The U.S. Securities and Exchange Commission recently imposed a $1 million administrative penalty against Pipeline Trading Systems LLC for misleading investors in connection with the operation of its dark pool. Pipeline was launched in 2004 as an alternative trading system operating as a "crossing network" to facilitate trades among institutional investors while minimizing market impact associated with information leakage about their large buy or sell orders. To that end, Pipeline advertised that to prevent pre-trade information leakage, it would not reveal the side or price of a customer order before a trade was completed. Pipeline also claimed that all users were treated equally.
According to the SEC, Pipeline's claims were false and misleading because one of its affiliates (a trading entity owned by its parent company) filled the vast majority of customer orders on Pipeline's system, by seeking to predict the trading intentions of Pipeline's customers and trade elsewhere in the same direction as customers before filling their orders on Pipeline's platform. Accordingly, the SEC found that Pipeline generally did not provide the "natural liquidity" it advertised. The SEC further found that the trading affiliate was given certain advantages not available to other users. These included providing the affiliate with a FIX connection to Pipeline's graphical user interface known as the "Block Board", soliciting and receiving input from the affiliate regarding the minimum order size for each stock, and providing the affiliate with information regarding ATS features designed to "predator proof" the system.
Ultimately, Pipeline was found to have violated the Securities Act prohibition against making false or misleading statements in the sale of securities, as well as Regulation ATS requirements regarding disclosure to be made to the SEC and the implementation of safeguards to protect confidential trading information.
The SEC release quotes Robert Khuzami, Director of the SEC's Enforcement Division as saying that "[h]owever orders are placed and executed, be it on an exchange floor or in an automated venue, whether dark or displayed, one principle remains fundamental – investors are entitled to accurate information as to how their trades are executed.
Alternative trading systems compete with exchanges for trade execution by providing alternative operation models, trades types and fee structures to facilitate a wide range of execution strategies. Crossing systems or crossing networks generally do not offer price discovery but are intended to facilitate trades between buyers and sellers who quote their prices on other trading systems. Dark pools meanwhile, are trading systems that accept buy or sell orders without pre-trade transparency (disclosure of the details of the trade, specifically price and quantity).
ATSs are regulated in Canada under National Instrument 21-101 Marketplace Operation and National Instrument 23-101 Trading Rules. ATSs are also regulated by the Investment Industry Regulatory Organization of Canada (IIROC) through its UMIR and Dealer Member Rules.
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