Here's the problem with the Citadel-KCG deal

The market-making arm of Citadel is in talks to purchase the NYSE floor seats owned by Knight Capital Group.

Let me say this bluntly and loudly: Asset managers and hedge-fund managers should not be allowed to own market makers … ever!

NYSE Traders
Noam Galai | Getty Images

Now, Citadel is a successful and legitimate financial firm operating in market making, asset management and investment technology. Under Citadel chief Ken Griffin, the hedge fund has produced market-beating returns for decades and he is considered among the smartest hedge-fund managers in the business. However, I think there is an enormous conflict of interest in having a company that owns a large hedge fund, which seeks to move billions of dollars in trades every single day, also own an NYSE market maker, which facilitates those very same trades.

Many questions need to be answered here. Is Citadel's market-making operation allowed to make trades on behalf of Citadel?

Put more accurately, can Citadel trade through its NYSE market maker and, if so, will it have an unfair advantage over other institutions, and individuals, trading through the Citadel owned platform?

Citadel said on Tuesday that Citadel Securities is a separate business from Citadel the hedge fund and that Citadel Securities does not execute trades on behalf of the hedge fund.

I think that is all well and good but in my perfect world, which may admittedly prefer the past to the present, specific functions in the financial markets should be undertaken by separate firms, not just businesses separated by internal walls.

Citadel, which has a large high-frequency trading operation, said in an interview with CNBC that high-frequency trading adds liquidity to the stock market, not volatility.

After having witnessed the impact of marketplace innovations over a 32-year career, which involved stock-index arbitrage, also known as "program trading," "portfolio insurance," the development of new trading technologies, HFT, "dark pools," and sub-penny pricing, the folks who claim that these market structure changes dampen volatility and increase liquidity are full of it!

They all cite academic studies proving their point, rarely pointing out that those self-same studies were, and are, financed by the people engaging in the very activities in question.

At a certain point, one must say, "Enough is enough." We know what happens when the inmates run the asylum.

Editor's note: This op-ed has been updated to clarify that it is Citadel's market-marking arm that is in talks to buy the NYSE floor seats owned by Knight Capital Group.

Citadel issued the following statement:
Citadel Securities is a distinct and separate business from Citadel the hedge fund, and the two businesses operate completely independently. Citadel Securities does not execute a single trade on behalf of Citadel the hedge fund.

Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. Follow him on Twitter @rinsana.

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