LavaFlow Inc., a Citigroup (C) business unit, has consented to pay $ 5million to resolve U.S. Securities and Exchange Commission charges that it did not protect subscribers’ confidential trading data in its alternative trading system. LavaFlow consented to the SEC order without denying or admitting to the allegations.
Per the order, which institutes a settled administrative proceeding, LavaFlow, which runs an electronic communications network ATS, let an affiliate that runs a smart order router application to access and utilize confidential data related to non-displayed orders belonging to subscribers. The order router was not within ECN’s operations and LavaFlow lacked the proper procedures and safeguards to protect this confidential information.
Even though LavaFlow only let the affiliate use the confidential data for ECN subscribers that were also order router customers, the firm did not get subscribers’ consented for their confidential data to be used like this. LavaFlow also failed to disclose this use to the SEC.
LavaFlow has since discontinued this practice. Prior to that, however, the smart order router executed over 400 million shares over three years.
The SEC also claims that LavaFlow aided and abetted a violation by the affiliate that ran smart order router Lava Trading Inc., which kept offering brokerage firm services after it reregistered. During this several month period, Lava Trading made about $1.8 million. Citigroup Financial Products owns Lava Trading.
The SEC order says that LavaFlow violated certain rules of Regulation ATS and aided, abetted, and caused Lava Trade to violate the Securities Exchange Act of 1934. Of the $5 million settlement, $1.8 million in disgorgement of funds made by Lava Trading while it wasn’t registered, $350,000 in prejudgment interest, and a $2.85 million penalty. LavaFlow has been ordered to cease and desist from future violations.
Alternative Trading System
This is a venue that executed stock traders fro traders, including broker-dealers. These stock trading venues are typically run by banks competing with more traditional order flow exchanges. Federal rules mandate that ATS have safeguards to protect its subscribers’ confidential trading information. In the last few months, trading systems have undergone closer regulator scrutiny, especially in relation to high-frequency traders and their relationship to exchange operators.
Just last week, Barclays (BARC) sought to have a dark pool lawsuit filed against it by New York regulators dismissed. The state’s Attorney General Eric Schneiderman claims the British bank lied about giving preferential treatment to high-frequency traders and committed securities fraud.
According to the complaint, Barclays falsely portrayed how clients orders are routed and claims to protect the order from high-speed firms when actually the dark pool LX is operated to the advantage of traders. The bank is now arguing that Schneiderman used misleading data and cherry-picked facts to supports his claims.
Barclays claims that the dark pool lawsuit doesn’t succeed in identifying a specific fraud, failed to establish any material misstatements, and did not identify victims or any real harm.
The bank also says that the Martin Act, which the regulator claims Barclays violated, doesn’t apply to the lawsuit. Under the New York State securities law, prosecutors only have to prove that fraud occurred and doesn’t insist on proof that a firm meant to bilk investors. Barclay, however, said the act doesn’t apply to claims about how a dark pool is run and that Schneiderman’s office is overstepping its mandate in trying to regulate dark pools, which is an SEC job.
Since the case was filed, a number of clients have left Barclay’s LX and trading volume has declined by 75%.
Read the SEC Order (PDF)
Barclays Files to Dismiss New York Attorney General’s Dark-Pool Complaint, The Wall Street Journal, July 24, 2014
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$11M Award Against Citi is Vacated by the New York Supreme Court, Stockbroker Fraud Blog, January 30, 2014
Citigroup Settles Mortgage-Backed Securities Probe with DOJ for $7 Billion, Institutional Investor Securities Blog, July 14, 2014