Dark pools, by contrast, essentially piggyback, at minimal cost, on quotes set by the New York Stock Exchange, the Nasdaq Stock Market or the U.S.’s 11 other stock exchanges. The dark pools are under no obligation to provide data that the broad market uses for price discovery. What information they do make available tends to fail the fairness test: Price quotes are sometimes sent to select investors, giving them an unfair advantage. Regulators are also concerned that high-frequency traders are placing orders on the open exchanges in order to influence prices in dark pools to their advantage.
Public Service
If this were only a dispute between commercial interests, we could leave the exchanges to duke it out with the dark pools. The reality is that exchanges provide a public service. In the U.S., legislators recognized this in the 1930s, when the first laws governing exchanges and protecting investors were adopted. (Bloomberg LP, parent of Bloomberg News, owns a stake in a company, Bids Trading LP, which operates a dark pool.)
Although Europe’s regulators are pursuing one remedy, Canada might serve as a better model for the U.S. Last year, Canada required dark pools either to offer a superior price to that of the exchanges or to limit trading to large blocks of shares. Since then, buy-and-sell spreads have narrowed by 25 percent, and sharp price swings have declined.
Were the U.S. to adopt a price-improvement rule it might limit the ability of dark pools to leech off the quotes the exchanges generate at great expense.
Regulators should also consider restricting or banning the practice of sharing data with select clients, or require broad quote dissemination. Finra must also be more vigilant amid signs that dark pools have shared clues about customer trading intentions with proprietary traders working for the Wall Street firms that own some of the dark pools.
Dark pools aren’t going away. Regulators need to ensure that their further growth doesn’t cause unacceptable harm to U.S. financial markets.