How Ken Griffin’s Citadel transformed financial markets

And I’ll also take this.
And I’ll also take this.
Image: Reuters/Mike Blake
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Hedge fund boss Ken Griffin is more than a little paranoid. He’s been panned by reporters for the barrage of security checks needed to get to Citadel’s trading floor in his Chicago office, and lampooned for the hyper-stringent nondisclosure agreements he requires of exiting employees. He is loathe to talk to the press, and fiercely protective of his personal life.

Living in the shadows has been time well spent. Over the past four decades, he has quietly but methodically built a financial powerhouse intended to rival the likes of Goldman Sachs or Morgan Stanley, with grand ambitions to transform America’s financial landscape with a relentless technical edge.

But Griffin’s business ventures are too big to fly under the radar now. Behind the sparkly quant hedge fund that launched his Wall Street career stands his inconspicuously profitable trading operation, Citadel Securities. The firm is largely responsible for the rise of online brokerages and frenetic trading apps like Robinhood, whose pandemic stock-trading boom culminated in a Reddit-fueled short squeeze that rocked financial markets and stirred up a torrent of investor anger, fear, and conspiracy theories. That the palaver was enough to promptly warrant Congressional hearings is testament to just how removed the investing public is from today’s market mechanics.

Citadel Securities, which now handles roughly 40% of US retail trades, is key to understanding those mechanics, since it had a large hand in creating them. Through a series of fortuitous events and technological coups, Griffin has turned himself into one of the stock market’s most powerful middlemen, steadily replacing banks as the go-to matchmaker for all manner of institutions, from hedge funds to pension funds and most notably of late, of burgeoning retail brokers. “The way to think about Citadel is as the Amazon of trading,” says Spencer Mindlin, a capital markets technology analyst at Aite Group. In an industry that relies heavily on technology, Citadel has forged ahead by playing “a game of scale. You reach a point where it’s impossible for others to compete,” he says.

And just like Amazon, Citadel Securities likes to point out that the little guy has reaped the rewards of its technological lead. It’s never been cheaper for retail investors to trade. And yet, the system that those cheap trades rely upon, whereby Citadel pays retail brokers for customers’ orders, has raised questions about potential conflicts of interest among trading firms whose main customer is the brokers they serve, not small investors. It has also drawn attention to the scope of Griffin’s business affairs as an architect of financial markets who happens to also trade on the outcome, and to whether we want our financial titans to do both.

Who is Ken Griffin?

In keeping with his hedgie mystique, rare peeks into Griffin’s dealings tend to center on his personal art and real-estate splurges, as well as titanic donations to museums and universities. As a teen of the 80s, he spent his free time grilling local Computerland store employees and as a part-time debugger for IBM, Fortune wrote in a 2007 profile. In college, he moved on to trading convertible bonds from his third-floor Harvard dorm room against the university’s wishes, jerry-rigging a satellite dish to the side of the building to speed up his stock quote intel. A prominent Chicago hedge funder hired Griffin out of Harvard to run a $1 million portfolio, and after a year, in 1990, he went out on his own to start Citadel.

Three decades later, Griffin’s hedge fund is a global financial juggernaut based out of a 37-story office tower in Chicago’s Loop. With more than $30 billion in capital, Citadel touches just about every corner of the financial system. The trading firm came along a decade after the hedge fund, on the back of the dot-com boom, as online trading exploded at discount brokerages like E*Trade and TD Ameritrade.

Not known for his people skills (he has been called a “gulag” by a competing hedge fund boss for how he manages employees) Griffin is notorious for ruthlessly pursuing talent to stay ahead. The internet is littered with tales of Citadel being “Chicago’s revolving door,” where frenzied analysts and traders are promptly ushered out the door the minute their performance takes a dip.

The firm’s employment contracts reportedly read like iron-clad affidavits to ensure that nothing escapes the military-grade fortress Griffin’s fortunes depend upon. And when something does, Citadel fights back. It has chased down competing firms in court that have extracted intel about its prized algorithmic trading strategies from employees they’re trying to poach.

For all the fretting about Citadel’s cut-throat culture, so far turnover hasn’t cut into its growth. And in recent years Griffin has played up his softer side. He has launched “datathons” to attract aspiring quant whizzes away from tech firms with cash prizes and hope of a job. But workplace tension is hard to mask. A 21-year-old intern told the Financial Times his biggest challenge at Citadel was “the game theory aspect; you’re competing against a lot of people.”

How Griffin grew Citadel Securities

Part of Griffin’s success has been good timing. In the early 2000s, he applied his hedge fund’s quant-based investing know-how to his new market-making business, just as changes in stock market regulation and technology were taking hold. At the time, regulators were changing rules to make the back end of trading less opaque, which allowed brokers to compare how trades were executed and offer cheaper, easier trading to retail clients. In 2000, stock prices started trading in penny increments instead of quarters, which cut the price spreads that padded market maker profits, encouraging higher trading volume instead.

