The Securities and Exchange Commission today charged a Citigroup business unit operating an alternative trading system (ATS) with failing to protect the confidential trading data of its subscribers.
New York-based LavaFlow Inc. has agreed to pay $5 million to settle the SEC’s charges, including a $2.85 million penalty that is the agency’s largest to date against an ATS.
An ATS is a venue that executes stock trades on behalf of broker-dealers and other traders. LavaFlow operates a type of ATS known as an electronic communications network (ECN), which unlike a dark pool displays some information about pending orders in its system, such as best bid or best offer. Under federal rules, an ATS must have safeguards to protect the confidential trading information of its subscribers.
According to the SEC’s order instituting a settled administrative proceeding, LavaFlow allowed an affiliate operating a technology application known as a smart order router to access and use confidential information related to the non-displayed orders of LavaFlow’s ECN’s subscribers. The order router was located outside of the ECN’s operations and LavaFlow did not have adequate safeguards and procedures to protect the confidential information that the order router accessed. While LavaFlow only allowed the affiliate to use the confidential trading data for order router customers who also were ECN subscribers, the firm did not obtain consent from its subscribers to use their confidential information in this way, nor did LavaFlow disclose the use in its regulatory filings with the SEC.
According to the SEC’s order, LavaFlow eventually discontinued this practice, but not before the smart order router executed more than 400 million shares in a three-year period based in part on the subscriber information contained in the ECN’s unexecuted hidden orders. Said Andrew J. Ceresney, director of the SEC’s Enforcement Division:
Operators of alternative trading systems must protect confidential subscriber data and take steps to ensure that affiliates do not improperly use order information. We will continue to hold accountable firms that fail to follow the rules applicable to off-exchange venues.
