Pipeline Trading Systems Takes Privacy Too Far

  One of my favorite companies to cover over the past few years, dark pool provider Pipeline Trading Systems, has been nailed by the SEC for operating an affiliate company that was actually trading against its customers. 

  The Pipeline case is disappointing, and brings to light a whole new area that regulators now have to worry about - privately held trading venues. Because Pipeline Trading Systems LLC and Pipeline Financial Group are both registered in Delaware, the state that offers the least litigation and the most privacy (does not require director or officer names to be listed in the formation documents), there is little information to be found on its owners or its subsidiaries. 

  What can be found online is that Federspiel's original company - eXchange Advantage Corporation - exhibited at a venture capital beauty pageant in 2001, so it stands to reason that it received backing somewhere. This was apparently Pipeline's vehicle for providing liquidity to its dark pool ATS, it changed the name to Aurora then to Milstream, and was residing in the same NYC building as Pipeline. The whole thing flew in the face of Regulation ATS, and you would think both partners must have known that. Yet no one sussed that something was off.  
  The financial press has barely scratched the surface in this story, only looking at the SEC filing and not digging much further.The FT did turn up one interesting nugget: A non-exec at Pipeline, Giles Vardey, also serves as non-exec chairman at London micro cap exchange Plus Markets Group. He has been asked to step down from Plus Markets by a Middle Eastern investment syndicate. Curiouser and curiouser... 

  It isn't an easy task putting the pieces together. With private companies there are no legal identifiers, and audit trails often end in - well, Delaware. I believe in privacy but this goes too far. Scary.

A Tale of Two Regulatory Regimes

     One of these things is not like the other. In a tale of global regulatory disharmony, European regulators say they are going to crack down on high frequency trading, perhaps by forcing perpetrators to become de facto market makers, according to today's FT. They are concerned that HFT algorithms can remove liquidity when trading conditions go against them or are too volatile to read - as happened on the May 6th Flash Crash.
     Fair enough. But forcing HFTs and banks to be market makers in each and every instrument they trade is begging for trouble. It would require a huge amount of additional capital, an issue banks are already whining about. And it flies directly in the face of the U.S. Volcker Rule, the guidelines for which have just been laid out. Specifically, no bank should end up with a long or short position while performing market maker or hedging duties for customers.
     U.S. banks are already confused about the distinction between proprietary trading and taking the other side of a customer's trade, along with the risk exposure that it creates. If they sense that regulators will knock heads every time a client-related position is not fully hedged, they might just move their business elsewhere. This is exactly the regulatory arbitrage that Wall Street was worried about, because it could cost them a lot of business. NYC traders will be polishing up their EU passports.