Well, it’s been rumored to be “any day now” since late August 2015; yesterday several media sources announced that Credit Suisse and Barclays have reached a joint $154 million settlement with the SEC and AG Schneiderman’s office. Credit Suisse will pay a total of about $85 million ($30 million to each of the SEC and the AG, and $24.3 million in returned profits. Barclays will pay about $70 million ($35 million each to the SEC and the AG) to settle their charges.

Here are three of yesterday’s media articles on the settlement:

• Bloomberg
• New York Times
• Wall Street Journal

And here are the actual SEC settlement orders:

• Credit Suisse Crossfinder
• Credit Suisse Light Pool
• Barclays LX

We have written about the AG – Barclay’s lawsuit in many prior notes going back to mid-2014, including this one, so we won’t again delve into the extensive details about what Barclays did wrong. Feel free to read our prior notes, and feel free to read prior articles from business journalists (Matt Levine for example) defend Barclay’s actions:

(Matt Levine wrote several pieces, such as this one where he defended their charts (they said Sample!), and this one where he defended them for saying that they only claimed to be able to weed out HFT, and not that they actually did so.

“The bubble chart doesn’t say, “We don’t allow high-frequency traders.” It says something more like, “We hear your worries about high-frequency traders, and they worry us too, and here are some soothing bubbles.” Now that’s not fraud”

This morning we would like to focus on the SEC’s settlement with Credit Suisse. The list of violations is long, and the details are extremely interesting.

Sub Penny Trades

CS Crossfinder allowed for Sub-Penny trades in violation of Rule 612 in Reg NMS. They made use of a complex combination of three order tags to allow for the sub-penny pricing. This resulted in nearly 23% of all Crossfinder trades (499 million orders entered / 117 million orders executed). These were orders by HFT firms, and they achieved superior queue position, stepped in front of investor orders, allowed for extra intermediation between natural buyers and sellers.

Rule 612 of Reg NMS was passed with the SEC noting that they wanted to make sure to “deter the practice of stepping ahead of exposed trading interest by an economically insignificant amount.”

CS knew what they were doing was wrong, but they did it anyway:

“employees understood that the acceptance of orders priced in explicit subpenny prices would be rejected by Crossfinder, but that the use of the proper order tag would result in an order priced at a sub-penny increment that would be accepted by the system. In an email, a CSSU employee with supervisory responsibilities over Crossfinder counseled a subscriber “we are rejecting your orders because you are putting sub dollar [sic] price into [p]rice field. You need to use [the order tag] to offset the price.”

Confidential Information Sharing

 Between August 2008 and April 2013 Credit Suisse shared confidential order information from its ATS Crossfinder with participants outside the ATS. They did this by default to all sell-side firms (this should remind you a little of the discrimination that ITG engaged in), and for those buyside firms that chose to “opt-in”. This was not disclosed. Here is how it worked:

A sell-side firm would enter an order into Crossfinder because it was a large dark pool, and with the intention the orders would be protected and remain dark. Credit Suisse sent IOIs from these orders (that included symbol quantity side and price) to the AES Smart Order Router and AES IOI -Server. The AES IOI Server sent IOIs on these orders to two unnamed stock exchanges, so that those stock exchanges could use the information in outs outbound router.

 Special Non-disclosed Relationship With Two HFT Firms

CS operated a special technology called Crosslink that executed trades between algorithmic child orders and two HFT firms. These executions resulted from a series of back and forth message traffic (IOI, Notice of Match (NOM)). AES, and the HFT firms could send or not send actual orders into Crosslink that would match. This is akin to a secret special Flash Order for these two special HFT firms. They could decide to match an institutional child order, or they could decide to not match, and instead step ahead of the order in the general fragmented mess of a market.

This arrangement resulted in 19.1 million trades totaling 8.2 billion shares.

 Alpha Scoring

 Credit Suisse claimed it protected order flow from HFT by using “Alpha Scoring”. Subscribers were categorized as “Plus” (low-Alpha), “Max” (neutral-Alpha), “Opportunistic” (high-Alpha), or Natural. CS considered “Plus” as a worthy counterparty to institutional flow, but they considered “opportunistic” as a detrimental counterparty. This process was apparently subjective and non-transparent, and not done monthly, despite being touted in literature and conferences otherwise. CS ignored its own “objective” scoring and secretly placed certain HFT firms in the “plus” category, although the data showed the opposite to be true. CS only applied the Alpha Scoring to a subset of order flow streams from toxic participants.

AES Preferenced its Own Dark Pool

 Since 2011 CS told all clients that it used Heat Map technology to route orders in its SOR based on execution quality. It did not. It preferenced its own pool first, and it was a sequential router. To this day it still hits Crossfinder before it goes through the sequence of other destinations.

Credit Suisse Violated the 5% Rule

 From every month between August 2010 and at least February 2014 CS exceeded the 5% threshold from between 1 and 50 securities, where they should have turned off trading in those securities. The 5% threshold is supposed to be the line where CS should have publicized the quotes for that order flow in the lit market.

 Credit Suisse Had a Special Relationship with Two Registered Exchanges

 CS allowed two outbound routers at two registers stock exchanges to received IOIs from the CS IOI Server (which operated outside the Crossfinder ATS). CS could not control this order flow fairly, and in a non-discriminatory manner. Did this arrangement allow those two stock exchanges to give an unfair advantage to their router?

 Themis Commentary

 The details of this settlement demonstrate how there is no line between dark and lit order flow. CS engaged in fraud by misrepresenting how safe its pools were. CS also disadvantaged sell-side clientele by not protecting their order flow as they claimed they did for the buyside. Sell-side order flow was routed any which way but loose, and that flow was exposed to undiclosed leakage and market impact.

How can a dark pool subscriber get a fair “neutral” fill when:

• Their resting orders are allowed to be queue-jumped in illegal ways?
• Their orders are leaked to special HFT firms, who are free to selectively cherry-pick when they want to be the other side, or when they want to trade ahead of these orders?
• Their dark orders are leaked to public stock exchanges, and their high speed-clientele?
• Their orders are represented as being protected by objective criteria, and instead the venue’s management fudges the rankings and places “toxic” HFT firms in the safe buckets?

What other dark pools use pegged off-set pricing?

What other dark pools outside CS and Barclays have special arrangements with stock exchange routers?

What other dark pools have special arrangements with HFT firms?

Anyway – we hope our above understanding recaps the details of the SEC-AG-Credit Suisse settlement for you in an easy to understand manner.