May. 09, 2022
Dark Pools have facilitated questionable transactions. The SEC has noted this previously, here is your reminder: Bad Things Can Happen in the Dark Attracting sufficient liquidity to achieve critical mass has proven a continuous challenge for many dark pools. They have addressed this existential problem in various ways. For example, many dark pool operators have allowed their own proprietary trading desks to have access to their pools, while other operators have allowed their affiliates to trade within their pools.16 And still other operators have given high-speed traders access to their dark pools,17 all in an attempt to ensure that ATS subscribers will find counterparties for their trades as quickly and consistently as possible. Setting aside the propriety of these approaches, their adoption suggests that the implacable need that dark pools have for liquidity has intensified certain conflicts of interest between them and their subscribers. The inability to properly manage these conflicts of interest has led the Commission to bring a number of enforcement actions against dark pool operators in recent years.18 For example, in 2011, the Commission brought an enforcement action against one dark pool operator for falsely advertising that no proprietary trading took place in its dark pool.19 In reality, one of the operators affiliates not only engaged in proprietary trading in the pool, but it also secretly enjoyed unfair informational advantages, which it used to front-run subscribers trades.20 The lesson from this case, however, apparently fell on deaf ears. For just a few months ago, the Commission settled another enforcement action against one of the oldest dark pool operators because it, too, had failed to disclose that it was engaged in proprietary trading within its pool.21 That dark pool operator also gave its proprietary trading desk an unfair informational edge over other subscribers, despite guidance from the operators compliance department that this was improper.22 Of course, conflicts of interest come in many guises. For example, the Commission has brought enforcement actions against dark pools for failing to protect their subscribers confidential information.23 And, just last year, the Commission brought an enforcement action against one operator of a large dark pool because, among other things, it secretly offered high speed traders special order types that gave them an unfair advantage over other subscribers.24 Interestingly, this savvy dark pool operator knew how to play both sides of the fence. In addition to giving high frequency traders an unfair edge, this operator secretly allowed certain of its favored subscribers to avoid trading with those very same high frequency traders.25 This dismal litany of misconduct by dark pool operators appears to have led at least some market participants to lose faith in the ability of dark pools that are operated by broker-dealers to provide a level playing field.26 Bereft of regulatory intervention, these market participants seem to be taking matters into their own hands. Nine of the largest asset managers have banded together to form their own dark pool, one that is operated by and open exclusively to institutional investors.27 According to reports, one of the goals of this new buy-side institutions only dark pool is to eliminate the types of profit driven conflicts of interest that have been seen in some existing venues.28 This action by buy-side investors with approximately $14 trillion in assets under management29 seems to be a clear warning the markets arent working as well as they could, a warning that has gone unheeded for far too long.