"Barclays' dark pool was full of predators - there at Barclays' invitation." - NY Attorney General Eric SchneidermanReuters

The New York Attorney General, Eric Schneiderman, has slapped a securities fraud lawsuit on Barclays, claiming the bank gained an unfair edge through its high frequency trading (HFT) practices.

Schneiderman based the lawsuit around internal communications provided by former employees.

The lawsuit centres around claims that Barclays maximised profits by executing a bulk of transactions through HFT and on so-called "dark pools" - trading platforms that do not disclose trade or party details publicly until after the transaction is completed. The practice takes place despite the fact clients could have got a better deal on regular exchanges.

"The facts alleged in our complaint show that Barclays demonstrated a disturbing disregard for its investors in a systematic pattern of fraud and deceit," said Schneiderman.

"Barclays grew its dark pool by telling investors they were diving into safe waters. According to the lawsuit, Barclays' dark pool was full of predators – there at Barclays' invitation," he said.

"No regulator – no matter how broad their authority – can succeed on its own. I want to personally thank those that have courageously reported wrongdoing to our office and encourage others to do the same."

Schneiderman added that Barclays claimed that dark pool trading allowed it to "protect" clients from "predatory traders" by using HFT speed to get better prices for customers however he alleges that Barclays in fact used this practice to court the very traders it claimed to avoid.

Barclays said "we take these allegations very seriously". The bank said it is cooperating with authorities, looking at the matter internally, and that the integrity of markets is a top priority.

What is Dark Pool Trading and HFT?

Dark pool trading allows banks and financials to execute massive volumes of trades in an anonymous capacity, which has prompted many claims of price manipulation by cabals of traders. These massive chunks of trades can be executed in one go using high frequency trading techniques.

HFT is a technology enabled way of jumping in front of investors to trade a large number of orders at very fast speeds; often buying and selling in a fraction of a second; sometimes buying and selling at a profit of just one cent.

Why is Barclays in Trouble Again?IBTimes UK

However, if you multiply this by the millions that they go through each day, then you can see where the financial incentive comes into it.

Michael Lewis's book, Flash Boys: A Wall Street Revolt, he claims that with the use of expensive fibre optic lines, high frequency traders are able to get ahead of the regular buyers order, allowing them to profit from the knowledge of the prices in the slower feeds.

In other words those people with the means at their disposal can essentially rig the markets.

Highlights of the Claim

Schneiderman said Barclays heavily promoted a service called Liquidity Profiling, which Barclays claimed was a "surveillance" system that tracked every trade in the bank's dark pool in order to identify predatory traders, rate them based on the objective characteristics of their trading behaviour, and hold them accountable for engaging in predatory practices.

Contrary to those promises, the complaint alleges that:

  • Barclays has never prohibited any trader from participating in its dark pool, regardless of how predatory their activity was determined to be;
  • Barclays did not regularly update the ratings of high-frequency trading firms monitored by Liquidity Profiling;
  • Barclays "overrode" certain Liquidity Profiling ratings – including for some of its own internal trading desks that engaged in high-frequency trading – by assigning safe ratings to traders that were otherwise determined to be toxic.

Contrary to Barclays' representations that it protects clients from aggressive or predatory high-frequency trading in its dark pool, the bank in fact operates its dark pool to favor high-frequency traders, Schneiderman alleges. Barclays has actively sought to attract them by giving them systematic advantages over others trading in the pool, he claims.

Schneiderman's complaint includes the following:

  • Falsely underrepresenting the concentration of aggressive high-frequency trading in its dark pool;
  • Misrepresenting its Liquidity Profiling service, which Barclays claimed protected investors from predatory behaviour, by failing to provide many of the benefits marketed with the service;
  • Claiming that Barclays does not favour its own dark pool when routing client orders to trading venues, when in fact it does just that. As alleged in our Complaint, Barclays falsified an analysis of how it routed a major client's orders, said Schneiderman.