SEC Commissioner Stein Stresses Greater Transparency in Equity Markets
Commentary by Steven Lofchie
SEC Commissioner Kara Stein called for greater transparency in the capital markets. She argued that even though a "new digital age" has transformed the way in which securities are traded, "opaque" areas of the market remain and must be addressed.
Commissioner Stein remarked that in order to ensure that investors are given enough accurate information to make informed decisions, "dramatic reforms" must be adopted in the Alternative Trading Systems ("ATS") markets, which are also called "dark pool" markets. She warned that it is unclear whether dark pools continue to "perform the functions that were originally intended," and that "overall market price discovery may be distorted rather than enhanced" as more trading is routed to dark venues that have restricted access and limited reporting.
Commissioner Stein also argued that the consolidated audit trail ("CAT"), a system that has only been tested in theory, will help to implement greater transparency. She contended that the CAT would enable comprehensive and efficient tracking of every order and trade made in the market across venues and systems.
Commissioner Stein questioned whether there is sufficient transparency regarding the roles and responsibilities of key market players. Efforts toward greater transparency will result in the "fair and efficient allocation of capital," she said.
Commissioner Stein delivered her remarks before the Securities Traders Association's 82nd Annual Market Structure Conference.
Commentary
Commissioner Stein's statement that dark pools may no longer "perform the functions that were originally intended" is worth analyzing: by whom were they intended? Dark pools were never contrived by the regulators; rather, dark pools were a reaction by market participants to a regulatory scheme that was controversial when adopted. Two Commissioners dissented. Anyone who rereads those dissents would be impressed by the prescience of the objections.
Having asserted that dark pools do not work as intended, Commissioner Stein goes on to say that more and more participants prefer dark pools to ordinary exchanges for executing trades. That might lead one to believe that dark pools are working just fine (in the sense that market participants prefer to use them), and that it is the exchanges that fail to work as intended.
To phrase this differently, exchanges impose a cost on the people who use them; i.e., traders' quotes become public knowledge. Conversely, the users of dark pools are not required to bear the cost of this information and obtain the free benefit of seeing the quotes posted by other users of public exchanges. One may make the reasonable complaint that this is not fair, however, that does not mean that the government could improve the system automatically by abolishing dark pools. Under the same rationale, why would it not be legitimate to recommend abolishing public exchanges?
Of course, any suggestion that public exchanges should be abolished, like any suggestion that dark pools should be abolished, is not serious. But it is instructive in order to challenge the notions that (i) exchanges are good and dark pools are bad and (ii) if more traders prefer dark pools, then the government should abolish them. It would be great if we had a regulatory culture that experimented with market structure regulations, as was recently suggested by the Managed Funds Association. Perhaps there could be one list of stocks for which dark pool trading was prohibited, another list of stocks for which only trading (but not quotation) information was distributed, and a control group for both. Let's just see what works.
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