Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, October 24, 2011

Alternative Trading System Settles Charges It Failed to Disclose Trading by Affiliate

The SEC settled charges that Pipeline Trading Systems LLC and two of its top executives failed to disclose to customers of Pipeline’s “dark pool” trading platform that the vast majority of orders were filled by a trading operation affiliated with Pipeline.  Pipeline agreed to pay a $1 million penalty to settle the matter. Pipeline’s founder and chief executive officer, Fred J. Federspiel, and its chairman and former chief executive, Alfred R. Berkeley III, a former president and vice chairman of the NASDAQ Stock Market, each agreed to pay $100,000.

New York-based Pipeline was launched in 2004 as an SEC-registered alternative trading system, a privately operated platform to trade securities outside of traditional exchanges. Alternative trading systems that display little or no information about customer orders are known as “dark pools.” Institutional investors use these venues to hide their trading intentions from others and avoid moving the market with large orders to buy or sell stock.

According to the SEC’s order, Pipeline described its trading platform as a “crossing network” that matched customer orders with those from other customers, providing “natural liquidity.”

Pipeline’s claims were false and misleading because its parent company owned a trading entity that filled the vast majority of customer orders on Pipeline’s system, the SEC found. It said the affiliate, most recently known as Milstream Strategy Group LLC, sought 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. The SEC’s order found that Pipeline generally did not provide the “natural liquidity” it advertised.

Pipeline took certain steps to address the conflict of interest it created, including by paying the affiliate’s traders using a formula that rewarded them in part for giving favorable prices to Pipeline’s customers. The SEC’s order found that Pipeline failed to disclose the compensation formula or Milstream’s activities to its customers or in its filings to the SEC.

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