One year ago, in the first ever crack down on market manipulation and rigging in HFT-infested dark pools and ATS venues, the NY AG crushed Barclay's dark pool LX with just one lawsuit alleging the bank had misrepresented and taken advantage of gullible clients to benefit well-paying HFT parasitic scalpers who not only have never "provided liquidity" but merely frontrun whale orders and completely shut down any time the market turns against the prevailing momentum wave, in the process crushing liquidity.
Following the Barclays debacle, which confirmed not only what Michael Lewis had said earlier in 2014 about HFT manipulation, but everything we had said about HFT manipulation since 2009, the paid defenders of the HFT criminal syndicate scrambled to prove that it was "only" one bad sheep in a herd of well-meaning, tame and well-behaved liquidity providing animals.
A year later, enough time had passed since the Barclays bust that the more gullible elements almost believed these paid defenders of market-rigging. Then the best laid plan of vacuum tubes and men went horribly wrong when at the end of July, none other than the original dark pool, ITG, was busted for using a prop trading silo to frontrun client order flow using an HFT architecture.
Worse, as we revealed and as was confirmed later, the person behind this latest HFT manipulation charge was none other than Hitesh Mittal, the current head trader of mega quant fund AQR, the 4th largest in the world, whose boss Cliff Asness has over the years become one of the most vocal advocates of HFT. Now we know why.
And then, earlier today, the WSJ reported that none other than the operator of the biggest dark pool in the US by volume, Credit Suisse and its massive Crossfinder dark pool, "is in talks with regulators to settle allegations of wrongdoing at its “dark pool” with a record fine in the high tens of millions of dollars, according to people familiar with the matter."
The Swiss bank is negotiating a joint settlement with the New York Attorney General and the Securities and Exchange Commission. A deal could come as soon as the next several weeks, though talks could still fall apart, the people said. The settlement under discussion would lead to the largest fine ever levied against an operator of a private trading venue.
The case against Credit Suisse includes allegations that it provided unfair advantages to some traders, violated rules against pricing of stocks and didn’t adequately disclose to investors how CrossFinder works, according to the people familiar with the matter.
What is grotesque about this story is not that yet another dark pool has been found to cater solely to HFTs i.e., the best paying clients who will always get priority treatment by banks such as Credit Suisse and Barclays simply because that's all they do: pay to frontrun others because in a market which is rigged to the core, HFT and dark pool manipulation is now the rule. What is grotesque, is that back in December 2012, it was none other than Credit Suisse which conveniently explained and laid out all those forms of HFT manipulation which we accused virtually every HFT firm of employing since 2009... and which Credit Suisse itself is now accused of engaging in!
This is how Credit Suisse summarized all the predatory strategies of HFT algos in the market as of 2012:
- Quote Stuffing: the HFT trader sends huge numbers of orders and cancels
- Layering: multiple, large orders are placed passively with the goal of “pushing” the book away
- Order Book Fade: lightning-fast reactions to news and order book pressure lead to disappearing liquidity
- Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it.
And the punchline: Credit Suisse's Advanced Execution Services (i.e., the group behind its dark pool) was putching itself as the one venue where trading participants are immune from such abuse. From "High Frequency Trading – Measurement, Detection and Response" (which can be found on the website of edge.credit-suisse.com with a cursory title-based google search):
Dark pools using a synthetic EBBO (consolidated book) for their reference price are at higher risk of being gamed by quote stuffing. Exhibit 10 shows an example in Ashmore Group, where the Primary Bid and Ask (represented by the outer dark red and light blue lines at 356.2 and 355.7) are static, but the Chi-X bid moves (dark blue line). The consolidated EBBO shows a locked book, with the bid equal to the ask at 356.2.
This scenario could be exploited in EBBO-referenced dark pools. A gamer could place a sell order in the pool with a 356.2 limit, then place (and rapidly cancel) a Chi-X bid, also at 356.2. Any buy order pegged to mid would trade at the temporary gamed “mid” of 356.2 (as the EBBO bid and offer are both temporarily 356.2), paying the whole spread rather than half.
Crossfinder (Credit Suisse’s dark pool) does not use the EBBO, preferring to use primary-only data to help minimise the chance of midpoint gaming. Furthermore, when AES detects any quote stuffing, it may add extra protections across its orders (both lit and dark) to further reduce the risk of being gamed, more details of which are discussed later from page 7.
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Dark-only flow traded through AES (e.g. in tactics such as Crossfinder+) can minimise the chance of being affected by ‘mid-point gaming’ with by withdrawing from certain venues, raising MAQs and using tighter limits. These protections will allow the midpoint to come towards the order – enabling the strategy to participate at a temporarily more favourable price – but restrict it from moving away.
If apparent gaming occurs consistently on a particular venue or with a particular counterparty in Crossfinder, the AES Alpha Scorecard will pick this up and highlight that venue or that counterparty as exhibiting excessive “opportunistic” behaviour. Credit Suisse’s clients then have the ability to decide whether to trade on those venues or against that group of counterparties.
Flow that reaches Credit Suisse’s dark pool (Crossfinder) via aggregators does not receive such protections, as Crossfinder is simply an execution venue for this flow. When interacting through AES algorithms, these additional protections are available.
Turns out they weren't, and that anyone who believed the Credit Suisse reps and warrants was lied to, just like in Barclays' case, and quite likely all those parasitic HFT strategies, quote stuffing, layering, orderbook fading and momentum ignition, Credit Suisse raged against were being used against CS'own clients.
And, just like in Barclays case, these lies will now cost the Swiss bank tens of millions, or a fraction of the profits it made abusing its clients' trust.
But the biggest question, just like in the Barclays case, is whether the bulk of its carbon-based clients - we know the HFTs will never leave - will depart the Crossfinder dark pool, and send the orderflow volume on the Credit Suisse market plunging, which like with LX, will start a self-fulfilling prophecy of dark pool collapse since once the key clients leave there is no reason for anyone else to stay.
Finally, if this is what happens, who will be winner: upstart AEX, or Goldman Sachs, which as we reported recently is back in the HFT arena and as we reported in "Why Goldman Is About To Become The Biggest HFT Firm In The World", is likely the firm that is ordering the regulatory hits on its biggest competitors until it takes them all down one by one, in a New Normal replica of how Goldman destroyed Lehman back in 2008.