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Ivy Schmerken
Ivy Schmerken
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Another Dark Pool Scandal Erupts Over Information Sharing

The SEC's settlement with dark pool operator eBX over charges that Level ATS shared confidential client information with a third-party technology provider, raises trust issues for money managers.

Dark pools seem to be getting greyer and shadier by the minute judging from the latest scandal to rock this cottage industry.

Yesterday's news that the SEC charged Boston-based dark pool operator eBX LLC with failing to protect the confidential trading information of subscribers to the LeveL alternative trading system, is a concern for investment managers that think they are trading where no one can see their orders. Its also a warning that money managers should request information about third-party relationships that dark pools have with technology firms.

eBX, which operated LeveL ATS, was reportedly sharing information with a third party technology provider for use in its separate order routing business.

This alleged misbehavior should rifle money managers, mutual funds and hedge funds that entrust their orders to so-called anonymous trading entities.

There are 100 broker dealers who send orders into Level ATS on behalf of their institutional customers, reported the Wall Street Journal yesterday.

eBX allowed a third-party technology firm, which turns out to be Lava Trading, to use details on client orders, including the stocks involved and whether they were buy or sell orders, to its own advantage. Lava is the electronic trading unit of Citigroup, and is known for its order routing technology.

What is kept in the dark is the number of relationships that dark pools have with third-party technology providers and underlying ownership stakes.

eBX is partly owned by a consortium of Wall Street firms including Credit Suisse, Fidelity Investments, Bank of America Merrill Lynch, and the estate of Lehman Brothers Holdings. Lava and Citigroup were not accused of wrongdoing, reported the WSJ.

That improper advantage, the SEC said, came from detailed information about unexecuted orders within LeveL's dark pool. Knowing what buy or sell orders remained unexecuted within the trading venue helped inform Lava Trading's decisions on where to route its own customers' orders.

In a statement, LeveL's chief executive, Whit Conary, said Citigroup's Lava Trading had access to LeveL customers' information "solely to make routing decisions," and "at no time was customer information displayed to any customer placing orders or making trading decisions."

What is puzzling to me is why the owners of eBX didn't' scrutinize the information sharing policies of LeveL ATS? These firms are highly regulated by the SEC and FINRA and countless other bodies and many of them operate their own dark pools.

This latest dark-pool scandal sounds similar to the transgressions of Pipeline Trading Systems, which paid a $1 million fine in October of 2011 to the SEC for allowing an automated proprietary trading affiliate, Milstream, match against the vast majority of its customer orders. However, in this case, Lava, a third-party technology firm, was not trading on the information; it was using the confidential information to improve the decisions of its smart order router for other customers.

Dark pools are supposed to protect the confidentiality of their client's trading information and not share the orders with outside entities. Why else would they exist?

Nevertheless, it's nearly one year since the Pipeline scandal erupted and now we have another one.

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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