SEC, NYAG Sanction Three Dark Pools
The SEC and the New York Attorney General announced settlements with Barclays Capital Inc. and Credit Suisse Securities (USA) LLC centered on the operation of dark pool trading venues. In the Matter of Barclays Capital Inc., Adm. Proc. File No. 3-17077 (January 31, 2016); In the Matter of Credit Suisse Securities (USA) LLC, Adm. Proc. File No. 3-17079 (January 31, 2016)(“Light Pool”); In the Matter of Credit Suisse Securities (USA) LLC, Adm. Proc. File No. 3-17078 (January 31, 2016)(“Crosssfinder”).
Barclays is the only action in which the firm admitted the facts detailed in the Order and that its actions violated the federal securities laws. Barclays Capital Inc. is a registered broker-dealer. Since 2008 the firm has operated LX, an ATS that operates under Regulation ATS. It is the second largest ATS in the U.S., ranked by daily average trading volume in NMS stocks.
The proceeding focuses largely on protections subscribers were told the venue provided from aggressive traders – a primary point in each case — but which in fact did not work as represented. Key to those protections was LX product Liquidity Profiling. Available only to subscribers, it was touted as a protector from predatory trading. Subscribers were told that LX used graphic visualization tools to identify a latency arbitrage strategy. Advertising materials also claimed that Liquidity Profiling continuously policed the trading venue. LX claimed that it reviewed client behavior in the dark venue on a weekly basis so that aggressive behavior could be quickly identified and corrective action taken. In fact, visualization tools were not used to monitor for latency arbitrage on a regular basis. Likewise, the surveillance reports were not run each week.
Liquidity Profiling also evaluated the manner in which venue subscribers traded, according to Barclays. Specifically, traders were ranked from most aggressive to least aggressive. Liquidity Profiling would allow subscribers to block trading with those assigned to certain categories. What subscribers were not told was that Barclays used overrides to move certain subscribers from more aggressive to less aggressive categories. That resulted in some subscribers interacting with those in the most aggressive categories. Those included its market making desk and certain select traders, all of whom were permitted to trade with subscribers who had opted not to trade with aggressive traders.
Another facet of this difficulty was a chart included in Pitchbooks used to market LX. Beginning in December 2011 the book contained a slide with a bubble chart that was supposed to illustrate each subscriber’s order flow based on the top 100 LX participants. Over the next nine months the slide was not updated. When an update was added in October, the largest LX subscriber was dropped. Later versions of the Pitchbooks which included the slide also omitted the largest subscriber.
Finally, a critical issue concerned the calculation of NBBO. LX represented that it had direct feeds from major exchanges. In fact it did not have one from the NYSE. Rather, LX used data sources from the Securities Information Processors and direct feeds from BATS, ARCA and NASDAQ exchanges. Barclays also failed to limit access to confidential subscriber information – another key issue in each of the three cases — to those employees who operated the system or were responsible for compliance.
Following a December 2013 internal audit, Barclays took steps to correct some deficiencies. The firm retained an independent third part consultant to conduct a comprehensive review of its operation of LX.
The Order alleged violations of: Securities Act Section 17(a)(2) regarding material omissions; Exchange Act Section 15(c)(3) and the related rules, requiring risk management controls and supervisory procedures; Rule 301(b)(2) of Regulation ATS which requires the filing of certain reports; and Rule 301(b)(10) of Regulation ATS which requires the establishment of adequate oversight procedures for confidential information.
As part of the resolution of the proceeding, the firm agreed to implement a series of undertakings regarding the recommendations of the third-party consultant and its procedures and controls. Barclays also consented to the entry of a cease and desist order, based on the aforementioned admissions, and on Securities Act Section 17(a)(2), Exchange Act Section 15(c)(3) and the related rules, and Rules 301(b)(2) and 301(b)(1) of Regulation ATS and to a censure. The firm will pay a $35 million penalty.
The two proceedings which name as a Respondent Credit Suisse Securities (USA) LLC, a registered broker-dealer and investment adviser also focus on the operation of ATS systems. One focused on the operation of an ATS and electronic communications network or ECN known as Light Pool which was part of an advanced execution services. It accepted, matched and executed orders that were received from firm customers who were either direct subscribers or that were sent by firm algorithms to Light Pool.
Light Pool centered on what was called an “Alpha Formula/Scorecard.” Effectively this was another system that was designed to identify “opportunistic” traders. In fact the product was not implemented when Light Pool began trading in NMS stocks in June 2011 and the representations regarding it were not accurate. The venue also “backed away” from orders. The Order alleged violations of Securities Act Section 17(a)(2) regarding material omissions; Rule 301(b)(2) of Regulations ATS concerning the need to file an amendment on Form ATS prior to implementing material changes; and Rule 602(b) of Regulation NMS which requires, generally, that a broker or dealer to execute an order. To resolve this proceeding Respondent consented to the entry of a cease and desist order based on the Section and rules cited in the Order, to a censure and to pay a penalty of $10 million.
Crossfinder centers on an ATS operated as a dark pool that was as a private execution venue. For approximately a two year period Crossfinder accepted and ranked orders in increments smaller than one-cent – it accepted and prioritized sub-penny orders. This violated Rule 612 of Regulation NMS. Crossfinder also made misrepresentations regarding a proprietary methodology called “alpha scoring” that placed order flow from subscribers into various categories and was intended to address concerns regarding high frequency trades. Confidential subscriber information also was not adequately protected and the venue unreasonably limited several functionalities in an unfair or discriminatory manner.
The Order alleged violations of Securities Act Section 17(a)(2) regarding material omissions; Rule 301(b)(2) of Regulation ATS which requires an ATS to file an amendment on Form ATS prior to implementing a material change; Rule 301(b)(5)(ii)(B) of Regulation ATS which essentially prohibits limiting or discriminating with respect to access to services; Rule 301(b)(5)(ii)(D) of Regulation ATS which, under certain circumstances, requires an ATS to report all grants, denials and limitations of access; Rule 301(b)(10) of Regulation ATS which requires the venue to establish adequate safeguards regarding confidential information; and Rule 612 of Regulation NMS which prohibits sub-penny pricing.
To resolve the proceeding Respondent consented to the entry of a cease and desist order based on Securities Act Section 17(a)(2), Rules 301(b)(2), 301(b)(5) and 301(b)(10) of Regulation ATS and Rule 612 of Regulation NMS and to a censure. The firm also agreed to pay disgorgement of $20,675, 510.52, prejudgment interest and a penalty of $20 million.