Automated trading, alternative trading venues, high speed trading, the proliferation of order types and dark pools have been discussed in news articles and popular literate. The Commission has brought enforcement actions involving dark pools, alternative trading venues and order types, frequently tied to a failure to protect proprietary customer data or disclosure issues. The latest case brought by the agency in this area centers on a proprietary order routing system that was supposed to analyze order routing data to prioritize venues and, when coupled with other data, aid venue selection for clients placing trades. The system did that, according to the SEC, but not in the manner told to clients. In the Matter of Deutsche Bank Securities Inc., Adm. Proc. File No. 3-17730 (December 16, 2016).
Deutsche Bank, the broker-dealer – investment adviser affiliate of the international banking giant, has smart order routers known as SuperX+. It primarily routes orders to dark pools and some non-displayed orders to exchanges. In connection with this routing system Deutsche Bank began marketing a component of SuperX+ called the “Dark Pool Ranking Model,” or DRPM. The component was designed to assist in measuring the performance of potential trading venues. The system was supposed to measure the price movement from the time an order was routed to execution. Based on this information, the component ranked venues. The ranking was then combined with other data which measured the probability of execution based on historical information. In essence, DPRM Rankings determined if the venue was eligible to receive an order while the probability of fill determined if the venue would receive an order.
Deutsche Bank touted DPRM to clients and potential clients in conjunction with SuperX+. In some statements the firm touted it as the “quantitative core of [SuperX+]” while others noted that the tool was “a sophisticated dark pool ranking model that profiles dark pools” based on a variety of data. Since the data used for the rankings had to be updated periodically to be effective, the DPRM component was designed to periodically update its information.
Despite the necessity of updates, from December 20, 2011 through February 19, 2013 Deutsche Bank did not update the DPRM Rankings and the fill probability calculations. Clients were not told about the lack of updates – the firm did not tell them that potentially stale information was used in its routing system for millions of trades.
Clients were also not told that when SuperX+ was connected to seven new venues during the same period the rankings supposedly done by DPRM were determined subjectively by firm personnel rather than by the component. This is because there was no historical data available regarding the venues as required by DPRM to generate its rankings. Indeed, in some instances Deutsche Bank overrode the DPRM determinations such as when its own dark pool venue was given a low ranking which excluded it from receiving orders. While Deutsche Bank continued to tout DPRM, and the firm managed to update the data for the component in February 2013 – but the standard procedures were not followed — over a year long period beginning in February 2013 there were no new calculations of rankings or fill probability. In fact, the firm did not successfully update the component until 2014.
In February 2014 Deutsche Bank implemented a new statistical methodology for calculating the DPRM Ranking. The new method was based on price changes for orders routed by Deutsche Bank to the venue. A few months later the firm discovered the reason for its difficulties with updating the component. The systems had corrupted the data input for the DPRM and made it impossible for the firm’s computers to process the proper execution quality data.
Finally, beginning prior to the difficulties with DPRM, and continuing until early 2015, Deutsche Bank also failed to attach a copy of the SuperX subscriber manual and other materials to its Form ATS as required. The Order alleges violations of Securities Act Section 17(a)(2) and Rule 301(b)(2) of Regulation ATS.
In resolving the proceeding the Commission considered the remedial efforts of the firm. Deutsche Bank admitted the facts on which the Order was based and consented to the entry of a cease and desist order based on the Section and Rule cited as well as to a censure. In addition, the firm will pay a penalty of $18.5 million.