The moment was ripe for Citadel, which had an advantage over brokerages and banks because of its role as a hedge fund. Trained in the art of quant-driven portfolio theory, Citadel’s analysts could deftly read the markets to predict where prices were headed, rather than simply knowing how to spot current price spreads. “Market making today is a very quant-heavy endeavor. You’re making very small predictions around what is going to happen to capture the spread successfully,” says Shane Swanson, a financial technologies analyst at Greenwhich Securities. “Citadel had extraordinarily strong technologists.”

Another SEC rule change in 2005, which required brokers to route orders to the trading venue that gave the best price, allowed banks, brokers, and trading firms like Citadel to scoop up yet more of the market-making business, as trades moved off pricier traditional exchanges like the New York Stock Exchange and NASDAQ to less regulated firms. The share of US stock trades executed off public exchanges rose to a record high of 47% in January of this year, from roughly 33% a decade earlier.

Citadel Securities poached more of that business away from banks after the 2008 financial crisis. Banks started ducking out of market-making thanks in part to the Volcker rule, a provision of the 2010 Dodd-Frank Act designed to limit banks’ proprietary trading to ratchet down risk-taking. They found it hard to parse the difference between prop trading, where banks trade their own money for a profit, and market making, the buying and selling of securities for other investors to profit off the spread.

At the time, banks fretted that tech-savvy firms like Citadel Securities were less regulated and might prove less reliable in keeping markets humming during a crisis. Griffin countered that his firm’s tech prowess benefitted markets by swiftly crunching data in times of volatility. In his estimation, banks “publicly yearn for the old days when they extracted disproportionate rents from investors on the basis of anti-competitive business practices,” Griffin wrote in testimony for a 2014 hearing of the Senate Banking Committee.

Profiting from the pandemic

In the coming years, Griffin would continue to chisel away at banks’ market-making business as tighter bank regulations, such as stringent margin and capital rules, raised costs for banks and gave an advantage to outsiders. Citadel Securities moved from handling options trading alone to dominating equities, foreign exchange, Treasuries, credit indexes, ETFs and interest-rate swaps. In 2016, it gained a foothold in trading on the floor of the New York Stock Exchange, giving it a line into trading for companies like Spotify, Uber, and Virgin Galactic Holdings.

To Griffin, the pandemic offered another growth opportunity. At the onset of Covid-19,  the markets were “a macro trader’s dream,” a time to snap up discounts “when people are panicking,” he told a New York audience at a non-profit event last year. Just after the pandemic hit in late March, Griffin relocated his trading force from Chicago and New York to the Four Seasons Palm Beach in Florida, where he quarantined dozens of employees, some with their families, so they could focus on hammering away at volatile markets.

The wild market swings that boost trading revenues helped Citadel Securities generate a record $6.7 billion in trading revenue last year, nearly doubling its previous high two years earlier. In fact, Griffin’s trading business has been even more lucrative than his hedge fund, with profit margins up 67% in the first half of 2020. He is now the world’s 28th richest person, up from 150 just a few years ago.

What will Citadel do next?

In the wake of the 2008 crisis, Griffin had designs on building a more traditional investment bank to rival the Wall Street mainstays that had taken a hit. He hired big players away from Merrill Lynch, JPMorgan, and Microsoft to run that shop, but none of them lasted long in Griffin’s world, and the business petered out. It’s one of Griffin’s few documented failures, but it ultimately played in his favor. In paring down his banking operation to its electronic trading systems and infrastructure, Griffin skirted the mystifying task of managing long-term relationships with banking clients, which positioned him to thrive where his irascible temper works best: in the emotionless task of executing trades in real time.

Still, Griffin found his way back to those high-profile relationships through trading. Over the past few years, Citadel Securities has stepped up its role as market maker for private companies going public through direct listings, an emerging tactic that skirts the weighty underwriting, marketing, and investment banking fees of a traditional IPO. That’s a win for Griffin’s firm, which has overseen the trading piece of the job for tech darlings including Palantir, Asana, Uber, and Spotify, while leaving the stickier task of advising to traditional banks like Morgan Stanley.

It leaves him focused on the task of harnessing the retail investing boom. The era of frictionless trading that Griffin imagined is here, with market gyrations that market makers relish. Questions loom about the ethics of a system that sets up trading firms like Citadel Securities to profit off riskier bets from amateur investors, especially when the firm pays a premium to handle those lucrative orders.

But if new rules come out of the GameStop debacle, history suggests that Griffin will find a way to capitalize on them. “I love competition,” he told an investing conference in 2018. In his view, competition is what should drive economic policy changes, in order to promote innovation and drive a better deal for customers. Those kinds of changes are “what we should aspire to create when we think of architecting our economy,” he continued.

Competition is easy to love when you’re already ahead.