ATTORNEYS: H. ADAM PRUSSIN, EMMA GILMORE
POMERANTZ MONITOR, MAY/JUNE 2015
Pomerantz largely defeated defendants’ motion to dismiss our complaint against Barclays bank and several of its officers and directors. Our action accuses Barclays of making false and misleading statements about the operations of its “dark pool.” A “dark pool” is an alternative trading system that does not display quotations or subscribers’ orders to anyone other than to employees of the system. Dark pools were first established to avoid large block orders from influencing financial markets and to ensure trading privacy. Trading in dark pools is conducted away from public exchanges and the trades remain anonymous, lowering the risk that the trade will move the market price. About 15% of U.S. equity-trading volume is transacted in dark pools.
Precisely because these trades are conducted “in the dark,” institutional investors trading in these venues rely upon the honesty and integrity of their brokers and the dark pool operators to act in their clients’ best interest.
If given information about impending customer trades, high frequency traders in the dark pools can trade ahead of those customers and then profit at their expense by reselling the shares to complete the order. Studies seem to show that, as of 2009, high frequency trading accounted for 60%-73% of all U.S. equity trading volume. Keeping such traders away from the dark pools could help protect other investors from their front-running and other predatory trading practices.
After a series of scandals, and in particular disclosure of its manipulation of the LIBOR benchmark interest rates, Barclays commissioned an independent investigation of itself. As a result of the findings, it publicly pledged, among other things, to act with transparency and to impose strict controls over trading in its dark pool. These pledges, it turns out, were a sham. Barclays actually embarked instead on a campaign to make itself the largest dark pool in the industry, by hook or by crook.
An investigation by the New York Attorney General revealed that, in order to grow the dark pool, Barclays increased the number of orders that it, acting as broker, executed in the pool. This required that Barclays route more client orders into the dark pool, and ensure that there was sufficient liquidity to fill those orders. To convince the market of the safety of trading in its dark pool, Barclays represented that it would monitor the “toxicity” of the trading behavior in its dark pool and would “hold traders accountable if their trading was aggressive, predatory, or toxic.” Such “toxic” trading activity included high frequency trading, which it pledged to keep out of its dark pool.
But these alleged controls were illusory. One former director explained that Barclays “purports to have a toxicity framework that will protect you when everybody knows internally that [they don’t]”. Another former director described these controls as “a scam.” Our complaint alleged that Barclays representations about establishing a monitoring program to eliminate “toxic” trading from the dark pool were misleading because Barclays did not disclose that it did not eliminate traders who behaved in a predatory manner, did not restrict predatory traders access to the dark pool, did not monitor client orders continuously, and did not monitor some trading activity in the pool at all. In fact, plaintiffs allege, Barclays encouraged predatory traders to enter the dark pool.
The court’s decision is significant because of its emphasis on the importance to investors of corporate integrity. Barclays' motion to dismiss relied heavily on the contention that its misrepresentations about the dark pool were immaterial to investors because revenues from the dark pool were far less than 5% of the company’s total revenues. This figure is a statistical benchmark often used to assess materiality. In fact, revenues from the dark pool division contributed only 0.1% of Barclays total revenues. The court rejected Defendants’ myopic view of materiality and found that the misrepresentations went to the heart of the firm’s integrity and reputation, which had been jeopardized by its past well-publicized transgressions. The court’s decision means that misrepresentations about management’s integrity can be actionable even if the amounts of money involved in these transgressions falls below a presumptive numerical threshold.
The court also held that Defendant William White, the Head of Barclays’ Equities Electronic Trading, was a sufficiently high-ranking official that his intent to defraud could be imputed to the company itself. The court explained that “there is strong circumstantial evidence of conscious misbehavior or recklessness on [his]part. “Not only was White the source of many of the allegedly false allegations about [the dark pool] but he was the head of Equities Electronic Trading at Barclays, “the driving force behind the Company’s goal to be the number one dark pool,” and he “held himself [out] to the public as intimately knowledgeable about LX’s functions and purported transparency.”