News Journal:We need to shine a light on dark pools
If you are of a certain age, you may still think of stock traders as men in white shirts and suspenders with their hands raised, frantically yelling out bids on the New York Stock Exchange. In plain sight. For all to see.
That’s not the way many major players buy and sell anymore. Instead, they use “dark pools,” private venues where trades are made on a confidential basis, without any public scrutiny at all.
There were some valid reasons for the creation of dark pools back in the 1980s. If an institutional investor decided to sell a million shares of one stock all at once on the NYSE, it could cause a sometimes precipitous drop in the price of the stock. That’s why such an exchange trade was usually broken into small blocks and sold over a period of time. Dark pools made those unnecessary, making large trades far more efficient for big buyers and sellers. The problem is, no one but them now knows what’s going on, including government agencies charged with protecting the interests of all investors.
In 2014, 40 percent of U.S. stock trades took place off the exchanges, up from 16 percent in 2008.
What’s wrong with that?
It has been my contention for a long time that dark pools were places where some investors were going to be cheated. In my experience, wherever there is money changing hands without any transparency there will be people taking advantage of other people. This is especially exacerbated by the rise of high frequency traders who use computer algorithms to trade millions of shares in the wink of an eye.
My suspicions have just been confirmed. Recently, mega banks Barclays and Credit Suisse agreed to settle allegations by the Securities and Exchange Commission and New York Attorney General Eric Schneiderman that they misled investors on how they managed what went on in their dark pools. Barclays was fined $70 million and Credit Suisse set a new record for a dark pool operator fine of $84.3 million.
According to Bloomberg, “the dispute centered on whether the banks disclosed enough to their clients about trading in their dark pools. Barclays misrepresented to clients how it monitored its dark pools for high frequency trading, according to the statement. Credit Suisse systematically routed orders to its own dark pool, but told clients that it didn’t prioritize one trading venue over another, according to New York Attorney General Eric Schneiderman.”
According to Schneiderman, Credit Suisse actually had a secret agreement with two HFT firms that allowed them to trade in the dark pool at a considerable advantage over Credit Suisse’s clients. Essentially, the bank was sacrificing its own clients to encourage these firms to use its dark pool rather than another bank’s.
The abuses by these two banks came to light only because of some whistle blowing employees. If we have to depend on that happening on a regular basis, we are in real trouble.
Yes, even with the present non-existent agency oversight in place, there will continue to be occasional fines, probably even larger ones, levied against dark pool operators for their abuse of their own clients. But that hardly solves the real problem. It has become clear over recent years that the banks consider fines paid by their shareholders, not by bank managers, to be a cost of doing business. A couple of years ago, when Senator Elizabeth Warren said, “I think you are breaking the law,” JP Morgan Chase CEO Jamie Dimon famously responded, “So hit me with a fine. We can afford it.”
That kind of Wall Street arrogance has not changed, and it is contributing to the deterioration of investor confidence in our financial markets. The credibility of those markets has been absolutely essential to our entire economic system. If that credibility is lost, we risk losing our place as the world’s most trusted trading venue and will be on our way to becoming an economic backwater.
The mission statement of the SEC is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
Last week, SEC Chair Mary Jo White said “I think you’ll see more dark pool cases.”
Whether we see more cases soon depends on the SEC receiving the resources it needs to learn about new trading techniques and dark pool venues.
The president’s budget has allocated increased funds to do just that and more.
We should all demand that Congress give the SEC the funds it needs to prosecute these cases.
Ted Kaufman is a former U.S. senator from Delaware.