BUSINESS
03/18/2010 05:12 am ET Updated May 25, 2011

"Dark Pools": Regulators Turn Up The Heat On Opaque Stock Trading

The Securities and Exchange Commission is proposing tough new regulations of anonymous trading platforms that compete with traditional stock exchanges.

Referred to as "dark pools," these venues are private networks where traders can buy and sell stocks hidden from public view -- details of the trades are concealed, clouding the transactions like murky water. Critics argue that the lack of transparency ultimately hurts the market, because regular traders can't see the prices set by large institutional investors in these private networks, ultimately hurting the little guy. Critics also argue that dark pools are harder to regulate and more prone to abuse by participants.

Their share of stock trading has skyrocketed, hurting traditional exchanges like the NYSE and NASDAQ. The SEC's proposals were approved by a unanimous vote Wednesday and the rules will now be open to public comment for 90 days.

Per SEC Chairman Mary L. Schapiro:

Not all dark pools are the same. Today, we are focused on those dark pools that transmit electronic messages to a limited group of market participants. Those messages signal that the dark pool has an interest in either buying or selling a security. When the messages convey sufficient information to permit others to trade, it is called an actionable indication of interest...[which] in some cases...is only communicated within the dark pool itself...[or]...to other dark pools that have joined together to form a private trading network.

What this means is that participants in these private pools have access to information about a trade which other investors are denied. What's more, these participants are able to use and rely upon the prices provided by the publicly displayed markets, without contributing information of their own.

Given the growth of dark pools, this lack of transparency could create a two-tiered market that deprives the public of information about stock prices and liquidity.

Yesterday, U.S. Senator Charles Schumer called for just this kind of tougher oversight on a media conference call with Duncan Niederauer, CEO of NYSE Euronext, the company that owns the NYSE.

Schumer mentioned the benefits that have come with the growth of these off-exchange platforms, such as more liquidity in the marketplace. "But all of these benefits have come at a cost, " he said, "as our capital markets have become increasingly fragmented, market surveillance has not kept pace and I am concerned that a large and growing portion of market activity takes place in dark or semi-dark spaces...Together, these developments risk undermining the fairness, transparency and integrity that have become hallmarks of the U.S. capital markets."

Niederauer argued that exchanges like his have been hurt by the lack of regulation of dark pools, which have made them more attractive to large investors. The NYSE's market share has plummeted.

Schumer was among the first lawmakers to voice concerns about these largely unregulated trading venues, sending a July 24 letter to the SEC.

During Monday's call, Schumer pointed to the loss of the traditional exchanges' market share as one of the reasons behind his call for more stringent regulation of dark pools. The tougher the oversight, the less incentive to trade on them, hence more business for the New York-based exchanges.

"Obviously as a New Yorker, I'm concerned about New York and it remaining the center of the financial world and financial trading," he said. "...Here in New York there's an unfair disadvantage."

This year, Schumer and his political action committee have received at least $42,000 from NYSE's employees and its PAC, according to campaign finance data analyzed for the Huffington Post by the nonprofit Center for Responsive Politics -- at least $33,000 of which has flowed into his coffers since June 12. Only four other firms have given more to Schumer this year.

In comparison, from 2007 to 2008, Schumer received $5,000 from the exchange; in the two years prior, he received $3,000. During his entire first term as a U.S. Senator (between the 1998 and 2004 elections), NYSE employees and its PAC donated about $19,000 to Schumer's campaign fund.

Opponents of more regulation for dark pools have also contributed money to Schumer. Overall, the securities industry this year has contributed about $911,000 in campaign funds to Schumer and his leadership PAC, some of which comes from firms like Goldman Sachs and Citigroup -- major players in the dark pools. Goldman's employees and the firm's PAC have given about $23,000 to Schumer, while those from Citigroup have contributed about $24,000, according to the Center for Responsive Politics.

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