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Barclays Disputes NY Attorney General's Dark Pool Allegations

Asking a court to dismiss the NYAG's lawsuit, Barclays contends that highly sophisticated traders were not misled about high-frequency traders in its dark pool.

Barclays has filed a motion to dismiss the lawsuit filed by the New York State Attorney General last month accusing the firm of misleading institutional clients about the extent of high-frequency traders (HFTs) participating in its LX dark pool.

Barclays is asking a court to throw out the case on the grounds that its clients -- sophisticated traders and asset managers -- would not rely on “glossy marketing brochures or quotes from magazine articles the NYAG cites.”

However, the complaint filed by New York State Attorney General Eric T. Schneiderman on June 25 alleges that Barclays falsely advertised efforts to protect clients from predators through a liquidity profiling surveillance system, when, in reality, Barclays didn’t exclude any traders from the dark pool, and clients were trading against predators.

The lawsuit has hurt Barclay's trading business. Several large brokerage firms have reportedly stopped routing orders to Barclays LX. The private trading venue's volume dropped 79% in the week-and-a-half after the lawsuit was filed, according to a Reuters report citing data from the Financial Industry Regulatory Authority (FINRA). For the week of June 30, LX was the 12th largest dark pool, a steep drop from its second place ranking two weeks earlier, before the suit was filed.

Barclays: Complaint ignores highly sophisticated traders
Fighting the accusations, Barclays filed a 49-page motion in the New York State Supreme Court yesterday. “Fundamentally the compliant fails to identify any fraud -- establishing no material misstatements, no identified victims and no actual harm,” states Barclays in its motion. Barclays asserts that the compliant ignores that LX’s customers are highly sophisticated traders and asset managers responsible for investing millions or billions of assets, who execute trades across multiple markets and ATSs. It claims that such clients are capable of monitoring the quality of transactions based on extensive data and would not rely on marketing materials.

Barclays also asserts that the compliance is based on "clear and substantial factorial errors," which it will demonstrate if the litigation proceeds to the next stages.

Moreover, Barclays questions whether the NYAG’s authority extends to trading platforms through use of the Martin Act. Barclay points out that the Martin Act is limited to actions for fraud in the purchase or sale of “securities” and that an ATS is not a security.

The bank asserts that the Securities and Exchange Commission is responsible for regulating ATSs, and the NY AG is attempting to expand the Martin Act to cover ATSs, which threatens conflict between the Martin Act and the Securities Exchange Act of 1934.

Contending a conflict with federal laws, Barclays argues in its motion that Schneiderman’s suit has the potential to increase regulation on ATSs, which account for an estimated 40% of trading volume in the US and are “an important area of the economy.”

Barclays faults the NYAG’s compliant for not stipulating which highly sophisticated clients saw the alleged misstatements and whether the marketing materials were harmful to them. It notes that it uses statements from unidentified former Barclays customers and that the courts would be wary of anonymous, self-interested parties.

The complaint accuses Barclays of deceiving clients about the number of HFTs participating in the LX dark pool and even removing the name of a large HFT firm from a presentation.

But Barclays contends the marketing materials the NYAG relied upon “made clear that HFTs were a substantial part of LX traders and that it transparently marketed LX as a platform on which clients could benefit from the liquidity provided by HFTs while having the option of reducing exposure to aggressive order flow.”

Barclays points out that a chart in a marketing flyer, attacked by the NYAG for misrepresenting the number of HFTs in the pool, was clearly labeled “Sample,” and never said it depicted actual data for any particular client populations or time frame.

Despite the allegations from the NYAG’s complaint, Barclays claims it provided accurate and complete information about LX to tis clients. The bank says its marketing flyer states that 35% of LX traders were electronic liquidity providers (ELPs), a category including HFTs, and that 9% of LX trading volume was aggressive. But the NYAG's complaint mentions that buy-side clients were told that 6% of order flow was aggressive, while one HFT client was told that 25% comprised HFTs. 

What does policing a dark pool mean?
While the NYAG’s complaint criticizes Barclay’s for removing the name of Tradebot Systems, a key ELP associated with aggressive trading, from the chart, Barclays says it was appropriate to remove Tradebot's order flow “because the point of the chart was to show Barclay’s capability to monitor individual participants in the pool, not to show what’s in the pool.”

Responding to the allegation that Barclays didn’t police or punish bad trading behavior or prohibit any trading firm from participating in LX, the firm cites the definition of the Webster’s Third New Dictionary of the English language that  “police” means “to supervise the operation, execution, or administration of” something. Barclays said it never promised that it would bar traders from LX, and, although it didn’t expel traders, Barclays says that doesn’t mean it didn’t police the pool.

“The fact that Barclays did not entirely expel a firm from trading in its pool does not render statements that it would police the pool false,” claims Barclays.

However, according to the complaint, Barclays did not regularly update the ratings of high-frequency trading firms monitored by Liquidity Profiling. In response, Barclays says when clients came onboard it segmented order flow into categories, such as broker dealer, institutional, and ELP. Then it conducted periodic reviews, but it was not necessary to conduct more frequent reviews since clients’ trading behavior didn’t necessarily change that often. Market materials also mentioned that “robust visualization tools” were used to graph large amounts of trading data, so it was doing continuous monitoring.

But the AG’s complaint contends that Barclay’s overrode the ratings to make the order flow seem more passive than it was, alleging that Barclays even changed the rating of one of its internal trading desks that engaged in HFT to "passive." However, Barclays says the point of liquidity profiling was to move beyond simple segmentation of traders into HFT and non-HFT because not all clients of a particular type -- brokers, institutions, ELPs -- trade the same.

The bank claims the fact that one of Barclays’ trading desks engaged in high-frequency trading does not mean that the flow was not passive.

In response to Barclay’s motion to dismiss the lawsuit, the New York State Attorney General’s office issued the following statement:

The complaint filed last month by Attorney General Schneiderman clearly details the allegations that Barclays engaged in a persistent pattern of fraud and deceit, lying to its investors in order to grow its own dark pool. The Attorney General is committed to ensuring there is one set of rules for everyone in the markets, and will crack down on abuses wherever he sees them. We are confident that a judge will reject this motion and allow us to prove these disturbing allegations in Court.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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