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Citigroup ATS LavaFlow settles for $5mn charge

First Published 25th July 2014

New York-based LavaFlow 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.

Daniel Hawke, SEC

Daniel Hawke, SEC

"Because much of today's equity trading is automated, firms must protect sensitive information within computer networks just as aggressively as they police against the misuse of information by people."

The SEC today charged a Citigroup business unit operating an ATS with failing to protect the confidential trading data of its subscribers.

LavaFlow operates an 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.

"Operators of alternative trading systems must protect confidential subscriber data and take steps to ensure that affiliates do not improperly use order information," said Andrew Ceresney, director of the SEC's Enforcement Division. "We will continue to hold accountable firms that fail to follow the rules applicable to off-exchange venues."

Daniel Hawke, chief of the SEC Enforcement Division's Market Abuse Unit, added, "LavaFlow's subscribers trusted and expected that knowledge of their hidden orders would not escape the ATS. Because much of today's equity trading is automated, firms must protect sensitive information within computer networks just as aggressively as they police against the misuse of information by people."

Alternative trading systems currently execute approximately 12% of US equity trading volume. According to FINRA data, LavaFlow is estimated to be a top 10 ATS when measured by share or trade volume. LavaFlow is owned by Citigroup Financial Products.

In addition to the Regulation ATS violations, the SEC's order finds that LavaFlow aided and abetted a violation by the same affiliate that operated the smart order router, Lava Trading Inc., which continued to provide broker-dealer services for several months after it deregistered in August 2008.

Lava Trading, which also was owned by Citigroup Financial Products, earned approximately $1.8 million in broker-dealer business during this time period, and LavaFlow provided operational and administrative support while also responsible for a website that claimed Lava Trading was a registered broker-dealer.

Read the SEC order instituting administrative and cease-and-desist proceedings.