skin and pulp," explains the researcher.

"Increasing the objectivity and automating the grape quality monitoring tasks would be a technological breakthrough with regard to the traditional evaluation system of the grape, based on the knowledge of an expert, and it would have a great impact on the wine industry," adds Sánchez.

Source: Asociación RUVID