The number of active dark pools transacting in stocks that trade on major U.S. stock markets has tripled since 2002. In the face of the rapid growth of these venues, some commentators worry that their lack of transparency could create a two-tiered market that deprives the public of information about stock prices and liquidity.
On October 21, 2009, the SEC voted unanimously to propose measures intended to increase transparency of dark pools so investors get a clearer view of stock prices and liquidity.
The SEC's proposals address three specific concerns related to dark pools:
The first proposal would require actionable Indications of Interest (IOIs) - which are similar to a typical buy or sell quote - to be treated like other quotes and subject to the same disclosure rules.
The second proposal would lower the trading volume threshold applicable to alternative trading systems (ATS) for displaying best-priced orders. Currently, if an ATS displays orders to more than one person, it must display its best-priced orders to the public when its trading volume for a stock is 5 percent or more. The SEC's reform proposal would lower that percentage to 0.25 percent for ATSs.
The third proposal would create the same level of post-trade transparency for dark pools as for registered exchanges. Specifically the proposal would amend existing rules to require real-time disclosure of the identity of the dark pool that executed the trade.
While the SEC's desire to pursue market transparency is commendable, it should also be wary of moving too quickly in regulating "dark pool" markets. Dark pool trading offers significant benefits to large investors, including a shelter from the share price premiums that result from "flash trading."