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SEC proposes changes for ‘dark pools’

Federal regulators are proposing tighter oversight for so-called "dark pools," trading systems that don't publicly provide price quotes and compete with major stock exchanges.
/ Source: The Associated Press

Federal regulators are proposing tighter oversight for so-called "dark pools," trading systems that don't publicly provide price quotes and compete with major stock exchanges.

The Securities and Exchange Commission voted Wednesday to propose new rules that would require more stock quotes in the "dark pool" systems to be publicly displayed. The changes could be adopted sometime after a 90-day public comment period.

The alternative trading systems, private networks matching buyers and sellers of large blocks of stocks, have grown explosively in recent years and now account for an estimated 7.2 percent of all share volume. SEC officials have identified them as a potential emerging risk to markets and investors.

The SEC initiative is the latest action by the agency seeking to bring tighter oversight to the markets amid questions about transparency and fairness on Wall Street. The SEC has floated a proposal restricting short-selling — or betting against a stock — in down markets.

Last month, the agency proposed banning "flash orders," which give traders a split-second edge in buying or selling stocks. A flash order refers to certain members of exchanges — often large institutions — buying and selling information about ongoing stock trades milliseconds before that information is made public.

Institutional investors like pension funds may use dark pools to sell big blocks of stock away from the public scrutiny of an exchange like the New York Stock Exchange or Nasdaq Stock Market that could drive the share price lower.

"Given the growth of dark pools, this lack of transparency could create a two-tiered market that deprives the public of information about stock prices," SEC Chairman Mary Schapiro said before the vote at the agency's public meeting.

Republican Commissioners Kathleen Casey and Troy Paredes, while voting to put out the proposed new rules for public comment, cautioned against rushing to overly broad regulation that could have a negative impact on market innovation and competition.

Dark pools might decide to maintain stock trading at levels below those that trigger required public display under the proposed rules, Paredes said. "Darker dark pools" could be worse than the current situation, he suggested.

When investors place an order to buy or sell a stock on an exchange, the order is normally displayed for the public to view. With some dark pools, investors can signal their interest in buying or selling a stock but that indication of interest is communicated only to a group of market participants.

That means investors who operate within the dark pool have access to information about potential trades which other investors using public quotes do not, the SEC says.

The SEC proposal would require indications of interest to be treated like other stock quotes and subject to the same disclosure rules.

A 1999 SEC rule established a separate set of regulations for alternative trading systems, which have grown to 29 from 10 in 2002. The largest dark pools are Credit Suisse Group's CrossFinder, Knight Link, Goldman Sachs Group Inc.'s Sigma X, Getco and LeveL, according to the TABB Group, an analytical firm based in Westborough, Mass.

Others are London-based Turquoise Trading Ltd., a European system established by Citigroup Inc., Goldman Sachs, France's Societe Generale SA and other major banks; Toronto-based Alpha was set up by several major Canadian banks; and Liquidnet Inc. in New York.

NYSE chief executive Duncan Niederauer has asked the SEC to subject the alternative systems to a stricter set of regulations that is closer to the regime for the major exchanges. His proposed changes would go further than those being considered by the SEC.

"We are not against dark pools," Niederauer said Tuesday in a conference call with reporters. "We're in favor of competition; we'd just like it to be a level playing field."

Sen. Charles Schumer, D-N.Y., sent a letter to Schapiro asking the SEC commissioners to consider stricter regulations for the trading systems as well as establishment of a consolidated surveillance system for all markets, for which the alternative systems would contribute some of the cost.