FINRA Expands Review of Disclosures by 15 Dark Pool Operators

U.S. securities regulators are expanding their inquiry of private broker-run trading venues known as dark pools as they look to better understand how the platforms treat customer orders.

The Financial Industry Regulatory Authority is preparing to send a new round of letters to operators of 15 dark pools previously targeted for questions. The initial round of letters was partly Finra’s response to problems identified through previous enforcement cases against dark pool operators, John Malitzis, executive vice president of market regulation at Finra, said in a phone interview.

“We are evaluating the responses we got back from the firms and anticipate going back with further inquiry letters,” Malitzis said.

Finra first sent detailed examination letters to the dark-pool operators in September. The letters sought information about how dark pools route, represent, and handle customers’ buy and sell requests.

Dark pools are broker-operated private venues that don’t display quotes publicly. They attracted more trading volume as institutions sought to buy and sell without moving share prices.

Dark pools don’t identify the brokers and institutions that buy and sell on their systems and aren’t required to tell regulators how they handle customer orders.

The U.S. has more than 40 dark pools, which have tripled their share of trading volume since the first quarter of 2008, according to data compiled by New York-based Rosenblatt Securities Inc. A third of trading now occurs away from exchanges, up from 16 percent in early 2008, the Rosenblatt data shows.

Sweep Letter

Finra’s initial sweep letter asked dark pools whether whether certain customers get preferred access to information about orders. Doing so could give the preferred customer an advantage in trading.

Finra also asked the brokers what they disclose about customer order types and whether any conflicts of interest exist because of the broker’s own proprietary trading in the pool.

“Our letter is looking at really the relationship with customers and concerns about whether the customers understand how the orders are behind handled,” Malitzis said.

Finra also asked how brokers are paid for their services, how they handle erroneous trades, and how they protect the confidential order information supplied by customers. Finra is reviewing the use of indications of interest, or messages that let automated computer systems outside the dark pool know of buy or sell interest within the venue in order to solicit new orders, according to the letter.

Other Cases

Malitzis declined to say how many ongoing enforcement cases Finra has against dark pool operators.

Dark pool operator Pipeline Trading Systems LLC settled a case in October 2011 that alleged it failed to disclose that its affiliate was responsible for filling most orders on the platform.

Pipeline paid a $1 million fine to settle the Securities and Exchange Commission enforcement case. Pipeline’s chairman and chief executive officer, who also paid fines to settle claims, later left the firm.

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