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Bank of America Merrill Lynch reached an agreement with the New York Attorney General’s Office to settle the investigation into its electronic trading services.

Under the settlement agreement, Bank of America Merrill Lynch agreed to pay $42 million in penalty to New York State. The firm also admitted to violating the Martin Act, New York Securities Law and New York Executive Law.

In a statement, AG Eric Schneiderman said, “Bank of America Merrill Lynch went to astonishing lengths to defraud its own institutional clients...”

Bank of America Merrill Lynch used “masking” scheme

In its investigation, the AG’s Office found that Bank of America Merrill Lynch engaged in fraudulent activity for multiple years.

Starting in 2008, Bank of America Merrill Lynch concealed to its clients that it was routing millions of their orders for equity securities to electronic liquidity providers (ELPs). The AG’s Office noted that the firm’s scheme was intentional and systematic.

The firm admitted that it has undisclosed agreements with the ELPs including Citadel Securities, Knight Capital, D.E. Shaw, Two Sigma Securities, and Madoff Securities.

According to the AG’s Office, Bank of America Merrill Lynch accomplished its fraud through “masking.”  The process  involves changing the identity of the ELP and the trade confirmation message sent back to clients.

Although the ELP executed the trade, the code indicated that it happened in-house at Bank of America Merrill Lynch. The firm used masking to over 16 million client orders between 2008 and 2013, representing more than 4 billion trades.

Bank of America Merrill Lynch misrepresented its electronic trading services

In addition, the AG’s Office found that Bank of America Merrill Lynch misrepresented its electronic trading services to investors. Its objective was to make its electronic trading services look more safe and sophisticated.

The firm inflated its claims regarding the amount of retail orders routed to and executed in its dark pool called. Over the past several years, the firm claimed that 20% or even 30% of orders in its dark pool came from retail traders. However, in reality, the orders in its dark pool accounted no more than 5%. Its dark pool is called Instinct X.

Furthermore, the AG’s Office said the firm boasted using “Venue Analysis” to find the best trading venue and avoid low-liquidity for client’s orders. In reality, it did not use that analysis to route client trades.