News Journal: Shining some light into the monied world’s ‘dark pools’

I am going to be a member of a new SEC advisory committee that will focus on the structure and operations of the U.S. equities markets.
The Equity Market Structure Advisory Committee will be composed of a diverse group representing the financial services industry, academia, and public interest groups. I’m looking forward to our first meeting with an open mind, hoping to learn a lot. But I am sure the five SEC commissioners appointed me because I have been expressing concerns about the fairness and credibility of our equity markets for a long time.
I suspect the SEC created the committee in part because of the popularity of Michael Lewis’s 2014 bestseller, “Flash Boys.” His book made a compelling case that our equity markets are rigged in favor of High Frequency Traders who use incredibly fast computers and proprietary algorithms to gain unfair advantages.
If Lewis was right, our markets today are not meeting the standards SEC Chair Mary Jo White set for them when she announced the committee’s formation – “to operate openly, fairly and efficiently to benefit investors and promote capital formation.”
We all have a stake in making sure the U.S. equity markets have the highest level of credibility. That’s what has drawn investors from all over the world to them. We can’t afford to lose that advantage.
Even if you aren’t an active investor in stocks, chances are you hold assets in mutual funds, 401ks, or other pension funds. Most Americans have some personal reason to care about a fair market. Just as important, the equities markets have traditionally been the source of money our corporations need to grow and create jobs.
High Frequency Trading (HFT) now accounts for over fifty percent of all trading volume in the United States. It began to grow rapidly when SEC rules were changed to allow the movement of stock trading away from a few exchanges. Much of that trading is now done in “dark pools,” so named because they aren’t required to have the transparency of the traditional exchanges. That means no one, including the SEC, knows what is going on as High Frequency traders use super-fast computer algorithms to find and exploit price variations that may come and go in nanoseconds.
I’m hoping the new committee will find ways to make sure the SEC does know what’s going on. In the meanwhile, prosecutors alleging HFT improprieties have already initiated a number of cases. New York State Attorney General Eric Schneiderman has filed one such suit against Barclays Bank. The charge is that Barclays falsely claimed their dark pools were free of predatory trading by HFT firms.
A spokesman for the Attorney General said, “Our investigation into the unfair advantages enjoyed by high-frequency traders is broad and ongoing. We will continue to root out fraud and illegality in this area, whether it’s an alternative trading venue that lies to clients to benefit high-frequency traders, or a subscription service like Thomson Reuters that gives a special advantage to elite traders over the rest of the market.”
Thomson Reuters agreed in a settlement with New York’s AG to stop providing information to HFT traders two seconds before other investors.
Many say that an even bigger issue is the payments offered for orders from brokers by different trading venues. These offers create a conflict of interest for the traders’ basic responsibility to provide the very best price to their customers.
One example of that was the $14.4 million fine levied by the SEC and paid by the Swiss bank UBS for allowing favored customers in their dark pool to gain an unfair advantage.
It isn’t just government regulatory agencies and prosecutors who are concerned about HFT abuses. The Financial Industry Regulatory Authority, a private corporation that polices member brokers and exchanges, recently laid out an agenda for 2015 that stated: “Maintaining fair and orderly markets is a central objective for FINRA and is critical to restoring and preserving investor confidence in the U.S. capital markets. FINRA is adapting its surveillance program to identify potentially violative conduct made possible by advances in technology and changes in market structure, (e.g., abusive algorithms)…FINRA views abusive trading algorithms and deficient supervision for potential manipulation as among the most significant risks to the integrity of the markets. For that reason, FINRA will continue to pursue firms whose traders or customers use algorithms to manipulate the markets.”
It is way past time to return our equity markets to the standards of fairness and credibility they once had. I’m hoping the new Equity Market Structure Advisory Committee will help do that. Stay tuned.
Ted Kaufman is a former U.S. Senator from Delaware.