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(Updates with Barclays, Deutsche Bank, UBS and Credit Suisseshare prices)
By Karen Freifeld, John McCrank and Steve Slater
NEW YORK/LONDON, June 26 (Reuters) - New York's attorneygeneral has filed a securities fraud lawsuit against Barclays, accusing the British bank of giving an unfair edge inthe United States to high-frequency traders, while claiming tobe protecting other clients from them.
News of the lawsuit, which relates to Barclays' LX LiquidityCross 'dark pool' alternative trading system, drove a 5 percentfall in Barclays shares on Thursday. It also hit shares inEurope's Credit Suisse, Deutsche Bank and UBS as traders frettedabout the possibilty they could also be targeted.
The New York State attorney general's lawsuit alleges thatBarclays promised to get the best possible prices for customerslooking to buy or sell shares but instead took steps thatmaximized the bank's profits and executed nearly all of itscustomers' stock orders on LX instead of on exchanges or othervenues that might have offered better prices.
The action is the highest profile case yet to emerge in theU.S. authorities' efforts to ensure that dealers are not rippingoff investors in increasingly automated stock markets.
These probes have been progressing for up to a year, buttook on additional urgency in recent months, after best-sellingauthor Michael Lewis released the book "Flash Boys: A WallStreet Revolt" which contends that markets were rigged.
Dark pools were originally created to allow investors toexecute big trades without tipping off the market. Butever-larger volumes of trades have been shunted into dark poolsand their critics say the opacity of the markets may beresulting in more and more investors getting ripped off.
Barclays' London-listed shares were down 5.2 percent at218.25 pence by 1155 GMT on Thursday, their lowest level sinceNovember 2012 and extending their fall this year to 20 percent.Shares in Deutsche Bank were down 2.2 percent, withUBS and Credit Suisse 1.8 and 2.9 percentlower respectively.
Barclays could suffer a litigation cost of $163 million fromthe activities and Deutsche Bank and UBS could face similarcosts from an industry wide investigation, said analysts atCredit Suisse. They gave no estimate for their own bank.
The lawsuit delivers another blow to Chief Executive AntonyJenkins' efforts to restore Barclay's reputation after a seriesof scandals. He has said its culture, criticised as high-risk,high-reward, had to change and that systems and controls areimproving, but the emergence of past sins are hampering hisefforts.
New York Attorney General Eric Schneiderman said Barclaystold customers who chose to trade in its dark pool that theywould be protected from "predatory traders," which use theirspeed advantage to deprive other investors of small profits onevery trade. But in fact customers were not protected at all,and the bank courted predatory high-frequency traders in part bycharging them virtually nothing, Schneiderman alleged.
"Barclays grew its dark pool by telling investors they werediving into safe waters," Schneiderman said. "Barclays' darkpool was full of predators - there at Barclays' invitation."
"We take these allegations very seriously," Barclays said inan emailed statement. It added that it was cooperating with theauthorities, looking at the matter internally, and that theintegrity of markets was a top priority for the bank.
Schneiderman is looking at dark pools, which are typicallyowned by brokers, including all of the big banks, and whereparticipants are anonymous and trading information is hiddenuntil after the trades are completed.
The U.S. Securities and Exchange Commission has also takenan increased interest in issues surrounding dark pools andhigh-frequency trading. SEC Chair Mary Jo White earlier thismonth said her agency was developing a series of rules thatwould seek to make markets more transparent and fair for allinvestors, and the agency has also stepped up enforcementactions against dark pool operators.
Banks have admitted to bad behavior in other markets, afterprobes showed collusion in currency trading and short-terminterest rate products, among other areas.
NO AIRBAG, NO BRAKES
Jenkins took over as Barclays chief executive in August2012, replacing Bob Diamond who was ousted after the bank wasfined for the alleged manipulation of Libor benchmark interestrates.
Jenkins is trying to improve profitability by cutting costs,including the axing of around a quarter of investment bank jobs,while pushing for the change in culture.
But the bank continues to be dogged by issues around pastconduct, however. Last month it was fined 26 million pounds($43.8 million) for past failures in internal controls thatallowed a trader to manipulate the setting of gold prices.
The New York Attorney General's complaint against Barclays,which is based on internal communications provided by formeremployees, says while the firm told its clients it would keephigh-frequency traders that engage in "predatory" tradingpractices out of its dark pool, it never actually prevented anytrader from participating.
For example, the complaint alleged that Barclays falsifiedmarketing material it said showed the extent and type ofhigh-frequency traders in its dark pool by not includinghigh-frequency trading firm Tradebot Systems. Barclays hadalready identified Tradebot, which at the time was the largestparticipant in the dark pool, as having been engaged inaggressive trading behavior.
A spokeswoman for Tradebot, of Kansas City, Missouri, saidthe firm had no comment.
Barclays wooed high-frequency traders by disclosingdetailed, sensitive information about other customers to thefirms to help ensure their aggressive trading strategies wereeffective, and by charging them almost nothing, the complaintsaid. HFT accounts for around half of all U.S. trading volume.
The complaint did not specify the amount of damages beingsought from Barclays.
Barclays also told its clients it does not favor its owndark pool when routing client orders to trading venues, when inreality it was doing just that, the complaint said. One formerBarclays employee told the Attorney General's office that basedon the high amount of client orders Barclays was sending to itsown dark pool, better trading opportunities may have been missedelsewhere.
There was a lot going on in the dark pool that was not inthe best interests of Barclays clients, one former directorsaid, according to the complaint. "The practice of almostensuring that every counterparty would be a high-frequency firm,it seems to me that that wouldn't be in the best interest oftheir clients ... It's almost like they are building a car andsaying it has an airbag and there is no airbag or brakes."
The SEC is considering forcing dark pools and firms thatmatch customers' orders internally to tell regulators and thepublic how they operate. In early June, the SEC filed a civillawsuit against dark pool operator Liquidnet for allegedlyimproperly using its subscribers' confidential tradinginformation to market its services.
The SEC declined to comment on the lawsuit. (Additional reporting by Herb Lash in New York and Steve Slaterin London; Editing by Greg Mahlich and Sophie Walker)
