The hidden trading venues of Wall Street will finally have to open their curtains to the public in the coming months.
Alternative trading systems, more commonly known as dark pools, largely operate outside the public eye despite accounting for more than 10% of trading in the U.S. stock market. Now, two decades after the original regulation overseeing the venues was adopted, the SEC has approved a plan to force the 41 dark pools operating in the U.S. equity markets to begin publicly disclosing information about their businesses. The costs of preparing and disclosing that data could lead some dark pools to fold or merge, concentrating trading at fewer venues.
“All [alternative trading systems] should provide investors with information about who they are, what they do and how they do it,” SEC Commissioner Kara Stein said July 18 at the regulator’s open meeting, where the proposal was adopted by a unanimous vote.
Run by some of Wall Street’s largest institutions, including Fidelity Investments, Goldman Sachs Group Inc. and Credit Suisse Group AG, dark pools act as alternatives to “lit” securities exchanges such as those run by Intercontinental Exchange Inc., Nasdaq Inc. and Cboe Global Markets Inc.
But unlike exchanges, dark pools do not have to publicly disclose information about the trading on their venues, spurring market participants to ask how they handle trade orders. In May, dark pools accounted for about 12.82% of the average daily volume of shares traded, according to data from market structure research company TABB Group.
The murkiness of dark pools came into question several years ago, after the SEC cracked down on a string of dark pool operators that allegedly misled investors about their operations. As a result, the SEC began crafting a proposal in 2015 that would have pushed dark pools to begin reporting certain measures about their operations to the agency and the public.
That proposal was met with a largely positive response from market participants. Proprietary trading company Virtu Financial Inc. expressed its support in a 2015 comment letter, writing that “heightened transparency requirements would further benefit the marketplace.”
But dark pool operators such as Morgan Stanley and Luminex Trading & Analytics LLC, which was founded by Fidelity and eight other asset managers, questioned whether all the information the SEC was seeking in the disclosure forms was necessary for investors.
“Luminex, as a whole, was founded on transparency, and we’re certainly in favor of that,” Luminex Chief Compliance Officer Jim Dolan said in an interview. “Our concern about the specific  proposal was that it was too broad. It would require a lot of extraneous information for [dark pools] to report.”
Three years later, the SEC’s recently adopted rule change will require dark pool operators to disclose order types available on their venues, outbound routing practices, fees and the activities of the dark pool and its affiliates, among other information.
The disclosure forms, which companies will begin filing in early 2019, could impose higher regulatory costs on dark pool operators, depending on the exact specifications of the final rule, Luminex’s Dolan said.
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