[Marxism] Rise of the dark pools

Marv Gandall marvgandall at videotron.ca
Sat Nov 7 06:12:11 MST 2009

>From a speech to the Senate by Delaware Senator Ted Kaufman, published in
yesterday's Huffington Post:

(High frequency or flash trading refers to the growing practice of
investment houses like Goldman Sachs to locate and program servers next to
exchanges, giving them split second advance access to market information
which allows them to engage in automated front-running, executing orders on
their own account ahead of their customers and other traders.)

*    *    *


Due to rapid technological advances in computerized trading, the stock
markets have changed dramatically in recent years. They have become so
highly fragmented that they are opaque - beyond the scope of effective
surveillance. And our regulators have failed to keep pace.

The facts speak for themselves. We've gone from an era dominated by a
duopoly of the New York Stock Exchange and Nasdaq to a highly fragmented
market of more than 60 trading centers. Dark pools, which allow confidential
trading away from the public eye, have flourished, growing from 1.5 percent
to 12 percent of market trades in under five years.

Competition for orders is intense and increasingly problematic. Flash
orders, liquidity rebates, direct access granted to hedge funds by the
exchanges, dark pools, indications of interest, and payment for order flow
are each a consequence of these 60 centers all competing for market share.

Moreover, in just a few short years, high frequency trading - which feeds
everywhere on small price differences in the many fragmented trading
venues - has skyrocketed from 30 to 70 percent of the daily volume.

Indeed, the chief executive of one of the country's biggest block trading
dark pools was quoted two weeks ago as saying that the amount of money
devoted to high-frequency trading could "quintuple between this year and

Mr. President, we have no effective regulation in these markets.

Last week, Rick Ketchum, the Chairman & CEO of the Financial Industry
Regulatory Authority - the self-regulatory body governing broker-dealers -
gave a very thoughtful and candid speech, which I applaud. In it, Mr.
Ketchum admitted that we have inadequate regulatory market surveillance.

His candor was refreshing but also ominous: "There is much more to be done
in the areas of front-running, manipulation, abusive short selling, and just
having a better understanding of who is moving the markets and why."

Mr. Ketchum went on to say:

    There are impediments to regulatory effectiveness that are not terribly
well understood and potentially damaging to the integrity of the
markets...The decline of the primary market concept, where there was a
single price discovery market whose on-site regulator saw 90-plus percent of
the trading activity, has obviously become a reality. In its place are now
two or three or maybe four regulators all looking at an incomplete picture
of the market and knowing full well that this fractured approach does not

Mr. President, at the same time that we have no effective regulatory
surveillance, we have also learned about potential manipulation by high
frequency traders.


...One industry expert has warned about high-frequency malfunctions:

  The next Long Term Capital meltdown would happen in a five-minute time
period. ... At 1,000 shares per order and an average price of $20 per share,
$2.4 billion of improper trades could be executed in [a] short time frame.

This is a real problem, Mr. President. We have unregulated entities - hedge
funds - using high frequency trading programs interacting directly with the

As Chairman Reed said at last week's hearing, nothing requires
that these people even be located within the United States. Known as
"sponsored access," hedge funds use the name of a broker-dealer to gain
direct trading access to the exchange - but do not have to comply with any
of the broker-dealer rules or risk checks.


Even those on Wall Street responsible for overseeing their firms' high
frequency programs are not up to speed on the risks involved, according to a
recent study conducted by 7city Learning. In a survey of quantitative
analysts, who design and implement high frequency trading algorithms,
two-thirds asserted their supervisors "do not understand the work they do."

And though quants and risk managers played a central role exacerbating last
year's financial crisis, 86% of those surveyed indicated their supervisors'
"level of understanding of the job of a quant is the same or worse than it
was a year ago," and 70% said the same about their institutions as a whole.



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