U.S. Stock Exchanges Take on 'Dark' Trading ; Unable to Keep Shares off Private Markets, They Look to Create Their Own

By Popper, Nathaniel | International Herald Tribune, June 28, 2012 | Go to article overview

U.S. Stock Exchanges Take on 'Dark' Trading ; Unable to Keep Shares off Private Markets, They Look to Create Their Own


Popper, Nathaniel, International Herald Tribune


Public exchanges are fighting competition from so-called dark markets by looking to create their own, raising concerns about trading transparency.

While most people trading stocks at home in the United States imagine their orders zipping from their brokers onto one of the country's stock exchanges, almost none of the trades go anywhere near those public markets.

In reality, most trades placed through online brokers like TD Ameritrade and Scottrade are sold to Wall Street firms, which accumulate and trade against tens of millions of these shares a day, rather than send them to a regulated exchange like Nasdaq or the New York Stock Exchange. The Wall Street firms then quickly flip them and turn an easy profit because they have more resources and market knowledge than mom-and-pop investors.

The trading, which takes place away from the gaze of regulators and the public in what are known as the dark markets, has taken off in recent years and steadily eaten into the portion of all stock trading that takes place on the public exchanges. Now, though, the exchanges are fighting back by looking to create dark markets of their own.

NYSE Euronext, the company that owns the New York Stock Exchange, is asking regulators to approve a new platform that would attract orders from ordinary investors and then divert them away from the normal exchange with the aim of getting the investor a better price. Nasdaq and the exchange company Direct Edge said they had similar plans in the works.

The proposal looks like a technical tweak to help ordinary investors. But it has become the front line in a battle over what U.S. stock markets should look like after nearly a decade of fragmentation that has resulted in more than a third of all stock trades occurring in the dark, up from 15 percent in 2008, according to Rosenblatt Securities, a brokerage firm.

In the past, the exchanges have pushed regulators to force the dark markets to become better lit, but James Allen, the head of capital markets policy for the CFA Institute, said that with the new proposals the exchanges were acknowledging "that if you can't beat them, join them."

In doing so, they are ready to take a turn away from the idea of stock exchanges as places where all investors come together in the open and on equal footing.

"It could forever change what an exchange is and how it serves different factions of investors," said Christopher Nagy, the founder of KOR Trading, a firm that advises exchanges and brokers. "This proposal essentially says maybe not all people are equal."

The regulators have until July 7 to decide on the New York Stock Exchange proposal, and it is far from certain that it will win approval. But industry insiders say that even if it is rejected, the plans are forcing regulators to decide how they will deal with the vast transformation of U.S. stock markets in the past few years.

Since a crucial regulatory change was made in 2007, the United States has gone from having two major stock exchanges to having 13 public exchanges, as well as dozens of trading platforms where stocks are traded away from the public eye.

Regulators have not stood in the way of these changes, but they have expressed their discomfort with the complex current market structure, and their uncertainty about how to deal with it.

Duncan L. Niederauer, the chief executive of NYSE Euronext, said in a congressional hearing last Wednesday that the operators of off- exchange trading platforms were under less stringent oversight than the exchanges. He said that regulators should either tighten the rules on dark trading platforms or let the exchanges look more like those platforms.

The competition among platforms is credited with bringing down the cost of trading for investors of all types. But the fragmentation of the markets is also blamed for making the market infrastructure more prone to break down, as it did in the flash crash of May 2010, when stock prices plunged nearly 10 percent in 15 minutes. …

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