Last updated: June 26, 2014 1:18 pm

Top New York securities regulator sues Barclays over ‘dark pool’

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Shares in Barclays fell on Thursday on news that New York’s top securities regulator has sued the UK bank for allegedly favouring high-speed traders using its “dark pool” trading venue while misleading institutional investors.

Barclays’ share price closed down 6.5 per cent to 215p in London.

Eric Schneiderman, the state attorney-general, said Barclays had expanded its dark pool, Barclays LX, to one of the biggest off-exchange venues “by telling investors they were diving into safe waters . . . Barclays’ dark pool was full of predators – there at Barclays’ invitation”.

He said the lawsuit had been compiled with the help of former senior Barclays traders. The suit alleges the bank violated New York’s powerful Martin Act and is seeking an unstated amount of damages and restitution

Dark pools allow investors to trade large blocks of shares anonymously, with prices posted publicly only after deals are done. They were created as a way for institutional investors to place large orders without disadvantaging themselves by signalling to the wider market any market-moving trades.

Regulators, including the Securities and Exchange Commission, are concerned that dark pools have grown too quickly – to about 50 venues – without supervision or transparency and have pledged to increase oversight.

Barclays said: “We take these allegations very seriously. Barclays has been co-operating with the New York attorney-general and the SEC and has been examining this matter internally.”

The bank pulled a $1.5bn debt offering on Wednesday after news of the lawsuit emerged.

The UK’s Financial Conduct Authority was already aware of the US inquiry before the announcement but it is not currently involved in the investigation as the matter appears to be US-specific, according to a person familiar with the situation. While there have been market abuse actions against high-frequency traders, there are not thought to have been any FCA investigations akin to the Barclays dark pool inquiry.

The dark pool lawsuit is the latest legal setback for Barclays, which was embroiled in the Libor rate-fixing scandal and recently resolved claims that one of its traders had manipulated the London gold fix.

When asked whether other institutions were being investigated, Mr Schneiderman told CNBC on Thursday: “I cannot comment on ongoing investigations. The conduct here was so egregious and ongoing we felt we had to move on this.”

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According to the lawsuit filed in New York on Wednesday, Barclays allegedly falsified marketing materials to institutional investors concerning its “surveillance” system called Liquidity Profiling, which it told investors enabled it to identify predatory trading and ban “toxic” traders.

In the marketing document, the bank removed the identity of the dark pool’s largest customer, named on Wednesday as high-frequency trading firm Tradebot, whose trading Barclays had categorised as “toxic”, to minimise the appearance of high-speed traders, the lawsuit said.

Tradebot, which could not be reached for comment, is not accused of any wrongdoing.

In an email discussing the removal of Tradebot one Barclays trader said: “I had always liked the idea that we were being transparent, but happy to take liberties if we can all agree.”

In another email, Barclays’ head of equities sales noted that some people in the industry viewed the bank’s dark pool as a “toxic landfill” and so “[i]f we can help ourselves we should[;] it’s in our control”.

The lawsuit claims Liquidity Profiling offered “little or no benefit to Barclays’ clients . . . because Barclays does not actually police or punish bad trading behaviour”.

“Barclays has never prohibited a single firm from participating in its dark pool, no matter how toxic or predatory its activity was determined to be,” it adds.

The UK bank also falsely claimed it did not favour its own dark pool when routing client orders to trading venues, the lawsuit alleges. One director was fired and another resigned after Barclays changed statistics in a client presentation that showed 75 per cent of all orders were routed to its dark pool despite being required to get the best price for the trade. The version shown to an investor was changed to 35 per cent.

Barclays has never prohibited a single firm from participating in its dark pool, no matter how toxic or predatory its activity was determined to be

- NY lawsuit

The lawsuit quotes one former Barclays director as saying “there was a lot going on in the dark pool that was not in the best interests of clients”. “It’s almost like they are building a car and saying it has an airbag and there is no airbag or brakes,” it adds.

It is the first action by Mr Schneiderman’s office since he announced in March his concerns over high-speed trading. The state attorney-general has opened an inquiry into whether US stock exchanges and other trading platforms had given high-speed traders an unfair advantage over rivals. Six high-frequency trading firms have been subpoenaed as part of its investigation.

Carl Levin, a senior Democratic senator from Michigan and chairman of the Senate permanent subcommittee on investigations, said action was needed to end conflicts of interest in the US stock market.

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“The behaviour described in this complaint would put a bank’s financial interest in marketing its dark pool and profiting by providing access to predatory high-speed traders ahead of the interests of investors,” Mr Levin said.

Mary Jo White, SEC chairman, announced a series of proposals to overhaul market structure this month and highlighted her concerns about the lack of transparency in dark pools, suggesting new rules to increase disclosures would follow.

Ms White also recommended that dark pools register with the Financial Industry Regulatory Authority, Wall Street’s self-appointed regulator, to increase oversight.

There is also intensive policy and supervisory work being done in the UK and Europe on dark pools and high-frequency trading.

Martin Wheatley, the chief executive of the FCA, said earlier this month that dark trading was “comparatively low” in the UK and Europe as a percentage of trading volumes compared with the US. This disparity is expected to increase with the advent of the EU’s updated MIFID rules, which will place a cap on orders that can be executed away from lit order books as part of a tougher markets regime.

The UK now has a mix of exchange-led monitoring, with the regulator analysing risks and industry itself reporting suspicious activity, so “the challenge here becomes a shared one”, he said.

Additional reporting by Vivianne Rodrigues and John Aglionby

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