Academic journal article Vanderbilt Law Review

The Securities Black Market: Dark Pool Trading and the Need for a More Expansive Regulation ATS-N

Academic journal article Vanderbilt Law Review

The Securities Black Market: Dark Pool Trading and the Need for a More Expansive Regulation ATS-N

Article excerpt

Introduction: Stepping Into Dark Pools

In early 2016, Barclays and Credit Suisse found themselves in the midst of a settlement with the Securities Exchange Commission ("SEC") over dark pool activity for a combined total of $154.3 million.1 Barclays alone settled for $70 million as a result of its misrepresentations regarding the methods used for monitoring high-frequency trade ("HFT") activity within its dark pool, "Barclays LX."2 As part of its settlement, the London-based bank also agreed to the implementation of an independent third-party consultant to review how the firm manages certain aspects of its dark pool business.3 Credit Suisse-who also faced charges of misrepresentation regarding the use of its dark pool, "Crossfinder," to facilitate internal order flow-settled for $84.3 million.4 After the settlement, New York Attorney General Eric Schneiderman stated, "These cases mark the first major victory in the fight against fraud in dark pool trading that began when we first sued Barclays: coordinated and aggressive government action, admissions of wrongdoing, and meaningful reforms to protect investors from predatory, high-frequency traders."5 Schneiderman later noted, "We will continue to take the fight to those who aim to rig the system and those who look the other way."6

A dark pool, a form of Alternative Trading System ("ATS"), is a private securities trading platform that-unlike public exchanges such as the New York Stock Exchange-allows participants to execute large block trades with delayed public disclosure.7 As neither party in a dark market transaction is trading on the public, or "lit," market or knows the identity of its counterparty, dark market trades allow participants to trade anonymously and keep trade strategies from competitors.8 Further, because dark market trades do not have to be publicly disclosed in real time, the price of a given security will, theoretically, stay relatively stable as the order is filled.9 As such, dark market trades are said to have "reduced market impact," which generally results in more favorable overall pricing to buyers and sellers.10 While a number of larger banking institutions advertise "dark pool" services, these services vary widely in size and nature.11 Furthermore, these relatively new financial instruments have little recognition within the law. Despite the regulatory issues posed by the mortgage crisis in 2008, the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 does not directly address dark pool trading within U.S. equity markets.12 While dark pools offer a number of benefits to both retail and institutional investors, including the supposed ability to hedge against HFT arbitrage, a number of informational and regulatory gaps brought about by dark pools' statuses as ATSs present issues to the Securities Exchange Act of 1934's goal of "protecting investors, maintaining fair, orderly and efficient markets, and facilitating the formation of capital."13

To address these regulatory gaps, this Note proposes that the SEC expand its proposed regulations by issuing quality trade facilitation ratings that give existing and prospective dark pool participants meaningful comparison criteria upon which to evaluate the effect different services have on quality execution. Such a rating would, for example, provide investors with insight as to how well a particular pool facilitates trades relative to the market given order size, order type, and services offered, among other criteria. In a sense, this system could be considered a more expansive version of the SEC's proposed Regulation ATS-N. Such a system would not only reduce the negative trading effects associated with dark pools, but would also limit missed liquidity,14 foster predictability, prevent against market manipulation, promote best execution, cure information asymmetry, and reduce barriers to entry to smaller investors. Part I explains how dark pools operate, describes how pools vary in size, form, and function, and lists the potential costs and benefits to dark market liquidity, generally. …

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