ITG Faces Fight for Reputation Amid Fallout From Dark-Pool Probe

Investment Technology Group Inc. built its reputation as a trustworthy broker. Now that it’s dealing with a government investigation, it must fight to keep that image.

The departures of Chief Executive Officer Bob Gasser and General Counsel Mats Goebels on Monday were a sign of the seriousness of the Securities and Exchange Commission’s probe. ITG said last week that it could be slapped with a record $20.3 million fine for actions taken by a market-making unit in its Posit dark pool.

The SEC’s probe puts ITG -- which operates one of the 10 largest alternative trading systems in the U.S. -- at a crossroads. A firm that has cultivated a client-friendly image now faces a fight to save its reputation and persuade clients its alleged wrongdoings are firmly behind it.

“ITG has a distinguished heritage of trust and integrity,” Interim CEO Jarrett Lilien said Tuesday during the company’s second-quarter earnings call. “There’s no question that this reputation has been tested, but we now have the opportunity and the responsibility to win it back.”

As ITG’s board searches for a permanent leader -- a process Chairman Maureen O’Hara said she is hopeful will be completed within three months -- Lilien must round up support among clients that have taken business elsewhere.

‘Probable’ Penalty

ITG reported that U.S. volume market share has fallen by a quarter since announcing a “probable” SEC penalty last week. The fall in volume was a combination of some clients sending fewer orders to ITG and others shutting the firm off entirely, the company said Tuesday.

International volume hasn’t been affected. ITG’s Posit platform attracted 1.2 percent of the European market Tuesday, not far from the 1 percent share it had July 29 before news of the SEC settlement broke, according to data from Bats Chi-X Europe.

Since disclosing the potential fine, ITG shares have fallen 23 percent, closing at $18.48 on Tuesday. Following the earnings call, Evercore ISI analyst Chris Allen reduced his target price for the stock to $24 from $33, writing in a note that ITG has “a lot of wood to chop.”

“The next step is for them to get out to clients, give them the full story and the unvarnished truth,” Larry Tabb, CEO of research firm Tabb Group LLC, said by phone. More management changes could follow in a “housecleaning effort,” he said, adding that a thorough audit of ITG’s order flow and technology would help restore some of customers’ lost faith.

Latest Salvo

The investigation into ITG is another salvo by regulators in their battle to police how Wall Street’s private venues have behaved in recent years. UBS Group AG settled an SEC complaint for a record $14.4 million in January, without admitting or denying its guilt. Barclays Plc is fighting a case brought by New York Attorney General Eric Schneiderman over how it marketed and operated its dark pool.

Pipeline Trading Systems LLC paid $1 million in 2011 as part of a settlement after the SEC found that a proprietary trading unit was trading against Pipeline clients. That breach of investor confidence spelled disaster for Pipeline, which was forced to close its doors.

“In a marketplace where there are dozens of pools of liquidity to choose from and obviously several stock exchanges to choose from, I think it’s really difficult” to hold onto volume and business, Tyler Gellasch, executive director of Healthy Markets Association, wrote in an e-mail. “It may be easier for brokers and traders to frankly just turn off a venue and not bother with it.”

SEC Investigation

The SEC is investigating violations concerning customer disclosures, regulatory filings and customer information controls, ITG said.

After taking the reins from Lilien -- who joined ITG’s board of directors in mid-April -- the next CEO could send the firm in a number of new directions, including becoming active in mergers and acquisitions. In March, the company was said to be in talks to buy brokerage-services provider Convergex for about $200 million. Lilien said Tuesday that he sees opportunities for both organic growth and “a series of other strategic alternatives.”

“Maybe that will reheat,” Tabb said. “With this action and the change in leadership, there’s a chance that there may be a change in focus.”

The SEC’s investigation has already come at a cost to shareholders: The firm on Monday announced a second-quarter loss of $10.2 million, which includes the more than $20 million set aside for a possible penalty.

Otherwise Sound

Sang Lee, co-founder of research firm Aite Group, believes that though the potential fine may have dealt a blow to ITG’s reputation, its core business remains sound, provided it can regain client trust.

“They have a huge transaction-cost-analysis piece, they have a research piece, they have a technology piece,” Lee said. “In terms of revenues and business relationships, they have multiple touch-points there.”

One outcome that could make it harder for ITG to put the case behind it is if the company admits guilt in the SEC settlement. Such admissions are relatively rare, but they can dramatically ramp up the stakes for a company.

“There’s a myriad of ways an admission of wrongdoing could come back to bite you,” Thomas Zaccaro, a former SEC enforcement attorney and now at Zaccaro Morgan LLP in Los Angeles, said by phone. “And you’re stuck with your admission.”

For example, any admissions could lead to shareholder lawsuits and create greater ill-will among clients, he said.

“The headline looks a lot different if the company is admitting the conduct, rather than settling on a not-admit-or-deny basis,” Zaccaro said.

ITG’s focus as it awaits the SEC settlement should be on contacting its customers directly, Aite’s Lee said.

“For a firm that’s very much technology-focused, I think right now their biggest asset from a technology perspective could be either a telephone or an in-person meeting,” Lee said.

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