Greater Light May Be Coming On Dark Pools

“Dark pools” of liquidity are a type of private, alternative trading system (“ATS”) in which participants can transact their trades without displaying quotations to the public. When investors place an order to buy or sell on an exchange, the exchange typically makes that order available for the public to view. With some dark pools, however, investors are able to signal that they have an interest in either buying or selling a security. But that so-called indication of interest (“IOI”) is communicated only to a subset of market participants.

That means that investors operating with the dark pool have access to information about a potential trade that other investors using public quotations do not. As a result, dark pool participants are able to have their orders filled, while those on publicly displayed markets go unfilled, even though dark pools use the information from publicly displayed markets to price the dark pool transactions. When dark pools share information about their trading interest with other dark pools, they can function like private networks that exclude the public investor.
 
The largest dark pools are sponsored by securities firms primarily to execute the orders of their customers and proprietary orders of the firms. The number of active dark pools transacting in stocks that trade on major U.S. stock markets has tripled since 2002. Some believe that, given this growth of dark pools, a lack of transparency could create a two-tiered market that deprives the public of information about stock prices and liquidity.
 
Now, the Securities and Exchange Commission is proposed to increase transparency of dark pools so investors get a clearer view of stock prices and liquidity. The SEC's proposals address three specific concerns related to dark pools:
 
The first proposal would require actionable IOIs – which are similar to a typical buy or sell quote – to be treated like other quotes and subject to the same disclosure rules.
 
The second proposal would lower the trading volume threshold applicable to alternative trading systems (“ATS”) for displaying best-priced orders. Currently, if an ATS displays orders to more than one person, it must display its best-priced orders to the public when its trading volume for a stock is five percent or more. Today's proposal would lower that percentage to 0.25 percent for ATSs, including dark pools that use actionable IOIs.
 
The third proposal that would create the same level of post-trade transparency for dark pools - and other ATSs - as for registered exchanges. Specifically the proposal would amend existing rules to require real-time disclosure of the identity of the dark pool that executed the trade.
 
The SEC is seeking public comment on these proposals, and we welcome your thoughts here, as well.