Dark Pools Under Scrutiny from Securities Regulators

The U.K. Financial Conduct Authority (FCA) is going to shine the light on dark pools, according to the USA Today. The FCA will begin investigating dark pool conflicts of interest as one of its priorities over the next year, according to an announcement of its 2015-2016 priorities. This story was also covered by Bloomberg.

Dark pools seem to increasingly be the target of examinations by securities regulators and are ripe for whistleblower tips. Last summer, SEC Chair Mary Jo White expressed concern about the lack of transparency in dark pools in a speech. At that time, White said the SEC would work with the Financial Industry Regulatory Authority (FINRA) to expand disclosures by dark pools and consider requiring brokers to disclose routing decisions of large orders for institutional clients.

The SEC has also issued several fines against dark pool operators over the last year. Last summer, the SEC fined Liquidnet $2 million for allowing a separate business unit to improperly use the confidential information from its products for marketing purposes. In January, they also fined UBS $14.5 million for accepting trade orders at its dark pool in increments under a penny.

New York State has launched its own investigation into the operations of dark pools run by at least a half dozen investment banks. Goldman Sachs, Morgan Stanley, Credit Suisse, Deutsche Bank and UBS are some of the names that were mentioned in a Wall Street Journal article last year.

New York Attorney General Eric Schneiderman also filed a lawsuit against Barclays for misleading investors and violating the Martin Act last year. The lawsuit claims that Barclays made various material misrepresentations to its customers regarding order flow and the operation of its dark pool. It survived a motion to dismiss in February of this year.

With at least three government agencies around the world looking at practices in this industry, it could be safe to say that it is right up there with high frequency trading as a potential source of future enforcement actions by regulators.

For those that aren’t familiar with them, a dark pool is an off-exchange forum for anonymous transactions in securities. They have been used across various securities, including stocks, the foreign exchange market and fixed income bonds. Dark pools started in the late 1980s in order to provide a place to transact larger orders in securities without the pricing impact of posting on a public exchange. Activity in these forums was still a small percentage of trades as late as 2005, when they accounted for less than 5 percent of total trading. However, estimates put the number as high as 12 percent in 2012. Subsequently, there has been more and more interest in executing trades off the public exchanges. In 2014, approximately 40 percent of US stock trades did not happen on a public exchange.

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