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Will Citigroup Acquisition Spoil Lava Trading’s Neutrality?

Citigroup plans to purchase Lava Trading, but analysts question whether the direct-access trading platform will continue to be broker-neutral.

Citigroup disclosed on Friday that it's acquiring Lava Trading, a leading supplier of direct-access electronic-trading software and services to brokerage firms, institutional investors and hedge funds.

"I think it catapults us to a leading position in the electronic-execution arena," says James Forese, managing director and head of Citigroup Global Equities.

Lava will become a wholly owned, independent subsidiary of Citigroup following the closing of the transaction, which is expected during the third quarter of 2004. Richard Korhammer will remain chief executive officer of Lava and report to Forese.

Lava pulls together all the market-data from exchanges, market makers and electronic communications networks in listed and over-the-counter stocks; figures out which destination has the best price; and then routes the order there in milliseconds.

Though Forese declined to discuss how much Citigroup is paying for Lava, Robert Iati, director of TowerGroup's securities and capital markets practice, estimates the price "is north of $500 million" and could be as high as $1 billion. This is not surprising, he suggests, since Lava has about two-thirds of the market share in the direct-access trading space, he says. "Certainly they have dominant market share, a relatively unique technology and a great brand," says Iati.

The Citi/Lava deal follows a recent trend among brokerage houses acquiring direct-access trading technology providers. Most recently, BNY Securities acquired Sonic Financial Technologies in March and Bank of America Securities bought Direct Access Corporation in February. Similarly Goldman Sachs bought Spear, Leeds & Kellogg, which owns REDIPlus as its direct-access platform.

"Basically, the sell-side is looking to deepen its relationships with its buy-side clients and it sees the purchase of direct-access as a way to do that, and it helps them with access to multiple-market destinations," says Jodi Burns, senior analyst at Celent Communications . Forese says the investment bank was attracted to two sets of technologies that Lava offers in equities: One allows broker-dealers to route orders "intelligently, quickly and reliably. And, a second set of products are targeted toward institutional investors, which allow those clients to send orders either to broker-dealers or to exchanges or to execution points around the marketplace."

However, Iati thinks that the value Citi sees with this purchase "is much more of an internal value. They're going to offer some service that Lava provides and not allow anybody to offer it," he speculates.

But the acquisition immediately raised concerns from analysts who say the Lava Trading tools will no longer be regarded as broker-neutral because a broker will own it.

"I think the concerns about neutrality are valid," says Burns. Though Citigroup and Lava have said they are going to keep Lava as a separate entity, Burns says, "They're saying all the right things, but it remains to be seen. We really don't know until the acquisition is implemented," she says.

Iati says the transaction has to affect top broker-dealers, such as JPMorgan Securities, which recently signed a two-year contract to use Lava's equity trading and order-management system, ColorPalette.

"If you are a sell-side competitor [of Citigroup], I think it has to affect you," says Iati, who adds, "It's really impossible to measure how much business might be lost because of it."

Meanwhile, Citigroup is assuring other broker-dealers and buy-side institutions that it will maintain Lava Trading as a broker-neutral platform. "We will aggressively be marketing the product to our institutional-investor clients, and there, we will be endorsing the multi-dealer-broker neutral strategy as well, which is in keeping with what we believe our customers want."

Forese notes that Citigroup has been a user of Lava's broker-dealer products for a number of years, as have a number of large and small broker-dealers. "We will continue to use those [products] as we hope and expect other broker-dealers to use them," he says.

In addition to maintaining Lava as a separate company and as a separate legal entity, Forese says Citigroup is "going to create robust policies and procedures around information flow, for the most part restricting information flow out of Lava. We intend to have that audited by both internal and external auditors," he notes, "so that our clients can know that we are in compliance with those information policies."

In order to maintain confidentiality of all client data, the release states that Lava -- which has nearly 200 employees -- will operate independently of Citigroup and will continue to be housed at its 95 Morton St. headquarters in New York City.

Even with these precautions. Burn says, "Lava will be seen as a Citigroup product. It's hard to be seen as broker-neutral when you are owned by a broker," she says. "This is not specific to Lava, it is a general difficulty," she adds. "The burden is on Citigroup to set this up so that Lava actually remains broker-neutral," she adds. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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