A.G. Schneiderman Announces Record $42 Million Settlement With Bank Of America Merrill Lynch Over Fraudulent “Masking” Scheme In Electronic Trading Division
Bank of America Merrill Lynch Admits To Systematically Misleading Clients About How Stock Orders Were Handled; Admits to Violating New York’s Martin Act
$42 Million Penalty Is Largest Ever State Recovery In Connection With An Electronic Trading Investigation
NEW YORK – Attorney General Eric Schneiderman announced today that Bank of America Merrill Lynch (“BofAML”) will pay a record $42 million penalty to the State of New York to settle an investigation into fraudulent practices in connection with BofAML’s electronic trading services. As part of the settlement, BofAML admits that, pursuant to undisclosed agreements with so-called electronic liquidity providers (“ELPs”) such as Citadel Securities, Knight Capital, D.E. Shaw, Two Sigma Securities, and Madoff Securities, BofAML systematically concealed from its clients over a five-year period that it was secretly routing its clients’ orders for equity securities to such firms for execution. Attorney General Schneiderman’s investigation uncovered that BofAML made other misleading statements to its clients regarding several aspects of its electronic trading services—statements that made BofAML’s electronic trading services appear safer and more sophisticated than they really were. In addition to paying a penalty to New York State, BofAML admitted that it violated the Martin Act, New York’s securities law, and New York Executive Law § 63(12).
“Bank of America Merrill Lynch went to astonishing lengths to defraud its own institutional clients about who was seeing and filling their orders, who was trading in its dark pool, and the capabilities of its electronic trading services,” Attorney General Schneiderman said. “As Wall Street firms offer increasingly complex electronic trading services, they cannot use new technology to exploit their clients in service of their business relationships with large industry players, like Bank of America Merrill Lynch did here.”
The Attorney General’s investigation revealed, and BofAML admits, that BofAML engaged in a multi-year fraud in connection with the operation of its electronic trading division. Beginning in 2008, BofAML intentionally and methodically concealed from its clients that it was routing millions of their orders for equity securities to ELPs like Citadel, Two Sigma, Knight, and others. Instead, BofAML told its clients that those orders were executing in-house at BofAML. The company accomplished its fraud by re-programming its electronic trading systems to automatically doctor the trade confirmation messaging sent back to its clients after executions by these firms, in a process that BofAML employees referred to internally as “masking.” “Masking” involved replacing the identity of the ELP to whom the order was routed with a code indicating that the trade occurred in-house at BofAML. BofAML applied its “masking” strategy to over 16 million client orders between 2008 and 2013, representing over 4 billion traded shares.
In order to avoid detection, BofAML also altered post-trade reports called “transaction cost analysis” reports, which are meant to help clients understand where and how their orders are executed. BofAML generated reports that reflected that BofAML was the venue where clients’ trades had executed, even though the trades had actually been executed by ELPs. BofAML also altered client invoices and other written documentation that would ordinarily reveal to clients where their trades had executed.
As set forth fully in the Settlement Agreement, the Attorney General’s investigation also uncovered that BofAML made other inaccurate representations to investors about BofAML’s electronic trading services, in an effort to make the firm’s electronic trading services look more sophisticated and safer than they really were:
- BofAML inflated its claims about the amount of retail orders routed to and executed in its dark pool, called “Instinct X.” Over several years, BofAML claimed that 20% or even 30% of the orders in its dark pool came from retail traders. OAG’s investigation determined that, in reality, BofAML’s retail client orders typically accounted for no more than 5% of the orders in Instinct X. BofAML also significantly overstated the number of retail orders that were in fact executed in Instinct X once routed there.
- BofAML touted a “Venue Analysis” that it purportedly used to find the best trading venue for its clients’ orders, and to avoid low-liquidity or otherwise “toxic” trading venues. Over several years, BofAML distributed marketing materials that purported to represent how BofAML’s trading algorithms made “strategic” and “tactical” decisions about how and where to route client orders on an “order by order” basis. In fact, BofAML did not use that analysis to route client trades, and BofAML’s algorithms and order router did not access the analysis, or the data underlying it, to make trading decisions for clients. In addition, although the underlying data reflecting the performance of various venues changed over time, BofAML did not update the analysis it distributed to its clients.