What Barclays PLC Investors Need To Know About Securities Fraud Complaint

The New York Attorney General has filed a lawsuit against Barclays (LSE: BARC) (NYSE: BCS.US) that alleges that the bank gives an unfair edge to predatory high-frequency traders, despite Barclays claiming that investors were protected and swimming in “safe waters”.

The complaint did not specify the amount of monetary damages sought, but if the allegations against Barclays are proved then the fines would likely be sizeable. Barclays recently settled claims that it misled US mortgage lenders Fannie Mae and Freddie Mac during 2005-2007, paying $280m (£167m) in total.

Shares in Barclays fell 5% to 218p during early trade.

Swimming with sharks

BarclaysRegulators in the US — including the Securities and Exchange Commision, a federal agency which regulates markets — have begun shining a spotlight on ‘dark pools’ and high-frequency trading to make sure investors are protected.

Institutional investors use dark pools — private trading venues — to place large orders without revealing their hand to the market. Dark pools are increasingly commonplace and there are thought to be about 50 operating in the US, where they compete with the major stock markets. The London Stock Exchange is considered a ‘light market’ due to its transparency and level of regulation.

“Barclays’ dark pool was full of predators”, according to the lawsuit, even though it promised to get customers the best price for each trade. A different venue or exchange may have offered a better price.

Are you being ripped off?

Tradebot Systems, which trades over 5,000 times each month, was Barclays’ largest customer. According to the lawsuit Barclays removed the identity of Tradebot from marketing documents to cover up the appearance of high-speed traders.

If you’re a buy and hold investor then you aren’t concerned about short-term price fluctuations. The famous Buffett quote sums it up, “if you wouldn’t feel comfortable owning a company’s shares for ten years, you shouldn’t own them for ten minutes.”

For big institutions, however, it’s more problematic. If an institutional investor buys a million shares selling for £1 then the cost should be £1m. A high-frequency trading platform uses powerful computers to work out when this is happening. So after 10,000 shares have been sold for £1, the computer buys the remaining 990,000 first and sells them on at a higher price. It can be for just a penny extra and the high-frequency trader makes a £10,000 profit. This can happen hundreds of times a day which can rack up big returns.

What to do with your Barclays shares?

The question for Barclays investors centres on the remaining upside. The shares are down 20% this year, and while they may come up, there could be better opportunities elsewhere in the market. (Especially if the allegations are proven.) For what it's worth, we believe only a handful of companies will make impressive gains in 2014.

You can discover "What The Smart Money Is Buying Right Now" in the Motley Fool's latest free report.

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Mark does not own shares in Barclays.