How Barclays Got Caught Red-Handed With "Pernicious HFT Fraud"

Tyler Durden's picture

First it was gold, now it is HFT - poor Barclays just can't get away with any market rigging crime these days.

Remember when in the aftermath of the most recent Michael Lewis-inspired HFT scandal, one after another HFT and Dark Pool exchange swore up and down they know, see, hear and certainly trade no predatory algo evil? Turns out they lied, as usual.

As was reported earlier, the NY AG just charged Barclays with fraud (or rather, as Schneiderman called it repeatedly "pernicious fraud") for not only misrepresenting the nature of its dark pool to clients, but also exposing them to numerous "toxic" and predatory HFT algos - another word for algos which frontran orderflow either within the Barclays dark pool, Barclays LX - arguably the second largest venue in the US second only to Credit Suisse' Crossfinder - or on different lit and unlit venues as soon as they had seen the flow as indicated by Barclays.

As Bloomberg explains, "Barclays Plc was so bent on lifting its private trading venue to the upper ranks of Wall Street dark pools that it lied to customers and masked the role of high-frequency traders, according to New York’s attorney general."

Barclays falsified marketing materials to hide how much high-frequency traders were buying and selling, according to a complaint filed today by Eric Schneiderman. Barclays runs one of Wall Street’s largest dark pools, a private trading venue where investors can trade stocks mostly anonymously. Mark Lane, a spokesman for London-based Barclays, declined to comment.

Here Bloomberg goes so far as to give "critics" like us credit for something we have said since 2009:

Schneiderman’s action will fortify a suspicion common among critics of dark pools and high-frequency firms, which have proliferated in the past decade with advances in computer power and efforts to spur competition among U.S. trading venues. Namely, that in the rush to attract traders to their markets and boost profits, the venues have catered to computerized market makers to the detriment of individuals.

Actually, replace "fortify" with "confirm." Because what the Scheinderman action proves without doubt is that in order to generate ever-bigger trading revenue profits and to pull as much activity from lit exchanges, big banks and all other exchanges for that matter, would gladly sell order flow of traditional clients to HFTs in order to allow frontrunning of their orders. In exchange for this Barclays et al (yes, every other dark pool out there does the same) would be compensated handsomely from the same HFTs that make money without taking any risk, as all they do is simply frontrun legitimate orders.

Additionally, while comic, the recent spate of activity to tame HFTs appears to be solely the result of Michael Lewis' book... even though sites such as this one had described precisely what happens with HFT on both lit and unlit venues as early as 2009. Oh well, "whatever it takes."

Michael Lewis’s “Flash Boys,” released in March, said bank-owned dark pools serve as a key intersection between high-frequency traders and brokers’ investor clients. The banks, Lewis wrote, charge high-frequency traders for the right to trade against orders placed by their brokerage customers.

 

“Why would anyone pay for access to the customers’ orders inside a Wall Street bank’s dark pool?” Lewis wrote. “The straight answer was that a customer’s stock market order, inside a dark pool, was fat and juicy prey.”

But, wait, they swore that the only "provide liquidity." Oh, and they also lie constantly and also just happen to engage in criminal activity now and then. Btw, how is that Virtu IPO going? Because as everyone knows there is always only one cockroach, and today Barclays picked the short straw.

What is perhaps most interesting about the Barclays case is that the AG appears to have gotten assistance from some high level executives at Barclays itself.

Schneiderman paints a picture of “fraud and deceit” at Barclays perpetrated by unidentified executives who lied to customers about the role played by high-frequency traders in its market as part of an effort to increase its size. Some former “high-level” Barclays insiders helped frame the case, according to the complaint.

Well, clearly it was former, because if they were employed by the criminal bank before today's blockbuster lawsuit they certainly aren't any more.

