Last year, first in the aftermath of NYAG's lawsuit against Barclays followed promptly by Michael Lewis' "Flash Boys" (which over a year later is still a better seller than "GS Elevator's" attempt to be this generation's Tucker Max) exposing High Frequency Trading for being nothing more than a sophisticated gimmick enabling market rigging and bulk order frontrunning while pretending to "provide liquidity", the revulsion against HFTs hit a fever pitch that forced Virtu to postpone its IPO.
Several months later, because the market kept going higher, people quickly forgot why they were angry at a bunch of vacuum tubes, and Virtu not only re-IPOed (adding another year without a single trading day loss to its roster) but it was taken public by that "humanitarian" protagonist of Flash Boys, Goldman Sachs itself (which was so aghast at the scourge that is HFT it almost, almost, ended its own dark pool and HFT ambitions... before it decided to double down on HFT).
However, since the market is once again on the verge of a terminal liquidity seizure with its associated side-effects (see China for details), the authorities needed to remind the "market" just who the scapegoat will be when the next crash finally does come. Which is why earlier today in an unexpected "preliminary second quarter guidance" release, ITG, owner of the Posit dark pool, was just busted with a $22.6 million potential SEC settlement for what appears to have been blatant frontrunning of company clients in its own prop trading pod.
From the release:
During the second quarter of 2015, ITG commenced settlement discussions with the Staff of the Division of Enforcement of the SEC (the “SEC Enforcement Division”) in connection with the SEC’s investigation into a proprietary trading pilot operated within ITG’s AlterNet Securities, Inc. (“AlterNet”) subsidiary for sixteen months in 2010 through mid-2011. The investigation is focused on customer disclosures, Form ATS regulatory filings and customer information controls relating to the pilot’s trading activity, which included (a) crossing against sell-side clients in POSIT and (b) violations of ITG policy and procedures by a former employee. These violations principally involved information breaches for a period of several months in 2010 regarding sell-side parent orders flowing into ITG’s algorithms and executions by all customers in non-POSIT markets that were not otherwise available to ITG clients.
This would not be the first time a dark pool was busted for admitting it abused fragmented markets to frontrun clients. As Bloomberg reminds us, last year, the agency fined Liquidnet Holdings Inc. $2 million for not living up to client secrecy standards. In 2011, Pipeline Trading Systems LLC agreed to pay $1 million, in part because it had a proprietary trading unit that was secretly trading against client orders. Then there was of course NY AG Schneiderman's lawsuit against Barclays alleging the UK bank which has been busted for manipulating pretty much everything under the sun at least once falsely claimed that it closely monitored and shut off certain types of traders.
Still, the $22 million proposed settlement would be a record for a private Wall Street trading platform, surpassing the $14.4 million that UBS Group AG agreed to pay in January. More importantly, as Bloomberg also observes, the latest lawsuit "shows the steps authorities are taking against alternative trading systems such as dark pools."
In other words, everyone now knows HFTs are fair game for rigging and manipulation, and with the banks having already been bled dry by over a quarter trillion in litigation charges, it is now the HFTs' turn to pay their kickbacks to the government for allowing them to frontrun sheep for 7 years since the advent of Reg NMS.
What is particularly amusing in this case is that while everyone knows that when it comes to HFT's, it is never called "rigging" - the proper nomenclature is "glitch", so now we learn a new term to use instead of "criminal frontrunning" - drumroll... trading experiment, or as it is known in legal parlance "proprietary trading pilot."
ITG disclosed the discussions and potential fine in a statement Wednesday, saying the situation concerned an experimental market-making unit that a subsidiary ran in 2010 and 2011. The division traded using information not available to other customers of ITG’s private stock-trading system, which is against Securities and Exchange Commission rules.
ITG Chief Executive Officer Bob Gasser said the firm shut the trading experiment and hasn’t run a similar one since.
So let's get this straight: ITG had an in house prop trading group, or "pilot", which operated for nearly two years, whose only signal was client order flow, which it would frontrun, and make millions in profits. In other words, once again precisely what we have claimed since 2009. But oh yes, not everyone is guilty of such manipulation. Only Liquidnet... and Pipeline... and ITG... and countless other ATS and HFT firms for whom clients are better known as either "easy money" or muppets.
And yes, we get the "trading experiment" narrative: calling it "criminal market manipulation and order frontrunning scheme" just does not sound like something the Modern Markets Initiative would spend millions of dollars to get Congressmen to agree on.
But where the ITG client frontrunning case goes truly surreal and takes the cake, is that in addition to the fine, it also announced that one of its directors, Kevin O'Hara resigned effective immediately. This is what he said:
This letter serves to inform you that, effective immediately, I resign from the Board of Directors (“Board”) of Investment Technology Group, Inc. (“ITG”), and the attendant Board committees of which I am a member: Compensation, Technology, and Capital.
It has been my pleasure and an honor to serve the shareholders, clients, and employees of ITG, and to work alongside fellow directors over the last number of years. And, those years have witnessed ITG weather the slings and arrows of existential challenges: the 2008-09 financial crisis (and, subsequent, “Great Recession”), industry hyper-competition, and a highly dynamic regulatory environment.
However, as you know, over the last several months, continuous fundamental, strategic and vital differences of opinion and direction have transpired at the Board level and, in particular, between me and the Board’s leadership. Although I believe in the importance of the governance concept of “loyal opposition,” alas, to everything there is a season. I do hope that my service in such role has, at the very least, furthered and continues to further the breadth of substantive deliberation and the process of decision-making by the Board.
I wish the very best for ITG and its employees.
Kevin J.P. O'Hara
So some board member quit the day his company was busted by the SEC for more market rigging and frontrunning its clients. Is that the punchline?
No. This is:
Mr. O’Hara worked in the Division of Enforcement of the U.S. Securities and Exchange Commission and as Special Assistant United States Attorney at the U.S. Department of Justice
And now proceed to laugh, or cry.