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Liquidnet Inc. has agreed to pay a $5 million civil penalty to resolve allegations brought by the U.S. Securities and Exchange Commission (SEC) that the broker-dealer failed to establish proper controls related to market access and the protection of confidential subscriber trading information. The settlement, which was announced on Friday, also includes a censure, though Liquidnet neither admits nor denies any of the SEC's findings.

According to the SEC’s order, Liquidnet violated the market access rule from 2019 through 2023. The market access rule, which was introduced to ensure that broker-dealers have proper financial risk management controls and supervisory procedures in place, requires firms to take steps to prevent the entry of orders that would exceed appropriate credit thresholds for non-broker-dealer customers. Broker-dealers must also regularly review the effectiveness of these controls and procedures.

The SEC alleged that from 2019 to 2023, Liquidnet violated the market access rule by setting credit thresholds for non-broker-dealer customers without first conducting proper due diligence on the customers' creditworthiness. According to the order, Liquidnet often set customer credit thresholds at a default value of $1 billion, irrespective of the customer's actual financial standing. The SEC claims that Liquidnet also failed to implement systems to prevent these thresholds from being exceeded, and that the company did not conduct the necessary reviews or certifications of compliance with the market access rule until 2023.

In addition to the market access violations, the SEC's order also highlighted issues regarding the protection of confidential subscriber trading information. Specifically, the SEC found that Liquidnet failed to establish adequate safeguards and procedures to limit access to confidential data, particularly for employees of the alternative trading system (ATS) who were not responsible for operating the system or ensuring compliance with applicable rules. Liquidnet reportedly allowed employees without operational or compliance responsibilities to access certain confidential subscriber trading information, which primarily included match and execution data. However, this access did not typically extend to subscribers' unmatched indications of interest, except on an aggregate and non-symbol specific basis.

The SEC further noted that Liquidnet did not have proper access controls for certain ATS data that was used by technology personnel for testing purposes, which led to additional concerns about the firm’s handling of sensitive information. The SEC’s order also pointed out that Liquidnet made material misrepresentations to customers about the firm’s compliance with the market access rule and its safeguards for protecting confidential trading information. In addition, the firm failed to disclose certain information in its Form ATS-N and Form ATS filings that would have clarified who had access to confidential subscriber trading information and the nature of that access.

Joseph Sansone, chief of the SEC's Market Abuse Unit, commented on the importance of proper controls for ATS operators, noting that these firms play a significant role in providing liquidity in public markets. He emphasized that it is crucial for ATS operators to have systems in place to mitigate risks related to market access and the potential exposure of confidential subscriber trading information in order to protect investors.

In response to the settlement, Liquidnet issued a statement saying that the firm has implemented a targeted program of specific measures to address the issues raised in the SEC's order and to prevent any future recurrence of similar problems. The company expressed appreciation for the collaboration with regulatory authorities and reaffirmed its commitment to upholding the highest standards of data protection and operational excellence.

The SEC’s investigation into Liquidnet was represented by Rachael Clarke, Mandy Sturmfelz, and Lindsay S. Moilanen. Legal counsel for Liquidnet was not immediately identified.

The case is In the Matter of Liquidnet Inc., case number 3-22394, before the U.S. Securities and Exchange Commission.