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Shedding Light on Dark Pools

Posted by Larry Doyle on October 20, 2009 4:17 PM |

Kudos to Joe Saluzzi once again. While a number of people in the markets have been pushing for increased oversight of high frequency trading, in my opinion, nobody deserves more credit than Joe Saluzzi of Themis Trading. The pressure initiated by Joe and pushed by others is starting to bear real results. How so?

The highly predatory nature of ‘flash orders’ will likely be discontinued. Now we learn that trading activity in dark pools will also likely be seriously restricted. What are dark pools? Why should you care? If you have an interest in the markets, you should care. Let’s navigate.

I was honored to have Joe join me on August 2nd on No Quarter Radio’s Sense on Cents with Larry Doyle. From my review of that interview, we learned that dark pools have developed in the following manner:

– Originally launched by one or two exchanges for the purpose of allowing major money managers to cross large blocks of stock ‘off the floor’ and thus protect the buyers and sellers identities and the price of the transaction

– Now every dealer and exchange have developed dark pools resulting in more and more business occurring off exchanges and without any benefit of transparency. Who is disadvantged? Those without access to the dark pools.

– Dark pools initially had minimum size orders, but many dark pools have increasingly shifted away from a size requirement.

– Dark pools have developed in such a way that some market participants will abuse the intended purpose of the facility, that is to transact, and instead will look to discover information on pending orders through these dark pools.

In summary, dark pools have become a facility which certain market participants are able to utilize at the expense of other market participants. As such, they provide anything but a level playing field. Why were these dark pools ever allowed to develop in such a fashion? Great question and likely a testament to the power of the Wall Street lobby and the profit driven structure of the exchanges.

At long last and thanks to the efforts of Joe and others who desire a fair and level playing field for all investors, the SEC is addressing the problems lurking in these dark pools. Bloomberg highlights this development in writing, Dark Pool Trade Limit Said to Be Cut 95% in SEC Plan:

The U.S. Securities and Exchange Commission will propose toughening its limits on the amount of anonymous trading carried out on stock platforms called dark pools, according to two people familiar with the deliberations.

The commission will propose lowering the amount of daily volume in a company’s shares that can be executed on the networks before prices must be made public to 0.25 percent from 5 percent tomorrow, said the people, who declined to be identified because the discussions weren’t public. John Nester, an SEC spokesman, declined to comment.

The rule change may curtail the number of transactions on dark pools, off-exchange platforms run by firms such as Goldman Sachs Group Inc. and Getco LLC that have drawn scrutiny from Democratic Senators Ted Kaufman of Delaware and Charles Schumer of New York. The systems usually shut down trading in a security when they approach the current 5 percent limit.

Traders turn to dark pools instead of public markets such as the New York Stock Exchange to avoid revealing their identities and giving competitors clues about their strategies. Kaufman and Schumer say the platforms limit transparency in securities markets and put smaller investors at a disadvantage.

A market that does not serve the interests of all its participants in an equitable fashion is not a market. An exchange which favors certain participants over others is not an exchange. Dark pools are another form of crony capitalism.

Thank you Joe Saluzzi for exposing the inequity in this corner of our landscape.

LD

  • TeakWoodKite

    Why is Goldman Sachs aloud to participate in recluse transactions not available to the public for review when they are the recipients of the public bailouts?

    Great article, LD

    “Dark Pools” sounds like name of a financial horror flick or who doneit suspense/thillers.
    If there is no tracking of these trades, how does the government monitor for illict and terrorist financing? I am not say these entities would knowingly be a party to these types of transactions, but I can’t help but be reminded of BCCI.

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