United States: FINRA Proposes Rules to Illuminate "Dark Pools"

The Financial Industry Regulatory Authority (FINRA) filed a rule proposal with the Securities and Exchange Commission (SEC or the Commission) on September 30 that would impose reporting requirements on alternative trading systems (ATSs), including dark pools.[1] Dark pools are a type of ATS in which participants can transact their trades without displaying quotations to the public.[2] Pursuant to the proposed rules, each ATS must report its aggregate weekly volumes and number of trades on a security-by-security basis to FINRA and indicate which trades take place on ATS platforms. Although the proposed rules will not apply to off-exchange trading venues that are excluded from Regulation ATS requirements,[3] the rules, if approved by the SEC, will increase publicly available information about these opaque and rapidly growing private markets.

Alternative trading systems are threatening to supplant traditional exchanges. In a speech at the Security Traders Association's market structure conference on October 2, SEC Chair Mary Jo White stated that more than half of the orders of long-term investors are executed on off-exchange "dark" venues.[4] However, only limited data on ATSs is publicly available. Commercial sources, including Rosenblatt Securities and Tabb Group, provide subscription sources of information on ATS trading, but these sources rely on self-reported data, which is limited in scope.

Dark pools match up trades of buyers and sellers anonymously, thereby allowing investors to trade large blocks of securities without having news of their orders move the market. While historically dark pools were used by large institutional investors, the average trade size has been declining as hedge funds and high-frequency trading firms have started to migrate to these systems.

Dark pools have been on FINRA's radar since at least last fall, when the regulator issued examination letters to several operators of ATSs, seeking copies of policies and procedures, descriptions of the visibility of order information by clients, information about how each firm uses indications of interest, and data on error handling and complaints, among other information. Earlier this year, FINRA sent a second round of letters, seeking information on how ATSs operate, how they route orders, what they disclose to clients and how they police trades.

FINRA is proposing to adopt new FINRA Rule 4552, which will require each ATS to report volume information regarding transactions within the ATS in securities (both equity and debt), subject to FINRA reporting obligations. Each ATS will be required to report to FINRA the aggregate weekly volume of transactions and number of trades within the ATS by security, within seven business days after the end of each calendar week. FINRA proposes to post the reported information on its website regarding National Market System (NMS) stocks in the S&P 500 Index or the Russell 1000 Index and certain exchange-traded products on a two-week delayed basis. All other NMS stocks and over-the-counter equity securities subject to FINRA trade reporting requirements would be published on a four-week delayed basis, to minimize potential market impact.

In a webcast to FINRA members, Richard Ketchum, FINRA's chief executive, stated that the rules will enable FINRA to understand the amount of activity occurring in each ATS, thereby increasing information about ATS trading generally and dark pool trading in particular.[5]

The proposed rules will also require each ATS to use a unique market participant identifier (MPID) when reporting order or trade information to FINRA. Under current FINRA rules, although each over-the-counter securities transaction in which an ATS is involved must be reported under FINRA rules, a broker-dealer operating an ATS may report trades executed within the ATS using the same MPID it uses for transactions in other areas of its business, making it impossible to determine from the trade reporting data which trades were executed on the ATS as opposed to other areas of the broker-dealer's business. Use of a unique MPID will permit FINRA to closely monitor for abusive conduct the trading that occurs in each ATS. Ketchum described the effort as "a real positive step from a market-integrity standpoint."[6]

Not surprisingly, the stock exchanges have requested that regulators curb trading in dark pools. Earlier this year, the chief executive officers of NYSE Euronext Inc., Nasdaq OMX Group Inc. and BATS Global Markets Inc. asked the SEC to pass a rule requiring brokers to route an order to an exchange unless they can improve on the best public quote by a defined amount.

FINRA is not alone in seeking more information about dark pool trading. As early as 2009, the SEC voted to propose measures "intended to increase transparency of dark pools so investors can get a clearer view of stock prices and liquidity."[7] In testimony before the Senate Banking Committee in March 2013, Mary Jo White noted that dark pools, among other technological developments, raise many questions, stating, "Do they result in unnecessary volatility, or create an uneven playing field? Or do these modern-day features bring benefits such as efficiency, price reduction, and healthy competition to our markets? Do they do all of these things? The experts and studies to date have not been consistent or definitive in their observations and findings about whether and to what extent harm is caused by the current market structure and practices."[8]

The SEC is seeking to answer these questions, and others, through more sophisticated data analysis. On October 9, the SEC announced that it was making a vast trove of data drawn from MIDAS, the SEC's market information and data analysis service, available on its website, to help inform the broader market structure debate.[9] The resources include a paper providing key metrics describing the underlying nature of off-exchange trading by the ATSs that trade equity securities, and a paper summarizing current studies addressing visible and dark market fragmentation.

By proposing rules requiring ATSs to report aggregate volume information and number of trades on a security-by-security basis and to obtain a unique MPID designed for exclusive use for reporting each ATS's transactions, FINRA is taking the first step toward increasing transparency in dark pools. We will continue to monitor this evolving area of regulation.

----------
[1] Regulation ATS defines an alternative trading system as "any organization, association, person, group of persons, or system: (1) That constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of [Exchange Act Rule 3b-16]; and (2) That does not: (i) Set rules governing the conduct of subscribers other than the conduct of such subscribers' trading on such organization, association, person, group of persons, or system; or (ii) Discipline subscribers other than by exclusion from trading." 17 C.F.R. § 242.300(a). Although ATSs operate similar to traditional exchanges, they are regulated as broker-dealers rather than as national security exchanges. The proposed rule change applies to any alternative trading system, as that term is defined in Regulation ATS, that has filed a Form ATS with the Commission.

[2] Securities and Exchange Commission Press Release, SEC Issues Proposals to Shed Greater Light on Dark Pools, Oct. 21, 2009, available at http://www.sec.gov/news/press/2009/2009-223.htm (SEC Dark Pool Press Release).

[3] Regulation of Exchanges and Alternative Trading Systems, Final Rule, SEC Release No. 34-40760, 63 Fed. Reg. 70844 (Dec. 22, 1998).

[4] Mary Jo White, Chair, U.S. Securities and Exchange Commission, Address to Security Traders Association 80th Annual Market Structure Conference, Focusing on Fundamentals: The Path to Address Equity Market Structure (Oct. 2, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370539857459 (Mary Jo White STA Speech).

[5] FINRA, July 2013 Board Update, available at http://www.finra.org/Industry/Regulation/Guidance/.

[6] Id.

[7] SEC Dark Pool Press Release.

[8] Testimony of Mary Jo White, Nominee for Chair of the U.S. Securities and Exchange Commission Before the United States Senate Committee on Banking, Housing and Urban Affairs, Mar. 12, 2013, available at
http://www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=619e5603-c2c8-4085-98c6-0014ce29bde7.

[9] Mary Jo White STA speech.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions