U.S. Securities Update: SEC Soliciting Comments on Proposed Increased Regulation of certain Alternative Trading Systems, including Dark Pools
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U.S. Securities Update: SEC Soliciting Comments on Proposed Increased Regulation of certain Alternative Trading Systems, including Dark Pools

On November 18, 2015, the U.S. Securities and Exchange Commission (the “SEC”) announced that it had “voted to propose rules to enhance operational transparency and regulatory oversight of alternative trading systems (“ATSs”) that trade stocks listed on a national securities exchange . . . , including ‘dark pools’.” Dark pools are ATSs 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 practical 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 possible price. Dark pools are generally owned by either large broker-dealers, exchanges or electronic market makers. Dark pools carry regulatory concerns as their lack of transparency could make market manipulation easier.

The new SEC rule-making follows recent SEC enforcement actions against dark pool operators for disclosure failures. In addition to previous enforcement actions, after the new rule was proposed, it was announced on February 1, 2016 that Barclays would pay to the SEC and State of New York a $70 million fine in connection with their admission that they had misled investors and violated U.S. securities laws in the way in which they had operated their dark pool. On the same day, it was announced that Credit Suisse would also pay a total of $84.3 million relating to similar violations. Both banks have been censured for their misconduct.

Just prior to the SEC proposed rule, on November 2, 2015, in remarks delivered to the Securities Industry and Financial Markets Association (“SIFMA”), SEC Division of Enforcement Director Andrew Ceresney highlighted four types of threats that have been the subject of recent SEC enforcement actions and that the SEC Division of Enforcement will continue to prioritize. These threats include 1) violations by exchanges and ATSs that have undermined fairness in trading venues; 2) misuse of confidential customer order information by dark pools and other ATSs; 3) failures to maintain adequate safeguards around automated trading systems in violation of the market access rule; and 4) schemes involving high volume manipulation, including layering and spoofing. Ceresney also emphasized that market structure investigations increasingly require an understanding of the underlying technology and the ability to analyze extremely large datasets.

SEC Proposed Rule “Regulation of NMS Stock Alternative Trading Systems”

In the 583-page proposed rule, the SEC proposed to amend the regulatory requirements in Regulation ATS under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) applicable to ATSs that transact in National Market System (“NMS”) stocks (“NMS Stocks”). This proposed rule, which was unanimously approved for release by the four members of the SEC Commission, would revise the regulations covering ATSs in the most significant way since 1998, when Regulation ATS was introduced.

As it currently stands, ATSs have few disclosure obligations. Yet in the years since 1998, when Regulation ATS was passed, ATSs have significantly grown in number and now command about 15% of the total dollar volume of stocks listed on a national exchange, SEC Chair Mary Jo White recently noted. “It is now time to amend Regulation ATS to shine a brighter and clearer light on ATSs for the benefit of investors and the markets generally,” Chair White said.

In addition to unveiling facts about their operations, the proposed rule would require dark pools to disclose activities of their broker-dealer operators and affiliates in a way that could reveal conflicts of interest. The proposed rule would, among other things, require ATSs that transact in NMS Stocks (“NMS ATSs”) to file a newly proposed Form ATS-N regarding:
  • the NMS ATSs’ operations and the activities of its broker-dealer operator and its affiliates, including:
    • their operation of non-ATS trading centers and other NMS ATSs;
    • products and services offered to subscribers;
    • arrangements with unaffiliated trading centers;
    • trading activities on the NMS ATS;
    • smart order router (or similar functionality) and algorithms used to send or receive subscriber orders;
    • shared employees that service the NMS ATSs’ operations and any other business unit or affiliate of the broker-dealer operator;
    • service providers to the NMS ATS;
    • differences in the availability of services, functionalities or procedures available to subscribers, as compared to the broker-dealer operator, and its affiliates; and
    • safeguards and procedures established to protect confidential trading information.
  • the manner of operations of the NMS ATS, including
    • subscribers;
    • types of orders;
    • connectivity, order entry, and co-location;
    • segmentation of order flow and notice of segmentation provided to any persons
    • display of orders and other trading interest;
    • trading services, including rules and procedures governing priority, pricing methodologies, allocation, matching and execution;
    • procedures governing trading during a suspension, system disruption or malfunction;
    • opening, reopening and closing processes, and after hours procedures;
    • use of market data;
    • fees;
    • procedures regarding trade reporting and clearance and settlement;
    • order display and execution access;
    • fair access trading standards; and
    • market quality statistics published or provided by the NMS ATS to one or more subscriber.
Upon reviewing a Form ATS-N, the SEC would declare such form effective after determining, without limitation, that the entity satisfies the definition of NMS ATS, that the form is not materially deficient with respect to accuracy, currency or completeness, and that the entity complies with U.S. securities laws, regulations and rules, including Regulation ATS.

This information would be publicly available on the SEC’s website, bringing the ATS segment of the securities market under more SEC scrutiny. If finalized, the rules represent a significant makeover to Regulation ATS.

For more information:
See the SEC Proposed Rule “Regulation of NMS Stock Alternative Trading Systems” (November 18, 2015) here.
See the SEC Press Release entitled “SEC Proposes Rules to Enhance Transparency and Oversight of Alternative Trading Systems” (November 18, 2015) here.
The SEC is soliciting comments until February 26, 2016. Comments can be made by sending an e-mail to including File Number S7-23-15 in the subject line.
See SEC Division of Enforcement Director Andrew Ceresney Remarks to SIFMA (November 2, 2015) here.
If you have any further questions regarding this please feel free to contact us.

Best regards,
Copyright © 2016 Forum for US Securities Lawyers in London, All rights reserved.

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