The U.S. Securities and Exchange Commission has settled a case against a U.S. dark pool, alleging that it failed to disclose to customers that the vast majority of its orders were being filled by an affiliate of the firm.
The said Monday that Pipeline Trading Systems LLC has settled with the regulator, without admitting or denying the findings of an SEC administrative order, and agreed to pay a US$1 million penalty. Pipeline’s founder and chief executive officer, Fred Federspiel, and its chairman and former chief executive, Alfred Berkeley III, each agreed to pay US$100,000. They also did not admit to or deny the SEC’s findings.
The SEC said that New York-based Pipeline, which was launched in 2004 as a registered alternative trading system, described its trading platform as a ‘crossing network’ that matched customer orders with those from other customers, providing ‘natural liquidity’. However, it says that Pipeline’s claims were false and misleading because its parent company owned a trading entity that filled the vast majority of customer orders on Pipeline’s system, the SEC found.
It said the affiliate, most recently known as Milstream Strategy Group LLC, sought to predict the trading intentions of Pipeline’s customers and trade elsewhere in the same direction as customers before filling their orders on Pipeline’s platform. The SEC’s order found that Pipeline generally did not provide the ‘natural liquidity’ it advertised.
The SEC also said that Pipeline took steps to address the conflict of interest it created, including paying the affiliate’s traders using a formula that rewarded them, in part, for giving favourable prices to Pipeline’s customers. The SEC’s order found that Pipeline failed to disclose the compensation formula, or Milstream’s activities, to its customers or in its filings to the SEC.
The SEC’s order also found that, although Pipeline represented that all users were treated the same, it provided Milstream with certain advantages over other users, including special access to certain information about the operations of the dark pool and to data connections that made it easier for Milstream to track history and activity in the dark pool. It also found that Pipeline failed adequately to protect customers’ confidential trading information, allowing access to it by the research director at Pipeline’s parent company, who acted as the manager for the affiliated trading entity from 2004 to 2006. The order does not allege that the research director sought to take advantage of the customer information.
“However orders are placed and executed, be it on an exchange floor or in an automated venue, whether dark or displayed, one principle remains fundamental – investors are entitled to accurate information as to how their trades are executed. Pipeline and its senior executives are being held to account because they misled their customers about how Pipeline’s dark pool really worked,” said Robert Khuzami, director of the SEC’s Enforcement Division.