Dark Pools face an increase in SEC Enforcement Actions


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Dark Pools face an increase in SEC Enforcement Actions

Dear <<First Name>>,

Dark pools are alternative trading systems (“ATS”) which allow off-exchange trading of securities for institutional investors. While any trades can be executed on a dark pool, they are typically used for block trades and are not accessible to the general public; trades on dark pools are executed anonymously and they do not display price quotes to the public. There are several advantages for dark pool participants executing large block trades on dark pools, rather than exchanges. First, the trades can be executed without the same market impact as if done on an exchange. Additionally, for all trades, there are lower transaction costs for dark pools.

The drawbacks of dark pools include the potential that, due to the lack of transparency, a buyer may not achieve the best price. Dark pools have also recently come under increasing scrutiny for creating opportunities for predatory high-frequency trading firms.  These firms use current technology to anticipate trades and then benefit from that market information. Dark pools are generally owned by either large broker-dealers, exchanges or electronic market makers. 

The U.S. Securities and Exchange Commission (the “SEC”) has increasingly brought enforcement actions against dark pools whose rules and incentives it claims harm investors. SEC Chair, Mary Jo White, in June 2014 announced a plan to reshape U.S. stock trading regulation, including initiatives to boost the transparency of dark pools. Recent enforcement actions demonstrate the SEC’s commitment to this issue. Below are highlights from three recent cases:
  • In January 2015, UBS Securities LLC (“UBS”) agreed to settle charges brought by the SEC and paid more than $14.4 million, including a $12 million penalty which represents the SEC’s largest penalty against an ATS. UBS ran afoul of regulations by allowing traders to buy and sell stocks priced at increments smaller than a penny, and it further erred by failing to adequately disclose this sub-penny system. It also failed to adequately disclose another trading feature that involved a “natural-only crossing restriction” which was developed to ensure that certain orders would not execute against orders placed by market makers and high-frequency trading firms. “The UBS dark pool was not a level playing field for all customers and did not operate as advertised,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement. “Our action shows our continued commitment to policing the equity markets to ensure fairness and compliance with all laws and rules.”
  • In July 2014, the SEC charged a Citigroup business unit operating an ATS with failing to protect the confidential trading data of its subscribers. New York-based LavaFlow Inc. agreed to pay $5 million to settle the SEC’s charges. “Operators of alternative trading systems must protect confidential subscriber data and take steps to ensure that affiliates do not improperly use order information,” said Andrew J. Ceresney, director of the SEC’s Enforcement Division. “We will continue to hold accountable firms that fail to follow the rules applicable to off-exchange venues.”
  • In June 2014, Liquidnet Holdings Inc. (“Liquidnet”), one of the biggest independent dark pool operators, agreed to pay a $2 million fine for not meeting client confidentiality standards. An SEC investigation found that Liquidnet violated both its regulatory obligations and its own promises to its subscribers during a nearly three-year period when it improperly allowed a business unit outside the dark pool operation to access the confidential trading data.
These actions demonstrate the SEC’s active concern about dark pool trading and the potential negative effects it may have on the markets. This initiative also indicates that the market will likely see increased regulation and oversight of ATS both by the SEC and the Financial Industry Regulatory Authority in the coming months and years. 

Best regards,

Daniel Winterfeldt
Head of International Capital Markets
CMS Cameron McKenna LLP
Founder and Co-Chair of the Forum

Ed Bibko 
Baker & McKenzie LLP
Co-Chair of the Forum
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