* * *

Here are some of the choice quotes from the NY AG lawsuit vs Barclays, and with at least 24 instances of the word "toxic" in the lawsuit, one can be sure there are many more good selections that we just wont have the space to fit:

Barclays allows high frequency traders to “cross-connect” to its servers. As of the filing of this Complaint, several dozen of the most well-known and sophisticated high frequency trading firms in the world are cross-connected with Barclays, allowing them to take advantage of Barclays’ non-high frequency trading clients, by getting a speed advantage over those slower-moving counterparties.

* * *

While Barclays represented that it used ultra-fast “direct data feeds” to process market price and trade data in order to deter latency arbitrage by high frequency traders in its dark pool, Barclays in fact processed that market data so slowly as to allow latency arbitrage. Internal analyses confirmed that Barclays’ slow processing of market data allowed high frequency traders to engage in such predatory activity.

* * *

According to a former senior Director in that division, “[a]t every sales meeting or product meeting, the main goal they were talking about was to grow the size of [Barclays’ dark pool] to become the largest pool. All the product team’s goals, which would also include their compensation[,] were tied to making the pool bigger. [Barclays had] great incentive at all costs to make the pool bigger.

To grow its dark pool, Barclays had to increase the number of orders that Barclays, acting as a broker, executed in the dark pool. This required Barclays to send more of its clients’ orders into the dark pool, and to make sure that there was sufficient liquidity in the dark pool to fill those orders. Barclays looked to attract high frequency traders to its dark pool to meet this need.

To grow its dark pool, Barclays had to increase the number of orders that Barclays, acting as a broker, executed in the dark pool. This required Barclays to send more of its clients’ orders into the dark pool, and to make sure that there was sufficient liquidity in the dark pool to fill those orders. Barclays looked to attract high frequency traders to its dark pool to meet this need.

In written marketing materials, statements to the media, and in sales meetings with clients, potential clients, and other market participants (hereinafter, “clients”), Barclays represented that it provides a safe, transparent trading environment, and helps to protect its clients from the risks of aggressive high frequency traders.

* * *

Far from being transparent regarding trading activity in its dark pool, Barclays made material misrepresentations regarding the extent of aggressive or predatory high frequency trading activity in the pool, and the level of protection Barclays provided from such activity.

Barclays Falsified an Analysis Purporting to Show the Extent of High Frequency Trading in its Dark Pool

Barclays’ sales staff heavily promoted this analysis to investors as a representation of the trading within the dark pool, and marketed that analysis as “a snapshot of the  participants” in order to show clients “an accurate view of our pool.” In addition, certain Barclays marketing materials appended a notation to the chart explaining that it  portrays the top 100 clients trading in the dark pool.

These representations were false. The chart and accompanying statements misrepresented the trading taking place in Barclays’ dark pool. That is because senior Barclays personnel de-emphasized the presence of high frequency traders in the pool, and removed from the analysis one of the largest and most toxic participants in Barclays’ dark pool.

* * *

On October 5, 2012, a draft version of the analysis was circulated by email to senior executives in Barclays’ Equities Electronic Trading division. The accompanying email noted that Barclays “de-emphasized the number of ELPs [electronic liquidity providers, or high frequency traders] by moving them to the back.” The email also stated that the chart “remov[es] Tradebot.” Tradebot Systems had historically been, and was at that time, the largest participant in Barclays’ dark pool, with an established history of trading activity that was known to Barclays as “toxic.” Those alterations had the effect of obscuring the amount of high frequency trading activity in the dark pool by disguising the total number of high frequency trading firms, and deleting one significant firm altogether. In a response email, one employee objected to the  modified chart, stating that removing Tradebot from the analysis was a falsification of the data.

* * *

A Vice President responsible for selling the dark pool to clients disputed that explanation, replying to the group that “[m]y point when selling that picture was always: ‘here is a snapshot of the participants in [Barclays’ dark pool] as an accurate view of our pool.’ I was never using it like an ‘illustration’” of Barclays capability to monitor the pool. “I had always liked the idea that we were being transparent, but happy to take liberties if we can all agree” (emphasis added).

