BCS Barclays PLC

Federal and state authorities are investigating whether Wall Street firms that handle millions of orders annually for retail clients have lived up to their obligation to provide the best possible treatment for those investors, according to people familiar with the matter.

The Justice Department's civil division has sent subpoenas to several firms including Citadel Securities, the market-making business of Citadel LLC, and KCG Holdings Inc. in connection with the probe, these people said.

The New York attorney general's office is also conducting a broad investigation into practices that may create an unfair disadvantage for retail investors whose stock orders are handled by electronic market makers, and has sent a subpoena to Citadel and other firms, one of the people said.

The federal subpoenas are issued under a civil fraud law, the Financial Institutions Reform, Recovery and Enforcement Act, or Firrea, which covers fraud affecting federally insured financial institutions, the people said.

Authorities are examining practices over several years surrounding electronic trading firms' payments to brokers to route retail orders to them, among other issues, people familiar with the inquiries said.

The nature of the Citadel and KCG investigations was reported earlier Tuesday by Reuters.

KCG disclosed last August that it was the subject of a Justice Department investigation, without providing further details.

A Citadel spokeswoman said: "As one of the largest market-makers and providers of liquidity in the U.S., we regularly receive inquiries from and work closely with a number of regulators and others regarding our business and market practices."

"We cooperate fully with such requests, but as a matter of practice, we don't confirm any particular inquiry," the spokeswoman, Katie Spring, said.

In 2014, then-Attorney General Eric Holder said the Justice Department was examining high-speed trading practices to determine whether they violate insider-trading laws. It is unclear if the current inquiries are separate from the investigations Mr. Holder described in 2014.

High-speed trading firms and off-exchange venues known as "dark pools" have been in the regulatory spotlight since the 2014 publication of Michael Lewis's "Flash Boys," which described how the U.S. stock market was "rigged" in favor of big banks, exchanges and high-frequency traders.

In January, the Securities and Exchange Commission and New York Attorney General Eric Schneiderman reached $154.3 million in settlements with Credit Suisse Group AG and Barclays PLC over their dark-pool operations.

The inquiries into historical trading practices at KCG and Citadel Securities go to the heart of the complex world behind stock trading. The two companies are the biggest players in what is called "wholesale market-making," where high-speed intermediaries handle trades on behalf of big retail brokerages such as Fidelity, TD Ameritrade and Scottrade.

In practice, when a retail investor uses a market order to buy a particular stock in his or her account, the broker almost always routes it to KCG, Citadel or a handful of smaller wholesale market makers. The wholesaler then completes the trade by matching it with an opposite order in its own inventory or going onto the stock market to find a match.

Wholesalers make tiny profits on many of those trades; over time, they add up to tens of millions of dollars. KCG had revenue of $258.9 million and pretax income of $75.5 million in its market-making division during the first quarter of 2016. The profits are primarily driven by wholesale market-making but the firm also does other types of market-making.

Part of the money wholesalers earn is often paid back directly to the broker in a practice known as "payment for order flow." Retail investors are also given a tiny "price improvement," meaning the price at which they are ultimately executed might be slightly cheaper if they are buyers or a bit higher if they are sellers.

Critics of the business have said wholesalers are unnecessary intermediaries that profit from retail stock orders without providing much benefit.

The Justice Department inquiries appear to be focused in part on the way wholesalers used different data feeds to establish they had met requirements to achieve the best price and to actually complete the trades.

Lawmakers including former Sen. Carl Levin (D., Mich.) have criticized the practice of selling retail orders to market makers, saying it presents an insurmountable conflict of interest for the broker receiving the fee.

Citadel has said the value of their service is straightforward—they provide retail investors an even better price than the best bid or offer on public exchanges. In effect, Citadel and KCG have replaced stock exchanges as the de facto destination for many retail-investor orders.

According to data from the Financial Industry Regulatory Authority released Monday, Citadel's market-making business executed nearly 6% of all trading in listed stocks. That means its market share in listed equities exceeds that of many smaller exchanges, including ones operated by Bats Global Markets and Nasdaq Inc.

Write to Aruna Viswanatha at Aruna.Viswanatha@wsj.com, Bradley Hope at bradley.hope@wsj.com and Dave Michaels at dave.michaels@wsj.com

(END) Dow Jones Newswires

May 10, 2016 15:15 ET (19:15 GMT)

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