October 22, 2010 / 6:53 PM / 7 years ago

FEATURE-Kansas City firms duel over flash crash

* Tradebot Systems: “Waddell Stupidity Caused Crash”

* Waddell says no changes needed after Oct. 1 report

* Feud shows calls for more judgments from regulators

* KC “a mini-financial center that nobody ever heard of”

By Ross Kerber and Carey Gillam

BOSTON/KANSAS CITY, MO., Oct 22 (Reuters) - A cowtown squabble between two financial firms along the Missouri River highlights the unresolved questions facing regulators after the May 6 “flash crash” that disrupted markets worldwide.

Kansas City, known more for beef than bankers, is now home to both a leading high-frequency trading firm, Tradebot Systems, and old-line mutual fund manager Waddell & Reed Financial Inc (WDR.N). Regulators this month cited trading by Waddell & Reed as a trigger for the crash, which temporarily wiped out $1 trillion.

Officials did not sanction the firm or even name it, though it was quickly identified by Reuters and other news organizations. The situation rankles some high-frequency traders who fear stricter rules and blame the fund company.

Pushing this case hardest is Dave Cummings, founder of Tradebot, on the eastern, Missouri side of the state border that divides Kansas City in half. “Waddell Stupidity Caused Crash,” Cummings titled an Oct. 3 memo.

“The first people everyone blames are the high frequency guys, but it began with the mutual fund guys,” he told Reuters.

Waddell & Reed declined to respond directly. But it has previously denied wrongdoing and lately launched a behind-the-scenes campaign of its own to win back skeptical investors. When one asked about the crash on an Oct. 12 conference call run by a fund that placed some of the trades, Asset Strategy, manager Ryan Caldwell was unapologetic.

“We have not changed anything. We’re not going to be changing anything,” said Caldwell. “We’re very confident in the processes, the tools, the markets and the people that we have.”

To some experts, the back-and-forth shows the questions the Securities and Exchange Commission and the Commodity Futures Trading Commission so far have failed to answer, fueling uneasiness among traders and fund managers.

“There’s a lot of fear in the (financial) community that they will be punished” by whatever solution regulators ultimately come up with, said Robert Litan, a Brookings Institution economist who recently returned to his Kansas roots and now oversees research at Kansas City’s Kauffman Foundation -- begun by a one-time owner of the city’s Royals baseball team.

“Anybody who could be affected by the solution is pointing the finger at somebody else,” he said.

SEC and CFTC officials would not comment.

FORMER WSJ REPORTER HELPED START FUND FAMILY

Litan added there is some irony the debate is playing out in a prairie city few realize is also home to American Century Investments and a Federal Reserve branch. “We are like a mini-financial center that nobody ever heard of,” he said.

Waddell & Reed manages $68 billion with 900 workers at a campus in the Kansas-side suburb of Overland Park. It was founded in 1937 by former Wall Street Journal reporter Chauncey Waddell and securities salesman Cameron Reed. Asset Strategy is now its biggest fund, which Caldwell and Michael Avery run with a gunslinger style unusual in the staid mutual funds industry.

The fund is among a growing number of “flexible portfolio” funds, with a broad mandate allowing it to invest more like a hedge fund than a traditional equity portfolio. Big holdings lately include gold and shares in Asian casino operators that Avery bets are poised to ride a middle-class boom.

The fund’s returns and inflows fell off in the first half of 2010, but its track record has improved lately. For the three months ended Sept 30, Asset Strategy took in $216 million, according to Lipper, a Thomson Reuters unit. Waddell & Reed is scheduled to report third-quarter earnings on Oct. 26.

Analysts say better numbers and lack of sanctions would help the company’s stock, down 10 percent this year, catch up with peers, whose shares are down an average of 4 percent. “The issue of the flash crash is behind them,” said Gabelli & Co’s Mac Sykes.

A HIGH FREQUENCY TRADER FIRES BACK

Not so fast, Cummings says. Cummings, a native Kansas Citian, previously traded wheat contracts before starting Tradebot in 1999, one of the first firms of its kind. Cummings says it was reckless for Waddell & Reed to omit a price limit that would have halted sales on May 6.

“It angers me when people blame technology for what are clearly lapses in human judgment,” he wrote in his note.

A Waddell & Reed spokesman, Roger Hoadley, declined to comment on Cummings’ memo. But he noted a report by researcher Nanex LLC -- using data with Waddell’s permission -- that found most of the fund manager’s May 6 trades came after the market bottomed, at a time the trades had supposedly caused demand to evaporate.

Cummings said the Nanex report did not account for enough trades. “I stand by my note,” he said.

Nanex Chief Executive Eric Hunsader said the data at least shows the fund was “well behaved.” But regulators should further probe the role high-frequency traders played, he said. (Additional reporting by Herbert Lash and Jonathan Spicer; Editing by Steve Orlofsky)

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