Barclays’ Head of Product Development (who was also the second in command within Barclays’ Equities Electronic Trading division) agreed. He responded, “I think the accuracy [of the chart] is secondary to [the] objective” of showing clients that Barclays monitors the trading in its dark pool, and “so if you want to move/kill certain bubbles, it doesn’t really matter.”

Barclays’ Head of Equities Sales responded, “Yes! U smart.”

* * *

The analysis also determined that the trading venues to which Barclays routed unfilled orders (after first having routed them to its own dark pool) tended to be venues hosted by high-speed trading firms, “[n]one of which,” recalled one Director, “had a reputation for being favorable to clients from an execution perspective.” Those venues included Knight Capital, Getco, and Citadel.

* * *

Another Director was then instructed to change crucial figures in the PowerPoint presentation, in order to make them more favorable to Barclays. Specifically, that Director was instructed to change Barclays’ internalization rate for all orders routed to dark venues from 75%, as noted above, to 35% – a number far less damning to Barclays and which would have the effect of making the Institutional Investor’s 88% internalization rate look like an outlier. As described by this former Director, this was an “intent [by Barclays] to shift blame to the client . . . This 35 percent is not true and not validated by anything.” Despite this Directors’ protestations, the analysis was altered, and the PowerPoint was presented to the Institutional Investor. Shortly after this incident, this Director resigned from Barclays.

* * *

On numerous occasions since 2011, Barclays disclosed detailed, sensitive information to major high frequency trading firms in order to encourage those firms to increase their activity in Barclays’ dark pool. That information, which was not generally supplied to other clients, included data that helped those firms maximize the effectiveness of their aggressive trading strategies in the dark pool. The information included:

  • The routing logic of Barclays’ order router, including the percentage of Barclays’ internal order flow that was first directed into its own dark pool;
  • A breakdown of trades executed in the dark pool by participant type (e.g., percentage of orders from institutional investors, high frequency traders, etc.); and
  • A breakdown of trades executed in the dark pool by “toxicity” level (see Section III (C), above, for discussion of Liquidity Profiling “toxicity” levels

Barclays shared this information in order to attract high frequency trading activity to its dark pool. For instance, in 2013, Barclays was approached by a prominent high  frequency trading firm seeking information similar to that set forth above. This firm informed Barclays that “we have our largest trading team . . . looking to get into the dark pool space,” and “are try[ing] to get more teams connected to your dark pool.” Barclays readily provided the requested information, despite the fact that this information was not generally provided to other clients.

* * *

As described by one former senior-level Director within the Equities Electronics Trading division, “Barclays was doing deals left and right with high frequency firms to invite them into the pool to be trading partners for the buy side. So the pool is mainly made up of high frequency firms.” “[T]he way the deal would work is [Barclays] would invite the high frequency firms in. They would trade with the buy side. The buy side would pay the commissions. The high frequency firms would pay basically nothing. They would make their money off of manipulating the price. Barclays would make their money off the buy side. And the buy side would totally be taken advantage of because they got stuck with the bad trade . . . this happened over and over again.”

* * *

In sum, Barclays’ courting of high frequency traders, and its willingness to falsify the extent of high frequency trading activity in its dark pool, was contrary to Barclays’ representations to clients that Barclays operated with “transparency” and provided a safe venue in which to trade. As described by one former senior Barclays Director:  “there was a lot going on in the dark pool that was not in the best interests of clients. The practice of almost ensuring that every counterparty would be a high frequency firm, it seems to me that that wouldn’t be in the best interest of their clients . . . It’s almost like they are building a car and saying it has an airbag and there is no airbag or brakes.”

* * *

In conclusion, Barclays response to all of the above, from its spokesman, "Integrity of the markets is a top priority of Barclays."

Clearly: after all why else would MarketsMedia award Barclays its "Best Dark Pool: Barclays LX" prize. Oh wait, more circular payment kickbacks. Never mind.

Source: The People of the State of NY against Barclays Capital