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Dark Pool Access Rules Must Be Reviewed, NYSE’s Leibowitz Says

Dark pools, the private stock platforms whose share of U.S. equity trading climbed to a record in April, have too much discretion to choose who can use them, NYSE Euronext Chief Operating Officer Larry Leibowitz said.

The venues are inaccessible to some investors until they’ve executed 5 percent of daily volume for a stock in four of the previous six months, according to Securities and Exchange Commission rules. Public exchanges such as the New York Stock Exchange provide all traders access to their bids and offers.

Leibowitz said regulators should reconsider the threshold at an SEC forum in Washington yesterday, five days after Rosenblatt Securities Inc. said dark pools accounted for 11.5 percent of U.S. equities trading volume in April. Nasdaq OMX Group Inc. and NYSE Euronext say uneven oversight gives dark pools an advantage at the expense of the public markets.

“The 5 percent rule is arbitrary,” Leibowitz said yesterday in Washington at a Securities and Exchange Commission hearing on the structure of U.S. equity markets. “It’s very difficult for exchanges to compete.”

Dark pools are used by mutual funds and pension funds seeking to mask their identities and the size of their transactions, an attempt to lower expenses by avoiding traders who try to profit off their buy and sell orders.

Greater Focus

The SEC proposed measures in October aimed at curtailing the growth of dark pools to avoid promoting a two-tiered market in which some investors have access to order information that others don’t receive. The commission increased its focus on the nonpublic venues in January as part of a broad overview of market structure.

The SEC set the 5 percent threshold that forces dark pools to open trading in a stock to all investors to allow venues to grow and provide trading options for investors. In January, the commission asked whether 5 percent is too high.

“If I went to zero, my competition then becomes the exchange,” said Andrew Silverman, global co-head of Morgan Stanley Electronic Trading. The private venues shouldn’t be required to provide “unfettered access to predatory orders,” he added.

There were 32 dark pools in the U.S. during the third quarter, according to the SEC. Most are run by broker-dealers such as Zurich-based Credit Suisse Group AG and New York-based Goldman Sachs Group Inc. and Morgan Stanley. Additional venues also operate as non-displayed markets without needing to register as alternative trading systems. There are currently 10 securities exchanges and will soon be 14.

Fidelity Magellan

Dark pools are needed because they help mutual funds keep their trades private, saving money for investors, said Brian Conroy, the head of global equity trading at Fidelity Investments. The Boston-based firm runs the $22.9 billion Fidelity Magellan Fund and $62.8 billion Fidelity Contrafund.

“Interaction and competition is actually very good for the marketplace,” he said. “We do not favor one type of trading venue or model over another.”

Exchanges offer advantages over dark pools, according to Dan Mathisson, the New York-based head of the Advanced Execution Services unit at Credit Suisse. They receive revenue from quotation and trading data sold to vendors such as Thomson Reuters Corp. and Bloomberg LP, the owner of Bloomberg News, and pay lower clearing fees for executions than brokers operating dark pools do, he said.

Credit Suisse’s Crossfinder, the largest dark pool in the U.S., handled 2.1 percent of equities trading in May, Mathisson said at the hearing.

When dark pools handle more than about 40 percent of trading in a given stock, volatility increases and the spread between the bid and ask prices widens, which hurts markets, Leibowitz said. While no one knows what the “tipping point” is, the SEC should review the effect more trading in dark pools has on stock prices, he said.

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