SEC Chair Says Dark Pools ‘May Need More Light’

The rapid rise of dark pools have prompted lawmakers, investors and traders in urging securities regulators to rein in the venue, saying it lacks transparency, distorts equity markets and affect prices.

Dark pool trading, which is done away from the traditional exchanges, offering complete anonymity, is used to hide details of large orders, usually blocks of shares, because that information can cause a stock’s price to move before the investor has a chance to get out of a trade.

The attraction of these dark pools is understandable. If an institutional investor, for instance, wants to dump say 2 million shares of  XYZ & Co., it traditionally would have to ring its broker, who would then have to contact the specialist on the NYSE floor. During this process however, information about the institution’s intent to sell its position would begin to leak out to other traders, conveying valuable information on the ticker’s available liquidity. Presumably, XYZ’s pps might plunge if the broad market noticed the transaction, and sentiment rapidly swung against the company.

In a speech at the IOSCO Technical Committee Conference in the Swiss city of Basel, SEC Chairwoman Mary Schapiro said today that “while there were legitimate reasons for market participants to maintain anonymity and engage in trading without moving the market, dark pools may lower the quality of publicly available information.” [Reuters]

“The SEC is considering whether the dark pools need more light,” Schapiro said.

Schapiro said also that some pools were not dark to all market participants but rather transmitted electronic messages to select individuals. This could lead to significant private markets that excluded public investors, she said.

“Such a two-tiered market would be inconsistent with the fundamental principles of fairness and efficiency that guide U.S. market structure policy,” Schapiro said.

All the major investment banks, like Morgan Stanley (NYSE:MS), Credit Suisse AG (NYSE:CS), and other major Wall Street firms  have dark pools operations. None though comes close to Sigma X, which is owned by Goldman Sachs (NYSE:GS).