High-Frequency Trader Isn't So Good With Numbers
Comment of the Day

March 12 2014

Commentary by Eoin Treacy

High-Frequency Trader Isn't So Good With Numbers

Thanks to a subscriber for this article by Jonathan Weil for Bloomberg. Here is a section: 

If the high-frequency trading firm Virtu Financial Inc. succeeds in becoming a public company this year, it would confirm yet again that the investing public has thrown caution to the wind when it comes to initial public offerings.

Virtu filed its registration statement with the Securities and Exchange Commission yesterday, and there was one disclosure in particular, on page 45, that caught my eye. The 12-year-old firm said that, in connection with its most recent audit, "we and our independent registered public accounting firm identified a material weakness in our internal controls over financial reporting," as of Dec. 31. The details are a sight to behold.

Basically, the company said it doesn't know how to do accounting.

"This material weakness related to our inability to prepare accurate financial statements, resulting from a lack of reconciliations, a lack of detailed review and insufficient resources and level of technical accounting expertise within the accounting function," Virtu's disclosure went on.

"Although we have hired senior accounting and finance employees, reallocated existing internal resources and retained third-party consultants to help enhance our internal controls over financial reporting following reviews of our accounting and finance function conducted by members of senior management and by a third-party consultant, there can be no assurance that we will remediate this material weakness or avoid future weaknesses or deficiencies."

You don't see trading firms admit to stuff like this very often. Remember MF Global Holdings Ltd., led by former New Jersey Governor Jon Corzine? Its internal controls were a mess, only investors weren't told that until after the company blew up in 2011. The last time I recall a financial-services company disclosing control problems during the run-up to an IPO was in 2005 when Refco Inc. went public. It went bankrupt the same year, and its chief executive officer later went to jail.

Elsewhere in its registration statement, Virtu said it had $182.2 million of net income last year and $203.3 million of shareholder equity as of Dec. 31. But the disclosure that Virtu lacks the ability to prepare accurate financial statements means it's hard to know what to make of those numbers. (Virtu's auditor is Deloitte & Touche LLP.)

?Now consider that, according to an article in the Financial Times, unnamed people familiar with Virtu's thinking said the IPO "could see the 151-person company raise as much as $250 million and give it a valuation of about $3 billion." The valuation would be several times its book value, which for a trading firm seems awfully rich. (Goldman Sachs Group Inc. trades for 1.1 times book.)


Eoin Treacy's view

The enthusiasm with which new IPOs have been greeted by investors over the last year has unsurprisingly resulted in private companies queuing up to sell at elevated prices. Provided new issues do well in the first month of trading, few people appear to raise too many questions. However, this environment is ripe for companies that might not otherwise have a chance of securing a listing succeeding in that venture. 

This article from zerohedge, also kindly submitted by a subscriber, highlights the hype Virtu’s attempt to list is being supported by. If the company is incapable of verifying its accounting how reliable is the claim that it has had so few losing trading days?

The hard reality remains that HFT relies on regulatory loopholes in order to front run market orders. The strategy will only work for as long as these loopholes remain open and the tide of regulation is slowly but surely beginning to turn against them. 

It would be supremely ironic if Virtu becomes a candidate for aggressive shorting assuming it succeeds in listing. 


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