Last month the SEC voted to issue rules to increase transparency of “dark pools” of liquidity.  Dark pools are a way of trading securities without publicly displaying quotes or orders.

Dark pools exist because many securities traders do not want to publicly display their desire to sell or purchase large amounts of shares for fear of significantly moving stock prices before being able to execute the order.  When an order is placed on an exchange, the exchange makes the order publicly available.  Historically, sophisticated traders could avoid public disclosure by enlisting a broker-dealer to inquire among other traders, or on the floor of an exchange, about taking a large order (without disclosing enough information to move the market).  Dark pools offer a modern, computerized way to confidentially search for a complementary trading interest.

Investors using a dark pool have access to information about potential trades that investors using public quotations do not, even though dark pools use the information from public markets to determine price.  Dark pools also network with each other to execute trades.  There are approximately 30 dark pools that transact in stock that trades on major US markets.

Dark pools raise the following concerns:

  1. Dark pools hide the true value of securities traded on public exchanges by siphoning significant orders from public markets (the so-called “two-tiered market” in which the public does not have fair access to the best prices);
  2. Dark pools create an information advantage for their operators and participants.  This information could potentially be misused to trade securities in public markets to the detriment of other investors not privy to the information;
  3. An unmonitored market is a target for market manipulation; and
  4. The phrase "dark pool" just sounds nefarious.

The SEC solution would seek to alleviate these concerns by:

  1. Requiring that information about an investor’s interest in buying or selling a stock be made publicly available, instead of just to participants in a dark pool; and
  2. Requiring that dark pools identify the trades for which they are responsible.

The next step is for the Commission to seek public comment.