Dark Pool Trade Limit Said to Be Cut 95% in SEC Plan

Dark Pool Trade Limit Said to Be Cut 95% in SEC Plan

Oct. 20 (Bloomberg) -- The U.S. Securities and Exchange Commission will propose toughening its limits on the amount of anonymous trading carried out on stock platforms called dark pools, according to two people familiar with the deliberations.

The commission will propose lowering the amount of daily volume in a company’s shares that can be executed on the networks before prices must be made public to 0.25 percent from 5 percent tomorrow, said the people, who declined to be identified because the discussions weren’t public. John Nester, an SEC spokesman, declined to comment.

The rule change may curtail the number of transactions on dark pools, off-exchange platforms run by firms such as Goldman Sachs Group Inc. and Getco LLC that have drawn scrutiny from Democratic Senators Ted Kaufman of Delaware and Charles Schumer of New York. The systems usually shut down trading in a security when they approach the current 5 percent limit.

“If you were to limit the dark pools to that small amount of trading, it will be much harder to find a counterparty,” said Dirk Hoffmann-Becking, a London-based analyst for Sanford C. Bernstein & Co. For stock exchanges, “if they would see less competition from the dark pool world, that would certainly be a positive for them.”

Concealing Trades

Traders turn to dark pools instead of public markets such as the New York Stock Exchange to avoid revealing their identities and giving competitors clues about their strategies. Kaufman and Schumer say the platforms limit transparency in securities markets and put smaller investors at a disadvantage.

The SEC will exempt block trades, or orders exceeding a certain number of shares, from the new rule, according to one of the people. Firms specializing in blocks account for 8 percent of all dark-pool trading in the U.S., according to data compiled by Aite Group LLC, a Boston-based financial-services consultant.

Transactions are biggest at Liquidnet Holdings Inc. and Pipeline Trading Systems LLC, where orders average 50,000 shares. That compares with 300 to 450 shares at venues such as Getco’s GES.

The 0.25 percent threshold is smaller than Schumer has proposed. He sent a letter to SEC Chairman Mary Schapiro today requesting that the agency force dark pools to publicly display buy and sell orders after matching more than 1 percent of a stock’s average daily volume.

Schumer, Niederauer

Schumer, who held a press briefing today with NYSE Euronext Chief Executive Officer Duncan Niederauer, also wants the SEC to establish a “robust” approval process for new dark pools and treat some so-called indications of interest as formal bids.

Brokers use indications of interest to demonstrate their willingness to trade shares. Schumer said they can be abused because they allow traders to gauge demand without the obligation to buy or sell.

“We are not against dark pools,” Niederauer said. The NYSE just wants a “more level playing field,” he added.

Employees at NYSE Euronext, the operator of the largest U.S. equity exchange, have contributed $27,250 to Schumer’s political campaigns since 2005, according to OpenSecrets.org.

Trading on dark pools such as Credit Suisse Group AG’s Crossfinder and Goldman Sachs’s Sigma X, the two largest, has more than quadrupled to 9.4 percent of all U.S. equity volume in three years, according to estimates by Tabb Group LLC, a New York-based financial-services consultant. Bloomberg LP, the parent of Bloomberg News, also owns Bloomberg Tradebook LLC, an electronic stock-trading network that links to dark pools.

Knight, ITG Decline

Knight Capital Group Inc. fell 3.2 percent in 4 p.m. Nasdaq Stock Market composite trading, the most since July 28. Investment Technology Group Inc. dropped up to 8.2 percent before paring its retreat to 1.9 percent. Both companies operate dark pools. Shares of Nasdaq OMX Group Inc., owner of the second-largest U.S. equity exchange, climbed 3.6 percent in the biggest rally since Aug. 7.

Investors use dark pools to execute bigger orders and avoid revealing details such as price and size that could move a stock, according to Sang Lee, a market analyst at Aite.

The growth is hurting traditional markets, which face more regulation, the World Federation of Exchanges said in a letter last month to Mario Draghi, chairman of the financial-stability board of the Basel-based Bank for International Settlements.

“The more the dark pools exist without any comprehensive regulation, the more you’re going to see liquidity siphon off from exchange markets,” Chicago Board Options Exchange Chief Executive Officer and WFE Chairman William Brodsky said at a conference in Vancouver on Oct. 7.

Publishing Data

NYSE Euronext will begin publishing how much stock trading is conducted on dark pools every day on its Web site. The NYSE will let firms that run the private networks display trading volume starting in November, the company said in a statement today. Barclays Plc, Getco LLC, Goldman Sachs, Knight Capital Group Inc. and UBS AG plan to participate, NYSE Euronext said.

Dark networks “can arbitrarily decide who gets to play in their pool and who doesn’t,” said Dan Mathisson, head of Credit Suisse’s algorithmic unit. “That’s something that needs to get cleaned up.”

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