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Small investors banding together online to pump up stocks like GameStop Corp. say they are defying Wall Street. But one of the biggest players in global markets stands to benefit from their frenetic trading.

Citadel Securities, the electronic-trading firm owned by hedge-fund billionaire Ken Griffin, has played a quiet but critical role in the frenzy of the last two weeks.

The firm—an affiliate of Mr. Griffin’s hedge fund, Citadel—executes orders placed by customers of Robinhood Markets Inc., TD Ameritrade and other online brokerages that have enjoyed surging volumes during the coronavirus pandemic.

Citadel Securities makes money by selling stocks or options for slightly more than it’s willing to buy them. The difference is often just a fraction of a penny per share. But repeated millions of times a day, it adds up to serious money.

Last year, net trading revenue at Citadel Securities was $6.7 billion, almost double the previous high in 2018, a person familiar with the matter said.

Among the forces propelling that growth was an influx of newbie traders, many stuck at home due to Covid-19 lockdowns. Lured by easy-to-use trading apps and an industry shift toward zero-commission trades, individual investors opened more than 10 million new brokerage accounts in 2020, JMP Securities estimates.

Meanwhile, a thriving subculture of day traders grew in corners of the internet like Reddit’s WallStreetBets forum, setting the stage for last week’s manic trading in GameStop, AMC Entertainment Holdings Inc. and several other popular stocks.

“This is the market that Ken Griffin and Citadel Securities have been waiting for," said Christopher Nagy, a former TD Ameritrade executive who is now a director of Healthy Markets Association, an investor group. “The last time the environment was this good for retail market-makers was back in the dot-com bubble."

The firm drew scrutiny last week when its majority owner, Mr. Griffin, participated in a $2.75 billion emergency cash infusion into Melvin Capital Management, a short seller that was facing steep losses due to the huge rally in GameStop’s stock.

Announced Monday, the deal meant Citadel, the hedge-fund firm, was propping up a fund that had bet against GameStop stock, while Citadel Securities had been profiting from the order flow of small investors placing bullish bets on GameStop.

Citadel Securities says it’s separately managed from the hedge-fund side of Mr. Griffin’s business. The firm also released data showing that during the past week, retail orders pouring into its systems for GameStop were roughly balanced between buyers and sellers, casting doubt on the popular narrative that small investors drove the stock to its record close of $347.51 on Wednesday.

The data showed that 29% of GameStop trading volume Monday through Thursday was handled by Citadel Securities, underlining its huge role in the market for stocks popular with individual investors. Overall, about 41% of U.S. retail stock-trading volume goes through Citadel Securities, while the next-biggest player in the business, Virtu Financial Inc., has a market share of around 32%, the firms say.

“We witnessed an extraordinary level of retail trading last week," a Citadel Securities spokesperson said. “At many times over the course of the week, the large brokerage firms depended upon our capabilities to handle the deluge of orders."

Citadel Securities also accounts for a large chunk of trading volume on public markets like the New York Stock Exchange as well as in options, futures, Treasurys and many markets overseas. Founded in 2002, the firm became a dominant player in electronic trading due to its technological prowess, quantitative skills and a hard-driving company culture. Rivals say it has grown increasingly tough to compete with Citadel Securities’ scale and efficiency.

“They’re really trying to take an Amazon approach to trading, where they try to squeeze out everyone else who’s not on their scale," said Scott Knudsen, a former executive at rival trading firm IMC Financial Markets who now leads Cove Markets, a cryptocurrency-trading startup.

Citadel Securities’ retail business has repeatedly drawn controversy. Like Virtu and other market makers, Citadel Securities pays brokerages for the right to trade against individual investors’ orders. During the first three quarters of 2020, the firm made over $700 million in such payments to major online brokerages, according to Piper Sandler.

Critics say this practice, called payment for order flow, skews brokers’ incentives so they seek to maximize revenues rather than ensure customers get the best price. The practice is banned in some overseas markets, like the U.K. Earlier this month, former U.S. Sen. Carl Levin published an op-ed piece in the Financial Times urging the incoming Biden administration to ban payment for order flow, calling it “a conflicted practice that siphons billions out of U.S. investors’ funds each year."

Brokers and trading firms, including Citadel Securities, say payment for order flow benefits investors, because they get a better deal than if the orders were sent to the NYSE or the Nasdaq Stock Market. Citadel Securities says it saved individual investors a total of $1.3 billion last year by executing their orders at better prices than those available on exchanges.

The argument is that, in fact, both sides win: Citadel Securities can offer individual investors better prices on stocks than it would on an exchange, because it knows it’s trading against a player too small to move the market. In contrast, when Citadel Securities trades on an exchange, it may end up trading with a fund manager that is driving a stock up or down with institutional-size purchases or sales—a situation that could result in losses for Citadel Securities.

Still, regulatory penalties have fueled suspicion about the firm’s handing of individual investors’ orders. In 2017, Citadel Securities paid $22.6 million to settle Securities and Exchange Commission charges that it misled customers about providing the best price on investors’ trades. Last year, the firm paid $700,000 to resolve claims by the Financial Industry Regulatory Authority that it traded ahead of customer orders in over-the-counter securities. In both cases, Citadel Securities didn’t admit wrongdoing.

This story has been published from a wire agency feed without modifications to the text.

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