Bank of America Merrill Lynch (BAC) will pay a $42M penalty to New York State to settle allegations that it engaged in fraudulent practices involving electronic trading services. According to a press release issued by New York Attorney General Eric Schneiderman, the bank admitted that over five years, it “systematically” hid from clients that it was “secretly routing” their equity securities orders to electronic liquidity providers, including Knight Capital, Citadel Securities, Two Sigma Securities, D.E. Shaw, and Madoff Securities, which then executed the transactions.
Bank of America Merrill Lynch, which is Bank of America’s corporate investment banking division, had “undisclosed” agreements with these providers. Its “masking” strategy was used in more than 16 million client orders that involved over 4 billion shares that were traded.
According to the probe by Schneiderman office, and Bank of America Merrill Lynch’s own admission, starting in 2008, the corporate investment banking division purposely took steps to hide that it was sending a number of equity securities orders made by clients to the electronic liquidity providers. Bank of America Merrill Lynch told investors that the orders were executed “in-house.” Meantime, it committed fraud by modifying its electronic trading systems to “automatically doctor” the trade confirmation that clients received after these other firms executed the transactions. Internally, Bank of America Merrill Lynch called this action “masking,” which consisted of replacing the electronic liquidity provider’s identity with a code to make it appear is if a trade execution had taken place through the bank instead.
The clients that were affected were institutional investors. In the release, AG Schneiderman accused the bank of going to “astonishing lengths” to defraud its clients over who was fulfilling their orders and making dark pool trades.
Bank of America’s corporate investment banking division modified “transaction cost analysis” reports to assist in this masking. The reports, which are generated after trades, are supposed to inform clients about where their trades were made and how they were executed. Once again, the reports made it appear as if the trades occurred in-house rather than via the electronic liquidity providers. Bank of America Merrill Lynch also hid this information by modifying invoices and other documentation.
The NY AG’s probe also found that the bank made misleading statements to clients about its electronic trading services, which made the services seem “safer and more sophisticated,” including:
· That at least 20% of orders in its Instinct X dark pool were from retail trades, when the real figure for retail trade orders was just 5%.
· Claiming that it used a certain kind of analysis to find the best trading venue for clients when actually no such analysis was employed to determine where to send clients orders.
The $42M penalty is the largest ever imposed by the State of New York related to electronic trading. In addition to admitting to a “multi-year fraud” related to the running of its electronic trading division, Bank of America Merrill Lynch acknowledged that it had violated New York’s Martin Act and the New York Executive Law § 63(12).
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