Breaking: World’s second largest FX interbank dealer Deutsche Bank ordered to pay $37 million fine over dark pool order routing

Attorney General Eric T. Schneiderman announced today that Deutsche Bank Securities, Inc. will pay a combined $37 million to the State of New York and the United States Securities and Exchange Commission (“SEC”) to settle investigations into false statements and omissions made in connection with the marketing of Deutsche Bank’s electronic equities order routing services, known as its “Dark Pool Ranking Model.”  As part of the agreement, Deutsche Bank admits that it misled investors and violated New York State and federal securities laws; the Attorney General’s Office and the SEC have also censured Deutsche Bank for its conduct.

Deutsche Bank is the world’s second largest FX interbank dealer by volume, with 14.54% of the world’s FX order flow in 2015 going through its London operations.

“Misleading and self-serving statements that defraud investors will not be tolerated. Electronic order routing systems that route investor orders to various markets, including dark pools, are a part of modern equities trading, and companies that promote their routing capabilities must do so truthfully,” said Attorney General Schneiderman.

The Attorney General’s investigation found – and Deutsche Bank admits – that for two years, from January 2012 through February 2014, Deutsche Bank’s “Dark Pool Ranking Model” (“DPRM”), which Deutsche Bank touted as the “core” of its order router (called “SuperX+”) was not functioning as Deutsche Bank represented.  In fact, when Deutsche Bank discovered in 2013 that a technological problem was causing a significant malfunction in the DPRM, Deutsche Bank did not fully correct the problem or tell clients about it.  Deutsche Bank did, however, ensure that its own dark pool was not impacted by the problem and would remain eligible to receive all client orders.

This settlement with Deutsche Bank arises from Attorney General Schneiderman’s Insider Trading 2.0 initiative, first announced in September 2013, and his Investor Protection Bureau’s investigation into the practices of electronic market makers, broker-dealers, and dark pool operators.  Earlier this year, the State of New York and the SEC reached landmark joint resolutions with Barclays and Credit Suisse concerning those companies’ misrepresentations and omissions about their dark pool and order routing services.  As part of his Insider Trading 2.0 initiative, Attorney General Schneiderman also reached agreements with Thomson Reuters, Business Wire, and others to end practices that unfairly advantaged high frequency traders.

A copy of the agreement with Deutsche Bank can be found here.

The Attorney General’s investigation of Deutsche Bank found, and Deutsche Bank has admitted, that Deutsche Bank’s marketing of its DPRM was materially misleading.  Deutsche Bank’s DPRM was designed to rank the dark pools to which Deutsche Bank routed client orders for equities via SuperX+ by measuring the execution quality and liquidity available at those venues.

For several years, Deutsche Bank represented to clients and potential clients that its DPRM would periodically re-rank the pools to which it routed based on the execution quality experienced in those venues, and that its SuperX+ router used “a sophisticated dark pool ranking model that profiles dark pools based on transaction cost, statistically determined compatibility for each order, client order attributes, and real time market conditions.” Deutsche Bank’s clients and potential clients were led to believe that the DPRM was being regularly updated with new, “objective” data in order to reflect the current state of trading in the venues to which Deutsche Bank routed orders, so as to route client orders to the most optimal venue for each order.

In truth, from January 2012 through February 2014, technological problems caused the execution quality rankings to not be performed.  Despite knowing about the problem for over a year, Deutsche Bank did not address the issue.

• From January 2012 through February 2013, Deutsche Bank used stale rankings (calculated in December 2011) instead of updating the DPRM calculations.   As a result, Deutsche Bank’s ostensibly “real time” rankings were frozen and stale for over a year.
• On February 19, 2013, Deutsche Bank attempted to update the rankings for the first time since December 2011 but was able to do so only for some venues.
• Thereafter, the DPRM again stopped working, and Deutsche Bank did not correct the problem until February 2014.

During the same period, Deutsche Bank added seven new trading venues to the roster of venues to which SuperX+ routed orders.  However, because the DPRM was not working, Deutsche Bank never objectively evaluated the execution quality of those venues.  Instead, Deutsche Bank assigned rankings to those venues based on mere estimates of their expected future performance.  Several of those subjective rankings differed meaningfully from the actual execution quality experienced in these venues.

Additionally, when Deutsche Bank attempted to update the DPRM rankings in February 2013, Deutsche Bank’s own dark pool (named “SuperX”) received a ranking that placed it in the bottom tier of eligible pools, which would have made it ineligible to receive a significant number of orders.  Believing this to be a computational error (but not, at that time, actually knowing whether that was true), Deutsche Bank manually overrode the ranking and “force-ranked” SuperX into its highest routing tier.  As a result, Deutsche Bank routed millions of orders to its own dark pool without the benefit of the “objective” execution quality review that Deutsche Bank had promised it would conduct.  A later forensic review of execution quality data from that time period, conducted after Attorney General Schneiderman commenced his investigation, confirmed that the low ranking was a computational error.

During the entire period from January 2012 through February 2014, Deutsche Bank never informed clients that its DPRM was not operational and that it was subjectively assigning rankings to new venues and to its own dark pool.  Rather, Deutsche Bank used misleading, present-tense descriptions of its order routing as an “objective,” and data-driven.  Between January 1, 2012, and February 28, 2014, SuperX+ routed approximately 1.39 billion orders, representing approximately 1.78 trillion shares.

The resolution announced today is the result of joint efforts by the New York Attorney General’s Office and the SEC.  Attorney General Schneiderman appreciates the successful collaboration with the SEC on this matter.

Attorney General Schneiderman’s investigation was handled by Assistant Attorneys General John Castiglione and Jordan Salberg of the Investor Protection Bureau.  Katherine C. Milgram is Chief of the Investor Protection Bureau. Manisha M. Sheth is the Executive Deputy Attorney General for Economic Justice.