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New York Attorney General Sues Dark Pool

The New York Attorney general has alleged that Barclays LX, a dark pool operated by Barclays Capital, falsely told institutional investors that it had systems in place to protect their trades and trading information from predatory high frequency traders, when in fact the dark pool was operated in a manner to favor the predatory traders.  The allegations are supported by emails from Barclays employees as well as information from former high-level Barclays insiders.

From 2011 to the present, Barclays marketed its dark pool to institutional investors in part by offering a service called “Liquidity Profiling,” which it described as a “sophisticated surveillance framework, helping to protect you from predatory trading.”  Barclays represented that it would “police trading behavior” in order to “restrict HFTs interacting with our clients.”  According to the allegations, these and other marketing claims relevant to the high frequency trading occurring within the dark pool were false.  The suit alleges that Barclays intentionally misrepresented the amount of predatory high frequency trading occurring within the pool, and did not in fact “police” or otherwise deter high frequency traders from interacting with institutional investors.  The complaint quotes an internal analysis describing major high frequency trading firms’ activity in the dark pool, describing it as “toxic.”

Rather than protecting clients from aggressive high frequency trading activity, the complaint alleges that Barclays instead encouraged such traders to participate in its dark pool by, among other actions, charging these firms “virtually nothing” to execute trades.  The complaint also alleges that Barclay shared “detailed, sensitive information” with major high-frequency firms in order to encourage them to increase their activity in the dark pool.  This data, the complaint alleges, helped the firms maximize the effectiveness of their aggressive trading strategies in the dark pool.  

Another portion of the complaint deals with so-called “latency arbitrage.”  Latency arbitrage refers to a strategy where high frequency traders are able to detect the presence of large pending orders, usually from institutional investors, and then trade ahead of an anticipated stock purchase or otherwise impact the price.  These strategies exploit the small, temporary pricing dislocations in a security that occur because of differential and/or delayed access to market data.  The complaint alleges that contrary to its advertised ultra-fast “direct data feeds” intended to deter latency arbitrage trading, in fact Barclays “processed that market data so slowly as to allow latency arbitrage.”  According to the complaint, Barclays’ internal analyses confirmed that slow processing of market data allowed high frequency traders to engage in predatory activity.

The text of the complaint can be found here.