by Securities and Exchange Commission
The Securities and Exchange Commission today announced charges against:
- a Los Angeles-based market access provider and two officials accused of violating the agency’s market access rule that requires firms to have adequate risk controls in place before providing customers with access to the market; and,
- a New York-based brokerage firm that operates a dark pool alternative trading system with improperly using subscribers’ confidential trading information in marketing its services.
New York-Based Dark Pool Operator Charged With Failing to Safeguard Confidential Trading Information
The Securities and Exchange Commission today charged a New York-based brokerage firm that operates a dark pool alternative trading system with improperly using subscribers’ confidential trading information in marketing its services.
Regulations require an alternative trading system (ATS) to establish and enforce safeguards and procedures to protect the confidential trading information of its subscribers. Among them is limiting access to subscribers’ data to employees who operate the ATS or have a direct compliance role.
An SEC investigation found that Liquidnet Inc. violated its regulatory obligations and its own promises to its ATS subscribers during a nearly three-year period when it improperly allowed a business unit outside the dark pool operation to access the confidential trading data. Employees in that unit used the confidential information about Liquidnet’s dark pool subscribers during marketing presentations and various communications to other customers. Liquidnet also used subscribers’ confidential trading information in two ATS sales tools that it devised.
SEC examiners spotted potential data access problems during an examination of Liquidnet and referred the matter to the Enforcement Division for further investigation. Liquidnet has agreed to settle the SEC’s charges and pay a $2 million penalty. Says Andrew J. Ceresney, director of the SEC Enforcement Division:
Dark pool operators violate the law when they fail to protect the confidential trading information that their subscribers entrust to them, as Liquidnet did here when it used this confidential information to try to expand its business. We will continue to aggressively police broker-dealers who operate an ATS and fail to rigorously ensure the protection of confidential trading information.
According to the SEC’s order instituting a settled administrative proceeding, Liquidnet’s core business is operating a block-trading dark pool for large institutional investors. Liquidnet has represented to its dark pool subscribers that it would keep their trading information confidential and allow them to trade with maximum anonymity and minimum information leakage. In an effort to find additional sources of liquidity for its dark pool, Liquidnet launched an Equity Capital Markets (ECM) desk in 2009 to offer block execution services to corporate issuers and control persons of corporate issuers as well as private equity and venture capital firms looking to execute large equity capital markets transactions with minimal market impact.
The SEC’s order finds that Liquidnet provided ECM employees with access to the confidential trading information of dark pool subscribers from 2009 to late 2011, and they used it to market ECM’s services. For example, ECM employees would provide issuers with descriptions of ATS subscribers who had recently indicated interest in buying or selling shares of issuers’ stock. These descriptions included the geographic locations, approximate assets under management, and investment styles of those dark pool subscribers. ECM employees used dark pool subscribers’ trading data to advise issuers about which institutional investors they should meet during investor conferences or non-deal roadshows. They also used dark pool subscriber data to advise ECM customers when they should execute transactions in the ATS given the liquidity the ECM employees could see in the dark pool. Says Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit:
Liquidnet’s subscribers trusted and believed that the firm was safeguarding their confidential information. Instead, the firm breached its assurances of confidentiality and anonymity to them by allowing its ECM employees to improperly access subscriber trading data.
According to the SEC’s order, Liquidnet also improperly used the confidential trading data of dark pool subscribers in two ATS sales tools. Liquidnet created “ships passing” alerts that alerted ATS sales employees to missed execution opportunities between subscriber algorithmic orders and subscriber indications. The firm also developed an application called Aqualytics, which identified subscribers to be contacted about Liquidnet’s recent dominance in certain stocks.
