Regulators target dark-pool traders

New York Attorney General Eric Schneiderman. Photo / Bloomberg

The operators of opaque stock trading venues known as "dark pools" are coming under renewed scrutiny from government regulators.

New York Attorney General Eric Schneiderman and the Securities and Exchange Commission announced Monday that two of the largest operators of dark pools, Barclays and Credit Suisse, would pay a combined $154.3 million after being accused of lying to customers about their operations.

Unlike traditional trading venues such as the New York Stock Exchange or Nasdaq, dark pools mask the identities of those buying or selling stock. For sophisticated traders, including pension funds, that secrecy makes it easier to move large blocks of stock without alerting other traders who could use the information to their advantage. But critics have warned that without proper regulation, the industry could become another avenue for manipulating the financial markets. (About 15 percent of daily U.S. stock-trading volume now occur in dark pools.)

In the settlement announced Monday, London-based Barclays is accused of not telling customers that its dark pool included high-frequency traders, who use complex computer algorithms to trade at blink-of-an-eye speeds. New York-based Credit Suisse was accused of similar deceptions.

Instead of keeping the high-speed traders out as it promised customers, Schneiderman alleged, the companies welcomed them in. His office sued Barclays in 2014 after being alerted to the issue by a whistleblower.

Operating in a dark pool, a high-frequency trader could potentially sniff out whether there is a large potential buyer or seller, said Haoxiang Zhu, an assistant professor at the MIT Sloan School of Management, who has studied the venues. "The institutional investors worry about leaking their transaction intentions because this information moves prices," Zhu said.

We have today have brought some light to the darkest parts of the market.

Barclays and Credit Suisse agreed to pay $70 million and $84.3 million in penalties, respectively. Barclays admitted wrongdoing as part of its settlement, but Credit Suisse did not.

"We have today have brought some light to the darkest parts of the market," said Schneiderman, who has made cracking down on predatory Wall Street trading practices a key issue.

Both companies said they were satisfied the matter had been resolved. "We are pleased to have resolved these matters with the SEC and the New York Attorney General," Credit Suisse said in a statement.

The fines were the largest ever levied by the SEC against dark pools. Regulators did not pursue charges against any individual employees.

We believe IEX will create an exchange where all market participants are on equal footing.

The settlements come as another dark pool, Investors Exchange, is fighting to join NYSE and others as a traditional stock exchange. The typically esoteric debate has taken on a higher profile in part because IEX was profiled by Michael Lewis in the book "Flash Boys," which chronicled the rise of high-frequency trading. IEX supporters say the platform could provide a critical counterweight to venues that favor high-frequency trading, while critics say the dark pool doesn't meet the standard of a heavily regulated exchange.

The company's application has been pending before the SEC, which has been lobbied heavily for months on the matter by members of Congress and Wall Street insiders.

The Teacher Retirement System of Texas, which has billions in assets, submitted a letter to the SEC in favor of IEX's application: "We believe IEX will create an exchange where all market participants are on equal footing."

The New York Stock Exchange is less enthusiastic: "Like the 'non-fat yogurt' shop on 'Seinfeld,' which actually serves tastier, full-fat yogurt to increase its sales, IEX advertises that it is 'A Fair, Simple Transparent Market,' whereas it proposes rules that would make IEX an unfair, complex and opaque exchange," NYSE said in a November letter to the SEC on the matter.