SEC CHARGES UBS SUBSIDIARY WITH DISCLOSURE FAILURES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged a subsidiary of UBS with disclosure failures and other securities law violations related to the operation and marketing of its dark pool.

UBS Securities LLC agreed to settle the charges by paying more than $14.4 million, including a $12 million penalty that is the SEC’s largest against an alternative trading system (ATS).

An SEC examination and investigation of UBS revealed that the firm failed to properly disclose to all subscribers the existence of an order type that it pitched almost exclusively to market makers and high-frequency trading firms.  The order type, called PrimaryPegPlus (PPP), enabled certain subscribers to buy and sell securities by placing orders priced in increments of less than one cent.  However, UBS was prohibited under Regulation NMS from accepting orders at those prices.  By doing so the firm enabled users of the PPP order type to place sub-penny-priced orders that jumped ahead of other orders submitted at legal, whole-penny prices.

Furthermore, the SEC investigation found that UBS similarly failed to disclose to all subscribers a “natural-only crossing restriction” developed to ensure that select orders would not execute against orders placed by market makers and high-frequency trading firms.  This shield was only available to benefit orders placed using UBS algorithms, which are automated trading strategies.  UBS did not disclose the existence of this feature to all subscribers until approximately 30 months after it was launched.

“The UBS dark pool was not a level playing field for all customers and did not operate as advertised,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.  “Our action shows our continued commitment to policing the equity markets to ensure fairness and compliance with all laws and rules.”

In addition to UBS’s disclosure failures that violated Section 17(a)(2) of the Securities Act of 1933 as well as its acceptance of sub-penny-priced orders that violated Regulation NMS, the SEC outlined several other violations of the federal securities laws by UBS in its order instituting a settled administrative proceeding:

The Form ATS and amendments that UBS filed with the SEC included inconsistent and incomplete statements about the dark pool’s acceptance of sub-penny orders and the natural-only crossing restriction.  The filing also failed to attach certain required documents.
UBS violated requirements under Regulation ATS by unreasonably prohibiting subscribers from using the natural-only crossing restriction and failing to establish written standards for granting access to subscribers.
UBS failed to preserve certain order data for the dark pool from at least August 2008 to March 2009 and August 2010 to November 2010.
UBS violated confidentiality requirements under Regulation ATS by giving full access to subscribers’ confidential trading information to 103 employees who should not have had it (primarily information technology personnel).
UBS consented to the SEC’s order without admitting or denying the findings.  The order censures the firm and requires payment of $2,240,702.50 in disgorgement, $235,686.14 in prejudgment interest, and the $12 million penalty.

The SEC’s investigation, which is continuing, was conducted by Stephen A. Larson, Charles D. Riely, Mandy B. Sturmfelz, and Mathew Wong of the Market Abuse Unit and Nancy A. Brown and Thomas P. Smith Jr. of the New York Regional Office.  The case was supervised by Amelia A. Cottrell of the New York office and Daniel M. Hawke of the Market Abuse Unit.  The SEC’s examination of UBS was conducted by Ilan Felix, Richard Heaphy, Michael McAuliffe, Patrick McCurdy, and Genevieve Skabeikis of the New York office.

SEC CHARGES CITIGROUP BUSINESS UNIT WITH FAILING TO PROTECT CONFIDENTIAL TRADING DATA

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission charged a Citigroup business unit operating an alternative trading system (ATS) with failing to protect the confidential trading data of its subscribers.

New York-based LavaFlow Inc. has agreed to pay $5 million to settle the SEC’s charges, including a $2.85 million penalty that is the agency’s largest to date against an ATS.

An ATS is a venue that executes stock trades on behalf of broker-dealers and other traders.  LavaFlow operates a type of ATS known as an electronic communications network (ECN), which unlike a dark pool displays some information about pending orders in its system, such as best bid or best offer.  Under federal rules, an ATS must have safeguards to protect the confidential trading information of its subscribers.

According to the SEC’s order instituting a settled administrative proceeding, LavaFlow allowed an affiliate operating a technology application known as a smart order router to access and use confidential information related to the non-displayed orders of LavaFlow’s ECN’s subscribers.  The order router was located outside of the ECN’s operations and LavaFlow did not have adequate safeguards and procedures to protect the confidential information that the order router accessed.  While LavaFlow only allowed the affiliate to use the confidential trading data for order router customers who also were ECN subscribers, the firm did not obtain consent from its subscribers to use their confidential information in this way, nor did LavaFlow disclose the use in its regulatory filings with the SEC.

According to the SEC’s order, LavaFlow eventually discontinued this practice, but not before the smart order router executed more than 400 million shares in a three-year period based in part on the subscriber information contained in the ECN’s unexecuted hidden orders.

