The idea of "dark pools" has been gaining attention over the last several months, though these arrangements have existed since before the financial crisis. This term also featured prominently in the various news stories that tracked the rising use of computerized algorithms in Wall St trading and the financial markets generally.
Dark pools are generally run by big banks and cater to institutional traders. (There is usually a minimum order amount of 10,000 shares.) Two banks at the center of the dark pool phenomenon, Barclays (NYSE:BCS; LON:BARC) and Credit Suisse (NYSE:CS), have agreed to pay fines for misleading investors about how each manages its dark pools.
Whether or not the fines levied actually prove fair retribution for the money that these banks swindled out of their clients is another matter entirely.
The SEC fines totaled $70 million for Barclays and $84.3 million for Credit Suisse. The latter will be split between the SEC and New York Attorney General's Office. Eric Schneiderman, the New York Attorney General, has been instrumental in investigating both cases.
What are Dark Pools?
In essence, a dark pool is a trading platform where the quantities bought and sold, as well as the identity of the parties involved, are kept secret. This is done in order to avoid influencing the markets dramatically in one direction or the other. It is also seen as a way to avoid tipping off other competing traders about what is taking place.
These are often considered ATSs: automated trading systems. Today, dark pools are associated almost exclusively with high-frequency trading (HFT) methods. HFT hasn't received the same media coverage that it did following financial journalist Michael Lewis's exposé, Flash Boys, published in 2014. Nonetheless, it's still a major aspect of the financial markets.
Obviously, big institutions prefer to use dark pools when the large size of their trades would hurt their competitive balance; but this kind of platform is also abused by shady traders and big-money interests that would prefer not to have their activities known by the public.
The investigation that led to the fines hinged upon whether or not the pair of banks in question disclosed sufficient information to their clients about how trading in their dark pools worked.
"Barclays misrepresented to clients how it monitored its dark pools for high-frequency trading, according to the [SEC] statement. Credit Suisse systematically routed orders to its own dark pool, but told clients that it didn’t prioritize one trading venue over another, according to New York Attorney General Eric Schneiderman."
In fact, Credit Suisse covertly routed all such orders to its own dark pools, Crossfinder and the ironically named Light Pool. For its part, Barclays admitted to wrongdoing, while Credit Suisse did not.
Notice in the (slightly outdated) graphic above that Credit Suisse and Barclays are unsurprisingly at the top of this list.
These fines are all well and good—and there should be more of them—but dark pools are still the bastion of market manipulators, who can execute huge volumes of trades without anyone knowing the action came from a single source. These pitfalls are exacerbated by the widespread use of HFT.
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