The SEC’s order charges Liquidnet with violating Section 17(a)(2) of the Securities Act of 1933, which prohibits obtaining money or property by means of materially false or misleading statements in the offer or sale of securities. Liquidnet also violated Rule 301(b)(2) of Regulation ATS, which requires that an ATS file certain amendments on Form ATS with the SEC, as well as Rule 301(b)(10) of Regulation ATS, which requires an ATS to establish adequate safeguards and procedures for protecting confidential trading information of its subscribers. Without admitting or denying the findings, Liquidnet consented to the SEC’s order, which censures the firm and requires it to pay the $2 million penalty and cease and desist from committing the violations.
The SEC’s investigation was conducted by Simona Suh, Stephen A. Larson, and Mandy B. Sturmfelz of the Market Abuse Unit and Thomas P. Smith Jr. and Jordan Baker of the New York Regional Office. The case was supervised by Amelia A. Cottrell of the New York office. The SEC examiners who conducted the examination of Liquidnet that led to the investigation were June Reinertsen, Maggie Simmermon, Ronald Sukhu, Ilan S. Felix, and Richard A. Heaphy of the New York office. The SEC appreciates the cooperation of the Financial Industry Regulatory Authority.
Wedbush Securities and Two Officials Charged for Market Access Violations
The SEC’s Enforcement Division alleges that Wedbush Securities Inc., which has consistently ranked as one of the five largest firms by trading volume on NASDAQ, failed to maintain direct and exclusive control over settings in trading platforms used by its customers to send orders to the markets. Wedbush did not have the required pre-trade controls, failed to restrict trading access to people whom the firm preapproved and authorized, and did not conduct an adequate annual review of its market access risk management controls. The Enforcement Division alleges that the firm’s violations of the market access rule were caused by Jeffrey Bell, the former executive vice president in charge of Wedbush’s market access business, and Christina Fillhart, a senior vice president in the market access division. Says Andrew J. Ceresney, director of the SEC Enforcement Division:
Wedbush provided market access to overseas traders without preapproval and without ensuring that they complied with U.S. law. We will hold Wedbush accountable for reaping substantial profits while failing to protect U.S. markets from the risks posed by these traders.
Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit, added:
The market access rule was adopted out of concerns that some broker-dealers did not have effective controls in place for their market access. This enforcement action against Wedbush is a cornerstone of our ongoing efforts to hold accountable any broker-dealers who fail to effectively implement market access controls and procedures.
According to the SEC’s order instituting administrative proceedings, the violations began in July 2011 and continued into 2013. Wedbush allowed the majority of its market access customers to send orders directly to U.S. trading venues by using trading platforms over which Wedbush did not have direct and exclusive control. Bell was aware of the requirements of the market access rule and should have known that the firm’s risk management controls and supervisory procedures related to market access did not comply with the market access rule. Fillhart also had responsibility for overseeing Wedbush’s market access business and received inquiries by exchanges about potential violations by Wedbush and its customers. Despite these red flags, Fillhart did not take adequate steps to prompt the firm to adopt reasonably designed risk management controls.
According to the SEC’s order, in addition to violating the market access rule (Securities Exchange Act Rule 15c3-5), Wedbush violated other regulatory requirements as a result of trading by its market access customers. These violations include Rule 203(b)(1) of Regulation SHO relating to short sales, Rule 611(c) of Regulation NMS related to intermarket sweep orders, Rule 17a-8 concerning anti-money laundering requirements, and Rule 17a-4(b)(4) concerning the preservation of records.
The proceeding before an administrative law judge will determine whether Wedbush willfully violated these provisions of the federal securities laws, and whether Bell and Fillhart were causes of the firm’s violations of the market access rule. The judge also will decide what sanctions, if any, are appropriate.
The SEC’s investigation was conducted by Steven Buchholz of the Market Abuse Unit and San Francisco Regional Office as well as Jina Choi, who formerly worked in the Market Abuse Unit and is now director of the San Francisco office. The case was supervised by Mr. Hawke and Robert Cohen, co-deputy chief of the Market Abuse Unit. The Enforcement Division’s litigation will be led by Lloyd Farnham and John Yun of the San Francisco office. The SEC appreciates the assistance of the Financial Industry Regulatory Authority.