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SEC and Liquidnet Settle Charges Regarding Confidentiality Breaches

On June 6, the SEC and Liquidnet agreed to settle charges that Liquidnet used confidential client information when marketing its services.  Liquidnet agreed to cease and desist from committing or causing violations of certain securities laws, was censured, and agreed to pay a civil penalty of $2,000,000.

Liquidnet operates a dark pool for large, institutional investors.  These investors chose to execute trades through its platform because it allowed “maximum anonymity and minimum information leakage.”  As part of its services, Liquidnet had access to its clients order management systems to match clients on both sides of a particular transaction.  When Liquidnet detects a match, the buyer and seller then anonymously negotiate the details of the transaction.  Liquidnet’s policies provide that only information necessary for the negotiation is revealed to the counterparty.

As a way to increase the liquidity available in the dark pool, Liquidnet established a small business unit called Equity Capital Markets (ECM) to attract corporate issuers and private equity and venture capital firms.  ECM employees had access to confidential trading information; and in some cases used this confidential data in their marketing efforts.  For example, marketing presentations included “descriptive characteristics of members that had recently indicated an interest in buying or selling the issuers’ stocks,” including information about “geographic locations, assets under management, and investment styles.”  Further, the employees would discuss recent trends in the issuers’ stocks with potential clients.  While Liquidnet had established general policies prohibited employees from using confidential information for anything other than performing required job duties, ECM employees never received guidance on how the confidentiality policy applied to their job duties.  ECM employees established information, unwritten guidelines on confidentiality that prevented them from sharing information about a client’s identity (or enough information that a third party could determine the client’s identity).  The SEC stated that the guidance “was premised on an unduly narrow view of Liquidnet’s confidentiality obligations, which required, more broadly, that Liquidnet protect its subscribers’ confidential trading information – and not solely the subscribers’ identity information.”

As a dark pool, federal securities laws required Liquidnet to “establish safeguards and procedures to protect subscribers’ confidential trading information and adopt and implement adequate oversight procedures to ensure that the safeguards and procedures for protecting subscribers’ confidential trading information are followed.”  Liquidnet’s own trading rules, incorporated into all subscription agreements, “assured members that the LIquidnet system would maintain ‘complete anonymity of every member and trader in the System during the entire lifecycle of an indication and order.’”  These trading rules did not indicate that the ECM employees had access to a client’s trading information or that such information was used to market to potential clients for the period at issue in the case.  As a result, Liquidnet violated various securities laws, including Section 17(a)(2) of the Securities Act and Rules 301(b)(2) and (10) of Regulation ATS.