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Pipeline Financial's Top Officers Leave in Wake of 'Dark Pool' Case

Wednesday, November 16, 2011

WALL STREET JOURNAL

By SCOTT PATTERSON And JENNY STRASBURG

The top two executives at Pipeline Financial Group Inc. left the company weeks after the Securities and Exchange Commission said the "dark pool" trading platform systematically mistreated customer orders for years.

Pipeline Chairman Alfred Berkeley and Chief Executive Fred Federspiel agreed to step down earlier this month as the firm struggled to recover from the securities regulator's allegations, which have crippled its trading business, according to a person familiar with the matter. Both men had agreed to pay fines to settle the SEC's complaint.

 Mr. Berkeley, 67 years old, decided to retire about a week ago, and Mr. Federspiel, 48, resigned Nov. 13, a company spokesman said when contacted Tuesday. Messages left at the listed home numbers for both men weren't returned.

Pipeline said Tuesday that it will appoint Jay Biancamano, 48, executive chairman, succeeding Mr. Berkeley. "My No. 1 goal is to regain the trust of our clients," Mr. Biancamano, who previously worked at New York dark-pool operator Liquidnet Holdings Inc., said in an interview.

The SEC last month fined a unit of the firm, Pipeline Trading Systems LLC, along with Messrs. Berkeley and Federspiel a combined $1.2 million as part of its settlement, in which the firm didn't admit or deny wrongdoing. The regulator had accused Pipeline Trading, operating as a registered trading network since 2004, of profiting ahead of orders clients had placed within the firm's dark pool, a private electronic network that caters to investors who seek to trade anonymously without attracting attention in ways that could move stock prices.

Pipeline advertised itself as a venue that matched investor orders directly, without an intermediary. But according to the SEC, a Pipeline entity called Milstream Strategy Group LLC used streams of information from Pipeline Trading Systems to help predict what shares Pipeline's customers were trying to buy and sell. Milstream in turn made similar trades before filling customer orders in the Pipeline dark pool, the SEC said.

After racking up losses in its first few years, the entity now known as Milstream began to make money in 2008. In 2008, 2009 and 2010, it took in profits of $18.4 million, $9.3 million and $4.5 million, respectively, the SEC said

Industry experts weren't surprised by the moves. "The fact that they appear to have allegedly hid all of this from their customers, I don't see how it could have ended any other way," said Justin Schack, a managing director at Rosenblatt Securities who tracks dark-pool activity.

The case was the SEC's first enforcement action involving dark pools, and it shocked the trading community, according to traders and other operators of electronic-trading systems. People who know Messrs. Berkeley and Federspiel said they were highly regarded among their peers. Mr. Berkeley was a former president and vice chairman of the Nasdaq Stock Market. Mr. Federspiel once worked at the Los Alamos National Laboratory as a nuclear physicist.

The securities regulator said Mr. Federspiel was directly involved in guiding Milstream to place orders in specific stocks to help inflate volumes within the dark pool, helping to facilitate client orders while also luring new business.

At the same time, he and Mr. Berkeley repeatedly assured current and potential clients in marketing materials and public statements going back at least to 2005 that Pipeline was safeguarding their trades, according to the SEC.

Pipeline, Mr. Federspiel said in one such statement cited by the SEC, was designed to reduce "the predatory practices that can occur in traditional trading venues … to the point of extinction."

In another case, Mr. Berkeley called Pipeline a "confidential channel" that kept clients' intentions secret.

"We have some of the smartest guys in the country figuring out how to make it hard to see customer orders," Mr. Berkeley said in a 2009 interview excerpted by the SEC. He called high-frequency traders "the natural enemy" of big investors like hedge funds and mutual funds.

The SEC added, "At the time, however, the [Pipeline] Affiliate was a high-frequency firm that sought to predict the side and price of Pipeline customers' orders and then typically traded on the same side as those orders in other trading venues before filling them" through Pipeline.

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