ITG Pays Record Dark Pool Fine for Secret Trading Desk

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Investment Technology Group Inc. agreed to pay a record fine for violations involving a dark pool and admitted wrongdoing over allegations that it ran a secret trading desk that misused information about clients’ orders.

ITG will pay a total of $20.3 million for operating a proprietary trading desk that used knowledge of customers’ requests to trade for its own benefit, leveraging data other users of the dark pool didn’t have, the U.S. Securities and Exchange Commission said in a statement Wednesday.

ITG generated $2.1 million in revenue from the desk, known as “Project Omega,” the SEC said. Profit amounted to $124,000, according to a person familiar with the matter, who asked not to be identified because the information isn’t public.

“The conduct here was egregious,” Andrew Ceresney, director of the SEC’s enforcement division, said during a conference call Wednesday. “The abuse of confidential information is significant.”

The regulator is pursuing other dark pool cases and has uncovered instances of behavior similar to ITG’s at other firms, Ceresney said. Those include misusing confidential information and misrepresenting to clients how certain dark pools operate. “This area remains a significant focus for us,” he said.

The action against ITG is the latest effort by regulators to police wrongdoing on alternative trading systems, which allow clients to buy and sell shares with more anonymity than they can on traditional stock exchanges. ITG’s $18 million fine surpasses the previous record penalty of $12 million that UBS Group AG agreed to pay in January.

Board Approval

ITG’s board approved Project Omega with the backing of senior management, according to the SEC, which said the wrongdoing spanned from April 2010 to July 2011. The division was run by Hitesh Mittal, who left the company in 2011. Chief Executive Officer Bob Gasser, who also ran ITG during the period covering the SEC’s allegations, was ousted last week.

After the SEC announced its enforcement case Wednesday, AQR Capital Management said it ended its employment relationship with Mittal, its head trader, on Aug. 9.

The employees at Project Omega included people with deep knowledge of ITG’s trading algorithms, the software that executes client orders, according to the SEC’s case against ITG. Some of them were allowed to retain access to information they’d needed in their prior roles.

Omega’s Advantage

The problem, according to the SEC, is Project Omega had an advantage over all other users of ITG’s Posit dark pool: It knew about the trades customers wanted to place. When a client wanted to buy a stock, Project Omega detected that and tried to buy the stock at the best price on a public venue. If it succeeded it then profitably sold to the client.

Another approach, called the Heatmap Strategy, involved using confidential customer information to sniff out demand on dark pools other than ITG’s own. Project Omega would then try to buy shares and sell them to participants who were trading on those venues.

The group operated in secrecy, according to the SEC.

“From the start, and during the entire time it was in operation, Project Omega’s existence and trading activities were kept confidential and were not disclosed to ITG customers or Posit subscribers or to the Commission,” the SEC said. “Even within ITG, Project Omega was only to be discussed on a ‘need-to-know’ basis, and even the customer-facing side of ITG was not informed of Omega’s existence.”

The order alleges that in December 2010, ITG executives and compliance department learned about some of Project Omega’s illicit tactics and suspended its trading. After making changes to its systems, the unit was restarted later that month, but with the same personnel.

Retaining Access

Even after the changes, “Project Omega continued to have improper access to information identifying Posit subscribers,” the SEC said.

The unit was eventually closed in July 2011, only after Mittal’s departure from the firm.

“Settling with the SEC was an important next step for ITG in our view,” wrote Evercore ISI analyst Chris Allen in a report. “A much bigger step will be rebuilding client trust, which will take time, particularly in light of the damning details in the SEC order.”

Allen also suggested that ITG’s board requires a shake-up.

“It appears four current members were on the board at the time this decision was made,” he wrote. “Given the initial decision by the Board and the lethargic reaction to the SEC investigation, we question whether the four acting board members since 2010 are fit to serve moving forward.”

Plunging Shares

Kevin J.P. O’Hara, who had been a director since 2007, quit on July 23, saying in his resignation letter, “Over the last several months, continuous fundamental, strategic and vital differences of opinion and direction have transpired at the Board level and, in particular, between me and the Board’s leadership.”

ITG shares fell 3.9 percent to $16.81 at 4 p.m. New York time Wednesday, reaching the lowest closing price since October. The stock plunged 24 percent on July 30, the day after ITG said an SEC settlement was probably coming.

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