Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

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.”

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Wall Street has a long history of investors profiting on their access to non-public information about the business prospects of publicly traded companies. However, new kinds of “insider” trading, kinds that are still legal, are the subject of increasing regulatory concern.

These technological advantages take several forms. As recently explained by Eyes, in flash trading, select investors pay for access to information about stock purchases and sales fractions of a second before the information becomes public.

Naked access occurs when brokerage firms pay sponsors-- firms approved to trade on particular exchanges-- to execute orders anonymously through the sponsors’ computers, getting tiny but profitable time advantages over the rest of investors. Accounting for more than half of the daily trading volume, “naked” access is currently solely regulated by rules imposed by participating exchanges and brokers. The SEC has threatened to implement rules that would undercut the speed advantage gained through such access. 

A “dark pool” is a private exchange over which sophisticated traders can electronically buy and sell large amounts of stock, taking advantage of technology that lets them complete transactions faster than could be achieved in the NYSE. As recently reported in a New York Times article about “dark pools,” these exchanges have caused the daily trading volume of the NYSE to decrease by approximately 39% over a four-year period.

While all of these practices pose complicated problems for regulators, they may also highlight a disturbing trend: that technological advantages may be overtaking investor acumen as the key to profiting on the markets.

Update on Dark Pools Regulation

Concerned about problems posed by “dark pool” markets, on October 21, 2009, the SEC voted to propose new rules that would require more stock quotes in the “dark pool” systems to be publicly displayed.  The rule changes may be adopted after a 90-day public comment period.  The SEC Chairman, Mary L. Schapiro, discussed the issue in a speech titled “Statement on Dark Pool Regulation Before the Commission Open Meeting.”

For more details on the proposed regulations, please see the October 28, 2009 Eyes post.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

In the face of a financial crisis fueled by widespread overvaluation of real estate and mortgage-backed assets, investment banks and other financial sector interests have successfully lobbied to undermine accounting rules that ensure the integrity of asset valuations. 

Bowing to intense lobbying efforts, in April of this year the Financial Accounting Standards Board (FASB) altered long-standing rules requiring banks to use “mark to market” accounting—that is, to value assets at what they would fetch in the current market. These changes permit companies to use inflated asset values and allowing companies to avoid having to recognize asset losses in reporting their earnings.

Investors should pay special attention to changes in FASB Staff Position 157-4, called Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.  In FSP 157-4, the FASB states that “[f]air value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation, or distressed sale) between market participants at the measurement date under current market conditions.”

However, amendments to FSP 157-4 contain a loophole permitting companies to disregard an observable market price for assets traded in an “inactive” market—that is, a market in which there is little or no data about current trading values. When markets are inactive, the new rule empowers companies to exercise their own judgment in estimating the fair value of assets traded on inactive markets.

This development is dangerous because companies have the power to ensure that markets are inactive by ceasing to sell or buy risky assets—permitting them to value the assets using their own estimates rather than market prices.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

How much of an advantage is it to know about trades three hundredths of second before the investing public? Enough to warrant the concern of the SEC. The issue involves flash trading or high-frequency trading, which gives select traders the ability to see buy and sell orders a fraction of a second before the information becomes public. This tiny time advantage can be highly profitable, because high-speed super computers are able to process the flashed information to help investors capitalize on trading patterns that are not yet public information. Mary L. Schapiro, chairwoman of the SEC commented in a September 17, 2009 speech that, "[f]lash orders may create a two-tiered market by allowing only selected participants to access information about the best available prices for listed securities."

 Last month the SEC voted unanimously to propose regulations that would ban flash trading. If the regulations are adopted, they would effectively prohibit all markets, including equity exchanges, options exchanges and alternative trading systems, from displaying marketable flash orders. The Commission is seeking public comment and data on a broad range of issues relating to flash orders, including the costs and benefits associated with the proposal. It is also seeking comment on whether the use of flash orders in the options markets should be evaluated differently than their use in the equity markets.

The proposed ban on flash orders is just one part of a broader effort by the SEC to more effectively regulate the U.S. stock market in the wake of last year’s financial crisis.

• Email This
• Print
• Comments
• Trackbacks
• Share Link