Dark Pools Face Enhanced Regulator Scrutiny

By Mani
Updated on

“Dark Pools” operators are now subjected to enhanced scrutiny from regulators, according to a Wall Street Journal Report.

Dark Pools Face Enhanced Regulator Scrutiny

Wall Street’s self-regulatory body, the Financial Industry Regulatory Authority (FINRA), sent 15 examination letters last month to ‘dark pools’ operators, seeking more information on  their operations, client profile and surveillance systems adopted.

What Were Dark Pools Set Up For?

Dark pools were set up to allow large investors to trade big blocks without having news of their orders move the price. Dark Pools don’t publish bids or offers on shares. They publish trade data only after transactions occur.

About 13 percent of all stock-market transactions take place on dark pools, an increase from 4 percent reported five years ago, according to the market research firm, Tabb Group.

Despite their popularity, regulators still have little clue on how the dark pools operate, since unlike exchanges, the dark pools are not required to disclose detailed information about their trading systems.

Three of the largest U.S. dark pools were operated by Credit Suisse Group AG (NYSE:CS), Goldman Sachs Group, Inc. (NYSE:GS) and Barclays PLC (NYSE:BCS). They reportedly received the letters from the regulator.

Potential For Abuse

Securities and Exchange Commission (SEC) officials also admitted last month that though dark pools are not inherently bad, they pose ‘potential for abuse’, since their quoting activity can’t be seen.

The regulators are monitoring whether firms are placing orders in the public market with the intention to manipulate prices in dark pools. Such information would facilitate high-speed traders as they would come to know the public price before it hits a dark pool.

Due to its opaque, lightly regulated, off-exchange trading nature, regulators are broadening dark pool oversight. The SEC is seeking information on how the order types operate and whether some order types are provided only to certain clients.

FINRA is also weighing whether to submit a plan to the SEC to enable it to more closely track dark pool trading volumes. The SEC has also been investigating whether some high-speed traders use these order types on stock exchanges in a way that could hurt other investors.

Some of the other information sought by FINRA include: how various units of a broker-dealer interact with customer orders on the brokers’ own dark pools, whether a firm’s proprietary traders can enter orders, quotes or other trading interests into its dark pool, whether dark pool operators are policing for abusive trading activities, how the firm’s surveillance system is designed to capture, and response measures taken to handle problematic activity.

During 2011, the SEC imposed a fine of $1 million on the now-defunct Pipeline Trading Systems LLC for their alleged failure to disclose that a secretive trading unit interacted with a vast majority of client orders. Last October, another dark pool operator, LeveL ATS, settled SEC allegations for its improper sharing of confidential trading information with one of its investors, a unit of Citigroup Inc (NYSE:C).

Interestingly, three large U.S. stock exchanges such as NYSE Euronext (NYSE:NYX) (EPA:NYX), Nasdaq OMX Group, Inc. (NASDAQ:NDAQ)  and Bats Global Markets, Inc (BATS:BATS) are lobbying for more restrictions on dark pools, arguing too much trading has become hidden on private venues, accentuating volatility in public markets.

Leave a Comment