Dark Pools, High Speed Trading and the NY AG’s Suit Against Barclays

The New York Attorney General’s insider trading 2.0 investigation is apparently expanding. Initially the investigation concerned the limits of insider trading, pushing the issue into questions more akin to fairness and a parity of information The investigation focused, for example, on questions concerning advance access to certain information sources which might involve market moving information. While those issues did not fit within the contours of traditional insider trading which centers in on the misuse of corporate information by insiders in its traditional form, the inquiry addressed important market issues.

Now the investigation has expanded into broader market and trading questions. The New York AG has brought an action against Barclays claiming that it defrauded customers of its dark pool. Specifically, the action centers on allegations that the financial institution falsified its marketing materials for the pool and misled users.

First, the bank misrepresented how it used the pool. Barclays stated that it did not favor its pool when seeking execution for orders. In fact the statement is not true.

Second, the bank misrepresented the safety of trading in the pool. Barclays claimed that it monitored the dark pool to eliminate high speed, predatory trading. Participants were told that the firm operated a surveillance system called Liquidity Profiling which tracked each trader to identify predatory traders, rate them based on certain characteristics and hold them accountable. In fact Barclays never precluded a participant from trading in the pool. The firm also did not regularly update ratings on high-frequency traders monitored by Liquidity Profiling. Indeed, in some instance Barclays overrode ratings from the system regarding high speed traders and assigned them safe ratings. Overall, in marketing the pool the financial institution misrepresented the number of high speed traders using it and the safety of the pool. This action is pending in New York State court.

The expansion of Insider Trading 2.0 into the operation of dark pools follows two prior SEC enforcement actions. In one the agency claimed essentially that the dark pool was not dark enough. Specifically, the complaint alleges that while participants were assured complete confidentiality in fact the pool used information and data about participants in marketing materials. In the Matter of Liquidnet, Inc., Adm. Proc. File No. 3-15912 (June 6, 2014).

Last fall, in its first action against a dark pool, the agency claimed that a dark pool misrepresented the manner in which it obtained executions for customers. In the Matter of Pipeline Trading Systems LLC, Adm. Proc. File No. 3-1460 (Oct. 24, 2011).