Oct. 21 (Bloomberg) -- U.S. regulators moved to expand disclosure of stock trades handled by so-called dark pools to eliminate advantages for customers using the nation’s fastest- growing markets.

The Securities and Exchange Commission, prodded by two Democratic lawmakers, unanimously proposed lowering the threshold for publicly reporting trades by the off-exchange platforms used by investors to avoid showing their trades. The agency will seek public comment before adopting new limits.

“As markets evolve, the commission must continually seek to preserve the essential role of the public markets in promoting efficient price discovery and investor confidence,” SEC Chairman Mary Schapiro said today in Washington.

The proposal is the latest sign the SEC is toughening oversight of strategies spurred by the growth of alternative exchanges and advances in technology. Dark pools are sometimes used by so-called high-frequency traders, brokerages that execute thousands of orders in a second to profit from tiny price gaps.

U.S. Senators Charles Schumer of New York and Ted Kaufman of Delaware, both Democrats, are urging regulators to crack down on practices they say create an unfair advantage for the biggest investors. Regulators proposed banning so-called flash trades, in which some investors get a half-second glimpse at share orders before the public, last month.

Dark Pools Grow

Trading on dark pools such as Zurich-based Credit Suisse Group AG’s Crossfinder and New York-based Goldman Sachs Group Inc.’s Sigma X, the two largest, has more than quadrupled to 9.4 percent of all U.S. equity volume in three years, according to Tabb Group LLC, a New York-based financial-services consultant.

Under the SEC plan, dark pools will have to publicly report quotes once they handle 0.25 percent of a stock’s daily average volume. The electronic networks usually shut down trading in a security when they approach the existing 5 percent limit.

The agency decided against a 1 percent or 2 percent limit because that would still allow “game playing” in which dark pools would halt trading once they got close to the threshold, said Michael Gaw, an assistant director in the SEC’s division of trading and markets. Dark pools wouldn’t be able to get around a 0.25 percent requirement, Gaw said.

The new SEC threshold may push smaller orders off of dark pools and onto exchanges, analysts said.

“If you were to limit the dark pools to that small amount of trading, it will be much harder to find a counterparty,” said Dirk Hoffmann-Becking, a London-based analyst for Sanford C. Bernstein & Co. For stock exchanges, “if they would see less competition from the dark pool world, that would certainly be a positive for them.”

NYSE, Nasdaq

NYSE Euronext and Nasdaq OMX Group Inc., operators of the biggest U.S. stock exchanges, may benefit from the rule change, according Matthew Samelson, the Stamford, Connecticut-based 2 founder of market research firm Woodbine Associates Inc. Both have lost market share as investors shifted to newer venues.

The New York Stock Exchange handled 28 percent of all U.S. equity trading in September, while Nasdaq processed 22.7 percent. Their combined share has fallen to 50.7 percent from 74.1 percent in March 2006.

The SEC will exempt so-called indications of interest that exceed $200,000 from the new rule. Traders use indications of interest to gauge demand for shares without any obligation to buy or sell.

The SEC also proposed a rule that would require immediate public disclosure of which dark pool executed a trade. The proposal wouldn’t apply to trades exceeding $200,000.

Mutual Fund Investors

The exemptions would allow mutual funds and other big investors to seek bids without moving the market. Firms specializing in large orders account for 8 percent of all dark- pool trading in the U.S., according to data compiled by Aite Group LLC, a financial- services consultant in Boston.

Transactions are biggest at New York-based Liquidnet Holdings Inc. and Pipeline Trading Systems LLC, where orders average 50,000 shares. That compares with 300 to 450 shares at venues such as Getco Execution Services, run by Chicago-based Getco LLC.

The SEC will seek comment from securities firms, exchanges and investors for 90 days before the agency decides whether to hold a second vote to make the proposals binding.

SEC Commissioner Kathleen Casey, a Republican, said the agency should develop a “deeper understanding” of dark pools and high-frequency trading before imposing stiffer regulations.

Off-Exchange Benefits

The growth of stock trading off exchanges has led to benefits, including faster execution of trades, more consumer choice and financial innovation, Casey said.

“The regulatory process re-thinking market structure” must be “driven by data, not politics or unfounded assumptions,” Casey said. “If we rush to regulate without complete understanding of the extent to which complex and dynamic activities may be interrelated, the specter of unintended consequences looms large.”

SEC staff members said they are conducting a broader review and intend to seek feedback from market participants.

Dark pools reduce costs and benefit small investors by letting mutual funds buy and sell securities in private, Goldman Sachs said in a statement posted on its Web site yesterday.

“Institutional investors can improve their trading performance by executing in an anonymous manner that diminishes their footprint,” according to Goldman Sachs, the most- profitable securities firm in history. “In doing so, the clients of these institutional investors, for example mutual funds and pension funds where the bulk of small investors have their money invested, are direct beneficiaries.”

To contact the reporters on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net.

Last Updated: October 21, 2009 15:26 EDT