Nearly two years after it was fined £290 million by Britain’s market regulator for manipulating the benchmark lending rate LIBOR, Barclays finds itself in the midst of another firestorm.
The New York State Attorney General has slapped a lawsuit seeking unspecified monetary damages and injunctive relief against the bank over “fraud and deceit” in its US-based dark pool, LX Liquidity Cross. Dark pools are anonymous, off-exchange venues used to buy and sell large blocks of shares.
The lawsuit covers the period since 2011. Attorney General Eric Schneiderman alleges that the bank had provided misleading information to clients and investors about the benefits of joining its dark pool. This included false information about safeguards to protect them from “aggressive” ‘high-frequency’ traders, who use super-fast computers to execute trades in milliseconds and take advantage of small changes in share prices.
This included failing to stop traders identified as predatory from participating in the pool, not updating the ratings of high-frequency trading firms, and overriding the surveillance ratings so that some traders who would have been identified as predatory were deemed “safe.” The Attorney General’s office also alleges the bank failed to make clients and investors aware of the sheer concentration of high-frequency trading in the dark pool, including failing to include the name of the dark pool’s largest participant, a high-frequency trading firm, in its marketing material.
Further, he alleges, Barclays did not make it clear that it routed a disproportionately high level of client orders to its own pool, and in one instance, when an analysis of its routing practices was conducted, senior executives asked for falsified information to be included in a presentation to a client in order to hide that bias.
“Barclays grew its dark pool by telling investors they were diving into safe waters,” said Schneiderman. “The facts alleged in our complaint show that Barclays demonstrated a disturbing disregard for its investors in a systematic pattern of fraud and deceit.” Barclays’ actions helped propel it from being barely in the top 10 US dark pools to one of its largest (according to Barclays’ own figures it was the largest, followed by UBS and Knight Link).
Whistleblowers The Attorney General praised former Barclays employees who had had the “courage” to report the wrongdoing and had provided his investigation with “meaningful information and testimony”.
Shares in Barclays dived following the announcement and were down 5.4 per cent in mid-afternoon trading in London. Barclays issued a brief statement acknowledging the suit, saying it had accorded it “top priority”. “We take these allegations very seriously. Barclays has been cooperating with the New York Attorney General and the SEC and has been examining this matter internally.”
What are high-frequency trades?
High-frequency trades are those that are executed with sophisticated programming to buy and sell stocks in millisecond intervals, taking advantage of small adjustments in share prices.
High-frequency trades form an increasingly large share of trading activity, particularly in the US (as much as 50 per cent, according to some reports).
In some cases they use a “latency arbitrage” to identify trading orders being put in by others on lower-speed technology, and then, exploiting their time advantage, buy and sell that stock back to the buyer at a marginally higher price.
High-frequency traders came into the spotlight recently in Michael Lewis’ latest book, Flash Boys .
What are dark pools?
Dark pools are off-exchange trading venues, typically run by investment banks, that provide an anonymous way to buy and sell large blocks of shares. The New York Attorney General’s Office estimates that over 40 per cent of US equity trades happen on such fora.
Because of the anonymous nature of the trading, they have been particularly attractive for high-speed traders, particularly of the “predatory” kind described in the NY State lawsuit.
So why use them? They allow buyers and sellers to move large blocks of shares without disturbing the larger market, and can be extremely liquid, cheap, fast and discreet.