The SEC announced settled charges against alternative trading systems (ATS) operator Liquidnet, alleging violations of the Market Access Rule, failure to protect trading information, and failure to amend its Form ATS and Form ATS-N under Regulation ATS.
The SEC also charged Liquidnet with making material misstatements about its compliance with the Market Access Rule and Reg ATS. To settle the charges, the company agreed to pay a $5m fine and retain a consultant to shore up its compliance procedures.
Non-broker dealers
ATS operators like Liquidnet provide market access to non-broker dealers, such as institutional investors. ATSs are typically more flexible and less regulated than traditional markets, and are exempt from exchange registration and related requirements.
The results of ATS trades are not typically publicly available (a “dark pool”), and ATS operators are required to keep trade information private. Around 16% of total US equity volume is executed via ATSs.
ATSs that provide market access to non-broker-dealer customers are subject to the Market Access Rule, which requires maintaining procedures to prevent the execution of orders that would exceed its customers’ credit limits.
Reg ATS also requires that ATS operators limit confidential customer details to certain employees of the ATS, sequestering the information from the company at large.
Reg ATS also requires periodic reporting that includes details about how an ATS is operated.
The SEC rarely pursues enforcement actions against ATS operators. In 2022, the agency fined ATS operator TZERO $800,000 for disclosure failures.
Credit thresholds
The SEC stated in its order that between 2019 and 2023, Liquidnet violated the Market Access Rule by failing to set credit thresholds without doing due diligence on its customers’ creditworthiness, “nearly always” setting credit caps at $1b regardless of its customers’ financial status.
The SEC also accused Liquidnet of granting inappropriate access to customer details by employees who did not have operational or compliance clearances, from 2019 to 2024. The agency stated that Liquidnet did not maintain adequate access controls for technology specialists accessing the information for testing purposes.
Liquidnet was further charged with failing to disclose who had access to those customer details on its Reg ATS forms, and for not maintaining effective policies and procedures to prevent the leaks.
This is the second time that Liquidnet has been hit with an SEC enforcement action, having received a fine of $2m in 2014 for similar mishandling of confidential customer details.
Rule violations
For failing to set correct credit caps, and for failing to limit access to customer trading information, Liquidnet was charged with violating:
- Section 15(c)(3) of the Exchange Act and Rule 15c3-5 thereunder (the “Market Access Rule.”)
- Rule 301(b)(10) of Regulation ATS, which “establish adequate written safeguards and written procedures to limit access to confidential subscriber trading information to employees of the ATS.”
For the above violations, Liquidnet was charged with providing inadequate disclosures under:
- Rules 301(b)(2) and 304 of Regulation ATS, requiring public disclosures on Form ATS-N about the operations of the NMS Stock ATSs and the activities of the broker-dealer operator and its affiliates.
- Rule 301(b)(2) of Regulation ATS, which requires disclosures to the Commission about the operations of Fixed Income ATS.