“Operators of alternative trading systems must protect confidential subscriber data and take steps to ensure that affiliates do not improperly use order information,” said Andrew J. Ceresney, director of the SEC’s Enforcement Division. “We will continue to hold accountable firms that fail to follow the rules applicable to off-exchange venues.”

Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit, added, “LavaFlow’s subscribers trusted and expected that knowledge of their hidden orders would not escape the ATS.  Because much of today’s equity trading is automated, firms must protect sensitive information within computer networks just as aggressively as they police against the misuse of information by people.”

Alternative trading systems currently execute approximately 12 percent of the U.S. equity trading volume.  According to Financial Industry Regulatory Authority data, LavaFlow is estimated to be a top 10 ATS when measured by share or trade volume.  LavaFlow is owned by Citigroup Financial Products.

In addition to the Regulation ATS violations, the SEC’s order finds that LavaFlow aided and abetted a violation by the same affiliate that operated the smart order router, Lava Trading Inc., which continued to provide broker-dealer services for several months after it deregistered in August 2008.  Lava Trading, which also was owned by Citigroup Financial Products, earned approximately $1.8 million in broker-dealer business during this time period, and LavaFlow provided operational and administrative support while also responsible for a website that claimed Lava Trading was a registered broker-dealer.

The SEC’s order finds that LavaFlow violated Rule 301(b)(10) of Regulation ATS, which requires an ATS to establish safeguards and procedures for protecting confidential trading information of its subscribers.  LavaFlow also violated Rule 301(b)(2) of Regulation ATS, which requires that an ATS file certain amendments on Form ATS with the SEC.  LavaFlow aided and abetted and caused Lava Trading’s violation of Section 15(a) of the Securities Exchange Act of 1934, which requires broker-dealer registration.  The SEC’s order, to which LavaFlow consented without admitting or denying the findings, requires the firm to pay $1.8 million in disgorgement of money earned by Lava Trading while unregistered plus $350,000 in prejudgment interest and a $2.85 million penalty.  The order also censures LavaFlow and requires the firm to cease and desist from committing or causing these violations.

The SEC’s investigation was conducted by Market Abuse Unit staff including Jason Breeding and Mandy Sturmfelz.  The investigation was supervised by Mr. Hawke, Robert Cohen, and Diana Tani.  The SEC’s National Exam Program and Division of Trading and Markets provided substantial assistance with the case.

SEC CHARGES BROKERAGE FIRM WITH IMPROPER USE OF TRADER CONFIDENTIAL INFORMATION

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission charged a New York-based brokerage firm that operates a dark pool alternative trading system with improperly using subscribers’ confidential trading information in marketing its services.

Regulations require an alternative trading system (ATS) to establish and enforce safeguards and procedures to protect the confidential trading information of its subscribers.  Among them is limiting access to subscribers’ data to employees who operate the ATS or have a direct compliance role.

An SEC investigation found that Liquidnet Inc. violated its regulatory obligations and its own promises to its ATS subscribers during a nearly three-year period when it improperly allowed a business unit outside the dark pool operation to access the confidential trading data.  Employees in that unit used the confidential information about Liquidnet’s dark pool subscribers during marketing presentations and various communications to other customers.  Liquidnet also used subscribers’ confidential trading information in two ATS sales tools that it devised.

SEC examiners spotted potential data access problems during an examination of Liquidnet and referred the matter to the Enforcement Division for further investigation.  Liquidnet has agreed to settle the SEC’s charges and pay a $2 million penalty.

“Dark pool operators violate the law when they fail to protect the confidential trading information that their subscribers entrust to them, as Liquidnet did here when it used this confidential information to try to expand its business,” said Andrew J. Ceresney, director of the SEC Enforcement Division.  “We will continue to aggressively police broker-dealers who operate an ATS and fail to rigorously ensure the protection of confidential trading information.”

According to the SEC’s order instituting a settled administrative proceeding, Liquidnet’s core business is operating a block-trading dark pool for large institutional investors.  Liquidnet has represented to its dark pool subscribers that it would keep their trading information confidential and allow them to trade with maximum anonymity and minimum information leakage.  In an effort to find additional sources of liquidity for its dark pool, Liquidnet launched an Equity Capital Markets (ECM) desk in 2009 to offer block execution services to corporate issuers and control persons of corporate issuers as well as private equity and venture capital firms looking to execute large equity capital markets transactions with minimal market impact.

The SEC’s order finds that Liquidnet provided ECM employees with access to the confidential trading information of dark pool subscribers from 2009 to late 2011, and they used it to market ECM’s services.  For example, ECM employees would provide issuers with descriptions of ATS subscribers who had recently indicated interest in buying or selling shares of issuers’ stock.  These descriptions included the geographic locations, approximate assets under management, and investment styles of those dark pool subscribers.  ECM employees used dark pool subscribers’ trading data to advise issuers about which institutional investors they should meet during investor conferences or non-deal roadshows.  They also used dark pool subscriber data to advise ECM customers when they should execute transactions in the ATS given the liquidity the ECM employees could see in the dark pool.

