The Securities and Exchange Commission has charged a Citigroup business unit operating an alternative trading system with failing to protect the confidential trading data of its subscribers. New York-based LavaFlow, owned by Citigroup Financial Products, agreed to pay $5 million to settle the SEC’s charges, including a $2.85 million penalty that is the agency’s largest to date against an ATS.
An ATS is a venue that executes stock trades on behalf of broker-dealers and other traders. LavaFlow operates a type of ATS known as an electronic communications network, which unlike a dark pool displays some information about pending orders in its system, such as best bid or best offer. Alternative trading systems currently execute approximately 12 percent of the U.S. equity trading volume; LavaFlow is estimated to be a top 10 ATS when measured by share or trade volume.
Under federal rules, an ATS must have safeguards to protect the confidential trading information of its subscribers. According to the SEC’s order instituting a settled administrative proceeding, LavaFlow allowed an affiliate operating a technology application known as a smart order router to access and use confidential information related to the non-displayed orders of LavaFlow’s ECN’s subscribers. The order router was located outside of the ECN’s operations and LavaFlow did not have adequate safeguards and procedures to protect the confidential information that the order router accessed. While LavaFlow only allowed the affiliate use of confidential trading data for customers who also were ECN subscribers, the firm did not obtain consent from them to use their confidential information in this way, nor did LavaFlow disclose the use in its regulatory filings with the SEC.
LavaFlow eventually discontinued this practice, but not before the smart order router executed more than 400 million shares in a three-year period based in part on the subscriber information contained in the ECN’s unexecuted hidden orders.
In addition to the Regulation ATS violations, the SEC’s order finds that LavaFlow aided and abetted a violation by the same affiliate that operated the smart order router, Lava Trading, which continued to provide broker-dealer services for several months after it deregistered in August 2008. Lava Trading, which also was owned by Citigroup Financial Products, earned approximately $1.8 million in broker-dealer business during this time period, and LavaFlow provided operational and administrative support while also responsible for a website that claimed Lava Trading was a registered broker-dealer.
The SEC’s order finds that LavaFlow violated Regulation ATS, which requires an ATS to establish safeguards and procedures for protecting confidential trading information of its subscribers. The order, to which LavaFlow consented without admitting or denying the findings, requires the firm to pay $1.8 million in disgorgement of money earned by Lava Trading while it was unregistered, plus $350,000 in prejudgment interest and a $2.85 million penalty.
No comments yet