(Bloomberg) — U.S. regulators imposed a record fine on UBS Group AG's dark pool for failing to follow rules designed to ensure stock trades are executed fairly.
In ordering UBS to pay $14.4 million, including a $12 million fine that exceeds all prior penalties against an alternative trading system, the Securities and Exchange Commission flagged a series of violations from 2008 to 2012. It said UBS let customers submit orders at prices denominated in increments smaller than a penny, something SEC rules prohibit because it can be used to get a better place in line when buying or selling stock.
The ability to trade in sub-penny increments also wasn't widely disclosed to UBS customers, and was instead pitched secretly to market makers including high-frequency traders, according to the SEC.
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"The UBS dark pool was not a level playing field for all customers and did not operate as advertised," Andrew J. Ceresney, the director of the SEC's Division of Enforcement, said in a statement Thursday. The SEC blamed both "technical problems" and two order types that effectively allowed orders to be priced in smaller-than-a-penny steps.
The action is the latest to target violations at dark pools, which rose to prominence as computers took over U.S. equity markets as places where large investors could trade without moving prices. UBS was cited for technical violations of Regulation NMS, the SEC regulation that took effect in 2007 to ensure that anyone trading shares on U.S. markets gets the best price available when placing an order.
Second Largest
UBS, which runs the second-largest U.S. dark pool, didn't admit to or deny the SEC's findings.
"UBS is pleased to resolve charges by the SEC arising from historical shortcomings in the operation of its ATS," UBS said in a statement today. "The issues that led to these charges were remedied in mid-2012, and the firm has updated and enhanced its supervisory and operational procedures."
While arcane, electronic order types for trading shares have become a focus in the debate around high-frequency trading. Where in the past human market makers acted as traffic cops matching requests to buy and sell stocks on exchange floors, now the process is managed by software that critics say is poorly understood by anyone but professional traders.
Just this week, a person with knowledge of the matter said the SEC was considering rules that would force dark pools to comply with some of the same requirements exchanges face. Among the ideas under review is forcing dark pools to disclose the types of orders they offer, according to the person.
PrimaryPegPlus
One of the UBS order types cited in today's complaint, called "PrimaryPegPlus," let users specify an intent to buy or sell stock at a percentage above or below prevailing market prices. According to the complaint, UBS only told a subset of subscribers that the order was available, almost all of them market makers or high-frequency traders.
"Because the second component of the formula determining the price of a PPP order — a subscriber-determined percentage of the spread –- nearly always yielded a sub-penny amount, PPP orders were nearly always priced in illegal, sub-penny increments," according to the SEC order.
The other, known as "Whole Penny Offset," let users enter orders one penny above or below the midpoint between the national best bid or offer for a given stock. Between January 2009 and June 2010, the protocol resulted in executions for about 1.5 million shares, the SEC said.
'This Is Crazy'
The SEC's findings represent a "clear, late violation of Reg NMS, which is very surprising," said Dave Lauer, the president of consulting firm Kor Group LLC. "If it has been since 2008, why are we talking about it now and not four, five years ago? This is crazy — seven years."
UBS also failed to live up to the secrecy pledges of the dark pool, giving 103 employees who shouldn't have had access the ability to see clients' confidential trading data, the SEC said.
New York Attorney General Eric Schneiderman sued Barclays Plc in New York State Supreme Court in Manhattan in June, accusing it of lying to customers and hiding the role of high- frequency traders in its dark pool. The bank in July filed papers asking the court to throw out the case, arguing the state hasn't shown that clients have been harmed.
–With assistance from Annabelle Ju in New York and Dave Michaels in Washington.
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