Brokers’ internal order matching systems came under heavy criticism by exchange officials and money managers during a market structure discussion held online last week by the Investment Company Institute.
Conference participants took aim at a host of ills allegedly brought on by dark pools, including harming the price discovery process, information leakage, a lack of information about fees, and a low level of price improvement.
Most of the criticism came from executives at exchanges that compete with broker dark pools, but representatives from the buyside vented as well.
“There needs to be a level playing field between the exchanges and the exchange-like institutions,” Matt Lyons, global trading manager at Capital Research and Management Company, said at the Web-based conference. “There need to be fee disclosures so you understand the incentives behind why people may be interacting with the exchange-like vehicles.”
With one exception, dark pool operators do not publish their fees. Neither do brokers educate their clients about the reasons behind their routing decisions nor the sizes of the fees they pay or receive. The only exception is Citadel Securities, which disclosed its fee structure for its Apogee dark pool.
Dark pool conflicts of interest aren’t limited to opaque pricing, according to Eric Noll, Nasdaq OMX Group’s head of transaction services in the U.S. “The main driver of the creation of many, many dark pools was to limit information leakage,” Noll said at the webinar. “But we find dark pools are no longer protecting information.”
Noll explained that a “subset” of dark pool users was obtaining information by interacting with orders in dark pools and then using that information to make a trading profit in the broader market. Noll’s charges are not new, and are typically leveled against so-called high-frequency trading firms.
Comments from Bill O’Brien, chief executive at exchange operator Direct Edge, echoed those of Noll and Lyons. “Exchanges are not always the best place to execute,” O’Brien said, “but the buyside has to accept that dark pools are much less regulated than exchanges and less transparent in their practices.”
The issue of information leakage from dark pools came to a head in the past year as two dark pool operators—Pipeline Trading and Level ATS—were fined by the Securities and Exchange Commission. The regulator charged the two pool operators with failing to disclose to their customers that the details of their orders were not kept exclusively within the pools.
