Stricter Dark Pool Rules Said to Be Under Consideration at SEC

Even as they’ve captured a bigger slice of U.S. stock trading, dark pools have faced less regulation than the better-known public exchanges. Regulators are taking steps to change that.

The Securities and Exchange Commission is developing rules that will force dark pools to comply with some of the same requirements exchanges face, according to a person with knowledge of the matter. Under consideration are requirements that address two key areas of concern for critics of dark pools: the disclosure of the types of orders available on the platforms and the source of pricing data, the person said.

Dark pools are beset with allegations that they don’t treat investors fairly. Most are operated by banks that use the platforms to fulfill clients’ orders without sending them to public markets like the New York Stock Exchange or Nasdaq Stock Market, where transparency is greater.

The SEC has gone after dark pools for breaking market rules. Last year, the agency fined Liquidnet Holdings Inc. $2 million for not living up to client secrecy standards. In 2011, Pipeline Trading Systems LLC agreed to pay $1 million to resolve claims it failed to provide the confidentiality and liquidity it advertised to customers.

New York Attorney General Eric Schneiderman has also taken aim at the industry. Last year his office sued Barclays Plc, claiming the bank lied to customers while secretly cozying up to high-frequency trading firms.

Aggressive Traders

The SEC is also weighing whether to require dark-pool operators to tell investors who else trades on their systems and whether they route unfilled orders to other platforms used by more aggressive traders, according to the person familiar with the matter, who asked to not be named because the effort isn’t public. SEC spokesman John Nester declined to comment.

Two of the areas under consideration for reform -- order types and price feeds -- are central to complaints about modern trading.

Order types are instructions for how to handle trades. Some allow traders to post orders that remain hidden. Critics including former Goldman Sachs Group Inc. trader Haim Bodek contend they can help computerized trading firms take advantage of other investors. Just today, the SEC announced a record $14 million fine against Bats Global Markets Inc., saying the Direct Edge stock exchanges it bought last year didn’t accurately describe their order types.

As for price feeds, there are two main types: the nationwide services that aggregate information from all markets, and the direct feeds each market offers for a fee. Because the former is effectively slower given the delay imposed by collating the information, the fastest traders subscribe to each direct feed so they can know about price fluctuations as quickly as possible.

Grand Bargain

Some dark pools use the aggregated feeds, known as securities information processors, or SIPs, to match trades, a source of concern for critics who say that means investors get dated information when deciding when to trade.

As the SEC considers new rules, others have weighed in with proposals to alter how dark pools operate. The New York Stock Exchange has tried in recent months to marshal support for a grand bargain between exchanges and private markets like dark pools, with the former agreeing to cut trading fees and the latter agreeing to rules that direct more orders onto public markets, a person familiar with the matter told Bloomberg News in December. Yesterday, the Wall Street Journal reported that exchange operator Nasdaq OMX Group Inc. wants to seek SEC permission to take over running some banks’ dark pools.

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