The Securities and Exchange Commission (SEC) is proposing rules which would bolster regulatory oversight and operational transparency at alternative trading systems (ATSs) including dark pools.
The proposal, which is now subject to public comment, would require ATSs to file detailed disclosures through a newly created Form ATS-N about their operations and the activities of their broker-dealer units, details on the types of orders, information on market data and algorithms utilised and their execution and priority procedures. This is all part of the regulatory effort to reduce conflict of interest at dark pools.
Furthermore, this information would be made public in what would allow market participants to better evaluate whether to conduct business with an ATS, as well as enabling them to be better informed when assessing order handling decisions made by their broker.
“Investors and other market participants need more and better information about how alternative trading systems work. The proposed changes would represent a critical step forward in delivering greater transparency to investors and enhancing equity market structure,” said SEC Chair Mary Jo White.
Dark pools have come in for heavy scrutiny since the publication of “Flashboys” in 2014 by Michael Lewis, which made a number of damning allegations against dark pools, including claims that the market was rigged in favour of high frequency traders (HFTs). Since the book was published, a number of dark pool providers have been issued with fines.
Agency broker ITG reached a $20.3 million settlement with the SEC in August 2015 following claims its brokerage unit operated a secret trading desk profiting off confidential client information within its dark pool. UBS was fined $14.4 million by the SEC following claims certain clients received preferential treatment on its ATS. Meanwhile, there are still on-going lawsuits pertaining to dark pools operated by Credit Suisse and Barclays.
Scrutiny over dark pools is also underway in the EU. The Markets in Financial Instruments Directive II (MiFID II) will impose thresholds on individual stocks that can be traded at any given dark pool at 4% and across dark pools at 8%. As such, this will force more institutional investors to trade on lit markets.
Proponents of dark pools argue they help provide liquidity in the market and allow investors to trade large blocks of shares without moving the market against them. If these investors are forced to migrate onto lit exchanges, their intentions could be spotted or gamed. Operating on a lit exchange could also force these investors to “slice and dice” trades, or offload securities over a longer time-frame.