Dark Pools Would Have to Shed Light on Conflicts Under SEC Rule

  • Commissioners propose new requirements in unanimous vote
  • Agency seeks rules amid complaints over preferential treatment

Wall Street’s private stock markets would have to reveal whether they favor any particular users including high-frequency traders under a proposal approved Wednesday by the U.S. Securities and Exchange Commission.

Many of the new disclosure requirements sought by the SEC mirror those currently reserved for public markets such as The New York Stock Exchange. The regulatory effort follows a series of enforcement actions in which Investment Technology Group Inc. and UBS Group AG paid tens of millions of dollars to settle allegations they misled investors about how their dark pools worked.

“Many of the disclosures that today’s proposal would require should reveal the very types of conflicts of interest that lay at the heart of the enforcement actions brought against dark pools by the commission and other regulators,” SEC Commissioner Luis Aguilar said at a meeting in Washington where the proposal was approved in a 4-0 vote.

The proposal would require dark pool operators to make a new public filing that spells out their conflicts of interest, including whether an affiliate trades in the dark pool. If the dark pool creates advantages for any particular users, it would have to reveal that in the filing. Dark pool operators also would have to publish any market-quality statistics they use to market the venue.

Intense Scrutiny

Dark pools have faced intense scrutiny over the past year from the SEC and regulators including New York Attorney General Eric Schneiderman, who alleged that Barclays Plc lied to customers about the role high-frequency traders played on its platform. Many banks including Credit Suisse Group AG have since published more about how their dark pools work, including whether clients such as mutual funds will have to cross paths with speed traders.

Long-term investors such as mutual funds historically have used dark pools to trade large orders without tipping the market to their intentions. But high-frequency traders also play an important role on the platforms, because they provide liquidity to ensure buy and sell orders get filled. The off-exchange markets don’t disclose prices of orders before they are executed.

Private trading venues operated by Wall Street brokers such as Credit Suisse, UBS Group AG, Goldman Sachs Group Inc. and Morgan Stanley accounted for about 16.25 percent of U.S. stock-trading volume in September, according to recent research by Rosenblatt Securities Inc.

‘Flash Boys’

The SEC vote came more than a year after Chair Mary Jo White said dark pools should provide more information about the firms that use them. Her announcement followed the publication of Michael Lewis’s book “Flash Boys,” which alleged proprietary traders used hyper-fast connections between markets to pick off investors whose orders sat in dark pools that used slower price feeds.

“It can be almost impossible for an investor to assess adequately the conflicts of interest that can arise for a broker-dealer operating” a dark pool, SEC Chair Mary Jo White said Wednesday.

Investment Technology Group Inc. agreed to pay $20.3 million in August to settle SEC claims that it ran a secret desk that used knowledge of client orders to trade for its own benefit. In January, UBS consented to pay $14.4 million over allegations that it created special order instructions that benefited high-frequency traders and didn’t tell other clients about them.

Barclays has publicly denied Schneiderman’s charges and has been fighting the case in court. The bank and the New York attorney general are negotiating a possible settlement, according to a person with knowledge of the matter. The SEC could settle with Barclays ahead of Schneiderman’s office, this person said.

Enhanced Disclosure

The SEC’s plan, which will be open for public comment for 60 days, would allow the regulator to declare whether a broker’s dark pool filing meets its requirements. If it doesn’t, the SEC could bar the venue from operating.

The filing would require disclosure of the types of traders who use the dark pool, fees charged by the broker and the rules for matching orders.

The proposal doesn’t apply to dark pools that trade Treasury bonds, corporate bonds or municipal securities, White said. Aguilar and Commissioner Kara Stein, both Democrats, questioned that decision, saying the agency should consider applying the new requirements to venues that trade Treasuries.

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