The Dark Pool Iceberg
Lawsuit Against Barclays Shows Need for More Scrutiny
By THE EDITORIAL BOARD NY Times JUNE 28, 2014
Shareholders and brokerage houses ditched Barclays at the end of last week, and who could blame them? In addition to its involvement in serial financial scandals — including the manipulation of interest rates and gold prices — the bank now stands accused of fraud related to its “dark pool,” essentially a private stock exchange.
Generally operated by banks, dark pools are supposed to be a safe way for institutional investors to execute block trades without worrying that their transactions will move market prices before the deal is completed.
A scathing lawsuit filed on Wednesday by the New York State attorney general, Eric Schneiderman, claims that Barclays repeatedly lied to brokers about the extent of aggressive and predatory high-speed trading in the pool — activity that exposed investors to precisely the type of price distortions they were trying to avoid and that, not incidentally, enriched Barclays by increasing the number of transactions executed in the pool.
The lying took the form of private and public assurances by Barclays that investors in its pool were continually shielded from high-speed trading when, to the contrary, the bank actively sought to attract such traders to its venue and even bolstered their trading strategies by giving them privileged information about the pool, according to the suit. All the while, the suit says, Barclays assured its clients that it sent their buy-and-sell orders to trading venues that offered the best terms when it actually sent almost all orders to its own dark pool first.
The direct victims of the alleged fraud are mutual funds, pension funds and other institutional investors that used the Barclays dark pool, one of the largest of more than 40 such off-exchange venues in the United States. The indirect victims are everyone whose money is invested in those funds.
There is no reason to believe that this kind of wrongdoing is limited to Barclays. Off-exchange venues have mushroomed in the past several years along with high-frequency trading, a twin development that demands more scrutiny. Today, more than a third of equity trading in the United States and Europe is done outside the public exchanges, and most major banks run dark pools, including Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS.
The lawsuit against Barclays is the first detailed one of its kind, relying on subpoenaed documents, whistle-blowers and market research to describe a pattern and practice of premeditated and habitual deceit, with the aim of profiting at the expense of clients and the smaller investors those clients serve.
It would be a shock if other dark pool operators were as brazen as Barclays is accused of being. It would not come as a shock, however, to learn that trades in other dark pools are also executed in ways that best serve the interests of the pool operator rather than those of the clients.
In a financial system that is presumably built on the integrity of its public markets, banks should not be entitled to operate increasingly in the shadows, where even large and savvy clients can get mugged. Financial regulators need to force more order and transparency on the system, and to prosecute the wrongdoing that comes to light in the process. Mr. Schneiderman has shown the way, but he can’t do it alone.
It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.
~ Thomas Sowell
AI
