The New York Times: Lawmakers Take Aim at Trading in Dark Pools

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Lawmakers Take Aim at Trading in Dark Pools

Source: The New York Times

By Cyrus Sanati

Washington lawmakers took aim at dark pools on Wednesday as a Senate banking subcommittee heard from regulators, traders and even a fellow senator on what effects the anonymous trading platforms have on the stock market and what new laws and regulations may be needed to protect investors.

The somewhat-contentious hearing pitted advocates for more transparency and tougher market oversight with those who played down the trading platforms' influence over the market.

The subcommittee hearing follows recommendations that the Securities and Exchange Commission made last week, which Wall Street opposes. The S.E.C. proposals threaten to erase much of the advantages that banks gain by operating and trading in dark pools, as opposed to using the exchanges, where information on trades are available to the public.

Dark pools allow traders, especially of large blocks of stock, to hide their intentions and avoid moving share prices. They have gained traction over the last decade as the average of trades has fallen sharply on the public exchanges. Since trades done inside and between other dark pools are not fully disclosed immediately to the public, there are concerns that banks may be profiting off from the information.

Setting the tone for the hearing, Senator Edward E. KAUFMAN, Democrat of Delaware, testified as a witness in front of the subcommittee on securities, insurance and investment to voice his concern over what he believes is a lack of regulatory scrutiny over a number of new trading techniques and platforms, like high-frequency trading and dark pools.

"Technological developments have far outpaced regulatory oversight, and traders who buy and sell stocks in milliseconds -- capitalizing everywhere on minute price differentials in a highly fragmented marketplace -- now predominate over value investors," Mr. KAUFMAN said in his prepared testimony to the subcommittee. "Liquidity as an end seems to have trumped the need for transparency and fairness and we risk creating a two-tiered market that is opaque, highly fragmented and unfair to long-term investors."

But other witnesses representing the trading industry, including Credit Suisse, which runs the largest dark pool, dismissed Mr. KAUFMAN's concern, asserting that dark pools had simply replaced the floor specialists and the market makers of the past and that it was business as usual in the markets.

"Transparency is not always good in the real-time markets," said Daniel Mathisson, managing director and head of advanced execution services for Credit Suisse. Mr. Mathisson noted that too much information could put some traders at risk who need anonymity to trade large blocks of shares.

"Credit Suisse believes that the main principles governing market structure decisions should be the principles of fair access and information protection," Mr. Mathisson said in his prepared testimony. "Fair access does not mean equality of results or forced equality of technological capabilities -- it means an equal opportunity to participate in trading destinations, whether displayed or dark, and an equal opportunity to invest in technology and processes that allow investors to perform their best."

Mr. KAUFMAN challenged Wall Street's assertions. "When you are trading thousands of trades in a second, that's the same as a specialist?" he said in an interview with DealBook following the hearing. "That is very different because specialists don't have algorithms to work the market."

Mr. KAUFMAN added, "There is no argument that there are things going on that are not transparent in high-frequency trading and in dark pools."

Senator Jim Bunning of Kentucky, the ranking Republican member of the subcommittee who also used to be a stockbroker, said during the hearing that he thought trades inside of a dark pool needed to "hit the tape," or shown to the public, once they are made. But he also said the identity of the person or institution making the trade did not be revealed.

Traders at the hearing said trades made in dark pools always hit the tape and were anonymous in order to protect the buyers and the sellers wishing to purchase or sell a large block of stock without causing market movements. They also noted that dark pools are a very small "niche market" and therefore immaterial to movement's in the broader market.

"Right now, dark pools are 12 percent of all trades," Mr. KAUFMAN shot back. "I don't call that a niche market."

The subcommittee hearing is the first to specifically address dark pools. There has been no specific legislation proposed as of yet that moves to curb dark pools. Senator Charles E. Schumer, Democrat of New York, said at the hearing that market surveillance should be consolidated and modernized to better police dark pools. But he has yet to push for any specific changes to the law.

Mr. KAUFMAN told DealBook that the hearing was just the first in a series in which the Senate is basically feeling out what it should do next. But he is confident that the Senate will act soon enough.

"The Senate's job is to lay out what the public framework is and what the law should be and it is up to the S.E.C. to regulate the law," Mr. KAUFMAN said. "I assure you that there are sections of what is going on that will requite Congressional action because of great changes that have happened in the marketplace."

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