Outlook 2016: A Fine Dark Pool Mess

After regulators dropped hints in 2014 that dark pools were going to be under greater scrutiny, the hammer finally came down.

After regulators dropped hints in 2014 that dark pools were going to be under greater scrutiny, the hammer finally came down. Last summer saw a wave of record fines for duplicitous or outright illegal activity that took place in leading unlit trading venues. And the fines had so many zeroes that one could be excused for thinking that the numbers came from the budget of a Hollywood feature film.

Most recently, Barclays andCredit Suisse agreed to settle allegations by New Yorks top cop and the U.S. Securities and Exchange Commission that they misled investors on how they managed their private trading platforms.

Barclays will pay $70 million, split evenly between the two enforcers,the largest fine levied on adark pooloperator, the SEC said Sunday in a statement. Credit Suisse will pay $84.3 million, according to the statement. That payment includes $24.3 million to the SEC for disgorgement and interest, with the remainder shared evenly between the two authorities.

Ouch!

This comes in the wake of earlier settlements. Last July, dark pool operator ITG paid a then-record $20.3 million fine for the role its subsidiary played in running a secret trading desk to trade against its dark pool clients. Code-named Project Omega, like the title of one of your father-in-laws airport novels, this prop trading desk made trades based on confidential client information. The ITG imbroglio led to the exit of CEO Rob Gasser and general counsel Mats Goebels, and the hiring of Frank Troise from JPMorgan Chase for the CEO role.

The ITG fine was a record for dark pools-but for only a few weeks. Late last summer, news broke that Credit Suisse was poised to pay a whopping $85 million for dark pool wrongdoing. The figure was split, with $35 million going to the New York Attorney Generals office and the remaining $50 million in fines and returned funds to the SEC. The Swiss investment bank was charged with failing to disclose how it operates its Crossfinder platform.

A third potentially massive dark pool fine-one that was estimated at $80 million in some news reports-was avoided when a New York district judge dismissed lawsuits against Barclays Capital. New York Attorney General Eric Schneiderman charged the British bank with engaging in a persistent pattern of fraud and deceit when it assured clients that their trades would be protected from predatory high-frequency traders.

The judge in the BarCap case even cited Michael Lewis, the author of the anti-HFT blockbuster Flash Boys, stating that the best-seller may well highlight inequalities in the structure of the nations financial system and the desirability for, or necessity of, reform. For the most part, however, those questions are not for the courts, but for commentators, private and semi-public entities (including the stock exchanges), and the political branches of government.

This recent and startling wave of dark pool fines is not new-Liquidnet Holdings paid $2 million in 2014 for failing to protect client secrecy and Pipeline Trading Systems paid $1 million for its proprietary trading unit dealing against client orders in 2011. And the scrutiny doesnt appear to be easing up anytime soon. At a November SEC meeting, SEC Chairwoman Mary Jo White said, It can be almost impossible for an investor to assess adequately the conflicts of interest that can arise for a broker-dealer operating a dark pool.

At the same meeting, SEC officials voted for greater oversight of dark pools and the role HFTs play in these unlit venues. Many of the disclosures that todays proposal would require should reveal the very types of conflicts of interest that lay at the heart of the enforcement actions brought against dark pools, said an SEC commissioner. The new dark pool/HFT proposal was approved in a 4-0 vote.

Dark pools, you have been warned.