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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Opening Remarks Regarding Dark Pools


Commissioner Elisse B. Walter

U.S. Securities and Exchange Commission

Open Meeting
Washington, D.C.
October 21, 2009

Thank you, Chairman Schapiro. I, too, would like to thank all of the staff and, in particular, the individuals in the Office of Market Supervision from the Division of Trading and Markets, who worked so hard in preparation for today's open meeting.

I am happy to support the staff's proposal.

As many are aware, the act of keeping certain aspects of an order or trade hidden from the public is as old as time. Look to the old "upstairs market" at the New York Stock Exchange as an example of an earlier form of dark liquidity. The concept behind dark pools is anything but new.

However, while dark pools have traditionally been used by institutional traders to execute large stock transactions without moving the market against themselves, dark pools have evolved to give smaller orders a chance at price improvement and additional liquidity — by, for instance, sending out private messages, or IOIs, to selected market participants concerning their actionable orders in NMS stocks. As the staff points out in the proposing release, most dark pools, though they may handle large orders, primarily execute trades with small sizes that are more comparable to the average size of trades in the public markets. These dark pools that primarily match smaller orders account for more than 90% of dark pool trading volume.

Therefore, dark pools are becoming a significant source of liquidity for NMS stocks. What is troubling to me, however, is that by sending out these actionable IOIs — which function quite similarly to displayed quotations, these dark pools are "lit" to a select group of market participants and "dark" with respect to the rest of the public.

The result is that substantial information about available trading interest at the best displayed prices is not being conveyed to all investors. Although investors have become accustomed to having access to the best available price in the market through the consolidated tape, as markets have become more fragmented and certain venues are not required to submit their trading interest to the tape, I believe the validity of that assumption certainly comes into question. Accordingly, because trading interest lying in dark pools may not be included in the public quote stream, it could impair price discovery and prevent investors from having accurate and complete information about interest at the best prices.

Also, because publicly displayed liquidity provides investors with a critical reference point for a stock, I believe there could be some truth to the criticism that every share that is crossed in the dark is a share that doesn't assist the market in determining an accurate price — as it is becoming increasingly difficult for investors to assume that the public quote takes into account all the trading information about the stock.

Further, I agree with the concern that actionable IOIs at the NBBO could deprive those who publicly display their interest at the best price from receiving a speedy execution, as well as divert order flow that otherwise might be routed directly to the public quoting markets. This could significantly discourage the public display of trading interest and harm quote competition among markets, thereby detracting from the efficiency and fairness of the national market system.

I, therefore, believe that the actions proposed today to, among other things, include actionable IOIs in the consolidated quote and identify darks pools and other ATSs in the consolidated trade data could begin to close the information gap and remove inequities for investors. I preliminarily believe the proposal should improve the quality of information about sources of liquidity in NMS stocks and provide investors with valuable and more complete information with which to judge their own transactions. This could thereby increase public confidence in the integrity of the U.S. equity markets.

Since dark pools raise a variety of important policy issues — other than those addressed in this proposing release, I also look forward to considering additional Commission action as it examines various market structure issues that arise from developments in the automated equities and options markets, including whether principles and precedents based on floor-based trading should apply to the present electronic environments. As I have mentioned before, I am particularly eager to move forward, in the near term, with respect to sponsored access, which, to me, presents a variety of unique risks and concerns, particularly when trading firms have unfiltered access to the markets. These risks could affect several market participants and potentially threaten the stability of the markets.

Thank you.


Modified: 10/21/2009