Private stock trading vs public exchanges
DARK pools have a scary name, and to critics they're scary places: private stock markets housed inside some of Wall Street's biggest banks. Created to let big investors swap large blocks of shares in secret, they've expanded to become a significant part of daily stock trading. More shares now change hands in dark pools than on the New York Stock Exchange. Dark pools have helped bring down trading costs. But whether markets as a whole suffer when too much trading information is private is something regulators around the world are trying to figure out - along with whether some dark pools have been taking advantage of the darkness to favor some customers over others.
The U.S. stock market has fragmented into 11 public exchanges and roughly 45 alternative trading systems, most of them dark pools. Rules to limit dark pool trading have been put in place by Canada and Australia and the European Union is weighing similar measures. Critics have complained that all traders are hurt by the fact that dark pools don't make orders public but only post completed trades. The publication in March of "Flash Boys" by Michael Lewis led to questions over whether some dark pools were designed in a way that let high-frequency traders place bets knowing which way the market was about to go. In June, New York Attorney General Eric Schneiderman filed suit against Barclays, charging that it lied to customers about how much business its dark pool did with highspeed traders and how client orders were routed, charges Barclays denies. The SEC imposed a $12 million fine on UBS for viola- tions at its dark pool. And the agency is developing rules to increase dark pool disclosures and may test a rule requiring that trades take place on public exchanges unless a significantly better price is offered elsewhere. The NYSE, meanwhile, has offered to cut trading fees sharply if all but the biggest orders are brought back to public exchanges.
Bonds, currencies and most other financial instruments are generally not traded on open exchanges, and there's always been some nonpublic trading in the stock market. Old hands reminisce about "upstairs trading," a euphemism for private, large-order deals. That was the exception: Since the SEC was formed in the wake of the stock market scandals that led to the panic of 1929, the agency has equated openness with fairness. Publicly shared bids and offers mean a level playing field, and the rapid sharing of price information is seen as central to the market's role in the efficient allocation of capital. Dark pools arose in the 1980s, when the SEC allowed brokers to bring together buyers and sellers of big blocks of shares. Their recent growth has been driven by electronic trading and a SEC rule meant to spur competition and cut transaction costs that took effect in 2007. Dark pools can charge lower fees than exchanges because they are usually just one unit in a larger firm. (Not all the operators of alternative trading systems are banks: Bloomberg LP, the parent of Bloomberg News, owns one, Bloomberg Tradebook, which is registered with the SEC.) Along the way, their client base changed. Dark pools are not generally venues for big orders anymore - one study found that the average order size is now just 200 shares. Dark pools are run in near-total secrecy. There's little disclosure about their rules, participants or activities.