Did You Hear About A.G. Schneiderman Going After Barclays’ Dark Pool?

Let’s get a few things out of the way right off the bat for those who are new to these pages:

I’m not a “shill for high frequency trading.”   I’m currently a retail putz who is the prime beneficiary of the current market structure, and more importantly, I have enough market experience to understand that fact.   In my prior life, I had expertise in execution (in size)  from both the buy side (ie: as customer)  and the sell side (as broker/dealer), which gives me a relatively unique view of how It All Works.

While there is a seemingly endless army of media Pollyannas eager and willing to write populist stories about high frequency trading designed to mislead the “poor ignorant retail investor,” and blame all woes on evil electronic HFT predators,  I have gone out of my way to try to explain that these mouthpieces are in no way actually advocating in the best interests of the retail investor.   (You want an immediate tangent?  here goes:  see today’s news of the SEC Tick Size Pilot which will increase the minimum tick size for a group of pilot stocks from 1c to 5c.  Congratulations: I hope everyone is happy: you just jacked bid/ask spreads 400% for the poor ignorant retail investor. )

Back on topic:  today, NY Attorney General Eric Schneiderman “announced fraud charges against Barclays in connection with marketing and operation of its dark pool.”    Let’s get another thing straight right away:  this post is NOT a defense of Barclays or a testimony in support of false advertising (which is what Schneiderman’s suit is largely about.)   What I want to do here is explain to you why, as a trader, reading Schneiderman’s complaint makes me shake my head and go “what’s the point?”

What I mean is this:  the current market structure is fragmented.  While Back In The Day we had no choice but to send NYSE-listed orders to the New York Stock Exchange and get our eyes ripped out by human specialists and floor traders scalping us for eighths and quarters, nowadays we can send our order to any of roughly a dozen different “exchanges” and multiple dozen “dark pools” for execution.   WE HAVE CHOICES.  I put that part in bold for you because it’s important.

So what Barclays did was make some misleading and false statements about their dark pool in order to get traders to send more orders there.  Bad, right?  We can all agree on that.   But here’s the thing:  When you send an order to Barclays’ dark pool, to NASDAQ, to the NYSE, or to Boiler Room Joe for execution, you get a fill back – and get this: you evaluate the quality of the fill!   If the fill you get from Market Center X (which could be any of the destinations I named in the previous sentence), it’s your job to recognize that and find a “better” place to send your orders.     Let me try to explain this with some stories from personal experience.

Back near the beginning of my career, around the turn of the millennium, NASDAQ’s dominance was starting to crack just a teeny bit and we (executing orders on the sell side) witnessed the rise of ECNs – electronic communications networks (Instanet was the first and perhaps the one most familiar to novices).   Each ECN allowed you to trade NASDAQ-listed stocks like $MSFT $INTC $CSCO and $QCOM.  (It’s somewhat ironic that of those 4 titans I think only $MSFT (no positions) can still be considered a titan, but anyway…)

So we had order routing access to INCA (Instinet), ARCA (Archipelago), REDI (Redi) and others.   They all made different claims about their order routing, costs, and execution qualities that they could offer us.    But when INCA told me that they were the best, I didn’t just send them the rest of my orders, explaining “yeah, Boss, they said they were the best – it’s right there in their marketing materials.”  No – I compared the fills I got from INCA to the fills I got elsewhere.   At the time, ARCA and REDI actually offered better capabilities to take liquidity from other venues (albeit at a higher order routing charge) and my job as a trader was to recognize that and maximize my executions (or minimize my slippage costs, to put it differently).  I sent more orders to ARCA and REDI because I got better fills from their routing and liquidity.  It’s not rocket science, right?

Let me try another anecdote:   When I was on the buy side I was a customer to the sell side.  In addition to executing orders myself through the ECNs I mentioned above, I would send orders to the sell side broker dealers.   I would pay them commission, and they would give me research.  That’s kinda how the whole Game works.   Another perk that big customers got was access to allocations on secondary offerings (my desk wasn’t allowed to participate in IPOs, for various regulatory quirks I won’t go into here).  So there was one firm, I’ll call them Schmoldman Schmachs, who told me “hey, we’ll get you great allocations on our secondaries.”   Guess what – that turned out to be blatantly false – FRAUDULENT advertising.   What happened was that every time I sent Schmoldman Schmachs an order for a “hot secondary,” – the kind that would trade up from the print – I’d get no fill.   When I sent them an order for what would turn out to be a dogshit busted secondary, I’d get plugged with a fill.   Did I sue Schmoldman Schmachs for fraud or complain to the AG?  No – I stopped sending them orders.  That’s how it works: you notice that your fills suck and you send your orders elsewhere.

Which brings me back to the Barclays “story,” and why I can’t get so worked up about it.   Does Schneiderman’s evidence sound like Barclays misled customers?  Absolutely.  Does it sound like in some cases they outright lied to customers, and even deliberately manipulated and massaged trading statistics to paint the view that they wanted in order to get more customer orders?  YES!  But in the end, the customers either liked the fills they were getting from the dark pool, or they didn’t.  They had a choice of 40 other places to send their orders if they didn’t like Barclays’ fills, and a traders’ job is to execute his orders responsibly.*

Is this making any sense yet?   Look:  I know damn well that people telling me that I – the poor little retail investor/trader – am being disadvantaged by high frequency traders are wrong.  I know this because I have knowledge and experience in the field.   What I’m trying to say here is that professional traders (and make no mistake:  your grandmother is not routing her Fidelity orders to Barclays’ dark pool – we are talking about professionals who have a fiduciary duty)  who are sending their orders to Barclays’ dark pool and getting back fills that they are unhappy with should STOP SENDING THEIR ORDERS TO BARCLAYS’ DARK POOL.   That’s how free markets work:  the consumer has choices. (and oh yeah – those traders should feel free to loudly tell everyone about their findings and crappy fills – about their consumer experience, about how much they think Barclays’ dark pool sucks.   From Schneiderman’s complaint, though,  it sounds like that’s not what’s happening at all: the traders/consumers/customers didn’t complain, rather, there was a former Barclays employee who is acting as a whistleblower.)

That’s why I think Schneiderman’s latest announcement today is yet another populist mission designed for political gain rather than to actually improve the market structure.   It’s easy to get people riled up by saying: “SEE?  FRAUD!”  But guys getting crappy fills from Barclays’ dark pool already KNOW that they’re getting crappy fills from Barclays’ dark pool.  Or perhaps they don’t, and THEY should be investigated for their own breach of fiduciary duty.  Fat chance, right?  Of course there’s always the case that the fills from Barclays’ dark pool weren’t even all that crappy – there is no detail of craptastic fills in the complaint…


High Frequency Trading – the Little Guy is the Big Winner

Schneiderman Press Release

Schneiderman Detailed Complaint


* there is a wrinkle here worthy of further comment:  starting on page 21 of the complaint, Schneiderman details complaints with the way Barclays themselves routed customer orders.   There is a possibility/probability / likelihood  that they violated Best Execution tenets here, and that’s most definitely their responsibility, not their customers’ responsibility.


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