“Liquidnet’s subscribers trusted and believed that the firm was safeguarding their confidential information,” said Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit.  “Instead, the firm breached its assurances of confidentiality and anonymity to them by allowing its ECM employees to improperly access subscriber trading data.”

According to the SEC’s order, Liquidnet also improperly used the confidential trading data of dark pool subscribers in two ATS sales tools.  Liquidnet created “ships passing” alerts that alerted ATS sales employees to missed execution opportunities between subscriber algorithmic orders and subscriber indications.  The firm also developed an application called Aqualytics, which identified subscribers to be contacted about Liquidnet’s recent dominance in certain stocks.

The SEC’s order charges Liquidnet with violating Section 17(a)(2) of the Securities Act of 1933, which prohibits obtaining money or property by means of materially false or misleading statements in the offer or sale of securities.  Liquidnet also violated Rule 301(b)(2) of Regulation ATS, which requires that an ATS file certain amendments on Form ATS with the SEC, as well as Rule 301(b)(10) of Regulation ATS, which requires an ATS to establish adequate safeguards and procedures for protecting confidential trading information of its subscribers.  Without admitting or denying the findings, Liquidnet consented to the SEC’s order, which censures the firm and requires it to pay the $2 million penalty and cease and desist from committing the violations.

The SEC’s investigation was conducted by Simona Suh, Stephen A. Larson, and Mandy B. Sturmfelz of the Market Abuse Unit and Thomas P. Smith Jr. and Jordan Baker of the New York Regional Office.  The case was supervised by Amelia A. Cottrell of the New York office.  The SEC examiners who conducted the examination of Liquidnet that led to the investigation were June Reinertsen, Maggie Simmermon, Ronald Sukhu, Ilan S. Felix, and Richard A. Heaphy of the New York office.  The SEC appreciates the cooperation of the Financial Industry Regulatory Authority.

TRADING SECURITIES IN THE "DARK POOL"

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Oct. 3, 2012 — The Securities and Exchange Commission today charged Boston-based dark pool operator eBX LLC with failing to protect the confidential trading information of its subscribers and failing to disclose to all subscribers that it allowed an outside firm to use their confidential trading information.

According to the SEC’s order instituting a settled administrative proceeding, eBX operates the alternative trading system LeveL ATS, which it calls a "dark pool" trading program. Dark pools do not display quotations to the public, meaning that investors who subscribe to a dark pool have access to potential trade opportunities that other investors using public markets do not. eBX inaccurately informed its subscribers that their flow of orders to buy or sell securities would be kept confidential and not shared outside of LeveL. eBX instead allowed an outside technology firm to use information about LeveL subscribers’ unexecuted orders for its own business purposes. The outside firm’s separate order routing business therefore received an information advantage over other LeveL subscribers because it was able to use its knowledge of their orders to make routing decisions for its own customers’ orders and increase its execution rate. eBX had insufficient safeguards and procedures to protect subscribers’ confidential trading information.

eBX agreed to pay an $800,000 penalty to settle the charges.

"Dark pools are dark for a reason: buyers and sellers expect confidentiality of their trading information," said Robert Khuzami, Director of the SEC’s Division of Enforcement. "Many eBX subscribers didn’t get the benefit of that bargain – they were unaware that another order routing system was given exclusive access to trading information that it used for its own benefit."

According to the SEC’s order, eBX and the outside firm it hired to run LeveL signed a subscription agreement in February 2008, after which the outside firm’s separate order routing business began to use certain LeveL subscribers’ confidential trading data. In November 2008, eBX signed a new agreement with the outside firm that allowed its order routing business to remember and use all LeveL subscribers’ unexecuted order information. As a result of the agreements, the outside firm’s order routing business began to fill far more of its orders than other LeveL users did. Its order router also knew how other eBX subscribers’ orders in LeveL were priced and could use that information to determine whether to route orders to LeveL or another venue based on where it knew it might get a better price for its own customers’ orders.

According to the SEC’s order, eBX failed to disclose in required SEC filings that it allowed LeveL subscribers’ unexecuted order information to be shared outside of LeveL.

In addition to the $800,000 penalty, eBX was censured and ordered to cease and desist from committing or causing further violations of certain provisions of the federal securities laws regulating alternative trading systems.

The SEC’s investigation was conducted by Mark Gera, James Goldman, Kathleen Shields, and Dawn Edick in the SEC’s Boston Regional Office. Mr. Gera led the related examination with assistance from Paul D’Amico and Rhonda Wilson under the supervision of Associate Regional Director Lucile Corkery.