Monday, February 1, 2016

Dark Pools, High Frequency Trading and Moral Hazard

Yesterday Reuters reported that Barclays and Credit Suisse agreed to pay the SEC and New York State Attorney General's Office 154.3 million to settle charges that they misled investors engaged in transactions in the firms' dark pools. Dark pools are trading platforms where trades remain non-transparent to other traders until fully executed. Dark pools have been criticized because their lack of transparency facilitates a range of fraudulent activities, especially as connected with high frequency trading:

Sarah N. Lynch. Barclays, Credit Suisse strike record deals with SEC, NY over dark pools. Reuters, Sun Jan 31, 2016

At the heart of the cases against both Barclays and Credit Suisse are allegations they misled investors in the dark pools, saying they would be protected from predatory high-frequency trading tactics.  
It appears from the article that no criminal charges were leveled against individuals despite allegations that the firms failed to protect investors from predatory high-frequency trading tactics, despite promising said protections.

Once again, financial regulators are encouraging MORAL HAZARD and reinforcing criminality by failing to hold individuals responsible for malfeasance.

In my recently completed book, Dispossession: Liberalism's Crisis, I describe this type of malfeasance in some detail in my chapter on the 2007-2008 financial crisis. Here is a relevant excerpt:

Lack of Transparency

The financial complex lacks transparency in key arenas: algorithmic trading and complex financial derivatives obscure transparency while entire operations – such as dark pools- are invisible to regulators. As explained previously, the banking sector insured by the FDIC in the US is supplemented by a vast and relatively non-transparent “shadow” financial system composed of money-market funds, hedge funds, finance companies, structured-finance vehicles, brokers and dealers, real-estate investment trusts, trust companies and financial firms other than banks.[i] The assessed value of the global shadow system skyrocketed in in 2002 from approximately $27 trillion, with about half of that deriving from US holdings, to $70 trillion in 2007, with the US share valued  at approximately $25 trillion. After contracting slightly during the recession, the shadow system expanded to $75 trillion, with US holdings valued at $25.2 trillion in 2013. The shadow system holds systemic risks because of its size, interconnectivity, and risk-seeking practices. Trading within the shadow system often occurs in non-transparent “dark pools.” The consolidation of money and power within the shadow system led the Fed to designate shadow institutions, such as Goldman Sachs, as systemically important enough during the financial crisis to receive federal funds, although technically ineligible.[ii]
In 2015, Goldman Sachs released a report on its rise of institutional investors in the shadow sector, which it described loosely in terms of lending activities conducted outside of commercial banking.[iii] Goldman Sachs argues growth of this sector was driven by the desire to evade increased regulation in the post-crisis period (after 2008), especially the Dodd-Frank Wall Street Reform and Consumer Protection Act, and increased capital requirements established by the Bank of International Settlements (BIS) with Basel III guidelines.[iv] As shall be explained presently, the shadow sector often engages in regulatory arbitrage by moving accounts and offices to more lenient regulatory environments, such as the City of London, which is a corporation[v] not fully subject to parliamentary authority.[vi]
Dark trading operations deliberately obscure transactions. Over the last few decades, trading has moved from the high volume exchanges into “dark pools,” or private trading platforms used by institutional investors and hedge funds, that are invisible to the public and to regulators. In fact, in 2009 only 36 percent of daily trades in stocks listed on the NYSE occurred on the exchange as the vast majority of transactions were executed in dark pools or on new electronic exchanges.[vii] By 2015, Nasdaq OMX Group, announced its intentions to seek approval from the SEC to operate dark pools for banks, despite previously lobbying against them because of their lack of transparency.[viii] As explained in an article about dark pools by financial journalist Graham Bowley, “These stealth markets enable sophisticated traders to buy and sell large blocks of stock in secrecy at lightning speed, a practice that has drawn scrutiny from the US Securities and Exchange Commission.”[ix] In January of 2015, UBS AG agreed to pay $14 million to settle allegations by the SEC that the company “created an uneven playing field inside its dark pool” and in August 2015 Credit Suisse and Barclays, entered settlement negotiations with the SEC and New York Attorney General in August 2015 regarding similar allegations, focusing in particular on (lack of) disclosure of accurate information about trading and systematic biases produced by high frequency traders.[x]
Electronic trading obscures by acceleration. High frequency trading (HFT) occurs in both dark pools and on the more commonly recognized exchanges, such as the NYSE. HFT involves powerful computers located immediately next to exchanges that rely on computer code to automatically purchase and sell vast quantities of securities. HFT has significantly increased turn-over of securities: In 2010 the average time a stock was held was only 22 seconds.[xi] California attorney and financial reformer Ellen Brown notes that HFT has become a major source of stock market trading volume: “High frequency trading firms now account for 73 percent of all US equity trades, although they represent only 2 percent of the approximately 20,000 firms in operation.”[xii] It does not matter which way the stock market fluctuates: so long as stock markets “move,” high frequency traders make money. HFT enable advantageous insight into sellers and buyers price points. Traders with the fastest HFT programs, located in close proximity to exchanges, have first access to information and can use flash orders to outmaneuver other investors, by discerning price points and by subsequently buying and selling large quantities of orders in micro-seconds: “HFT allows the program trader to peek at major incoming orders and jump in front of them to skim profits off the top” from large institutional orders by pension funds, mutual funds, etc.[xiii] High frequency trading (HFT) technology essentially enables profits to be gleaned from movement within markets by skimming the purchasing and selling activities of other traders, especially large institutional investors such as pension funds.[xiv]
High frequency trading provides opportunities for fraud. The speed at which HFT occurs allows traders to post sell or buy orders and then withdraw them within microseconds. High volume, high frequency trades that are modified or cancelled almost immediately after being placed are referred to as quote stuffing, as defined at the Nasdaq exchange: “A practice of placing an unusual number of buy or sell orders on a particular security and then immediately canceling them. This can create confusion in the market and trading opportunities for algorithmic traders.”[xv] Quote-stuffing, re-named “spoofing,” received attention when it was figured in contributing to the May 20, 2010 flash crash, a precipitous drop in markets attributed to high-frequency trading, but widely assigned to essentially fraudulent practices.

[i] Pedro Nicolaci da Costa and Ryan Tracy “As Fed Shines Light on Shadow Banking, Its Regulatory Limits Get Laid Bare,” The Wall Street Journal, December 21, 2014, A2.

[ii] Karen Mracek and Thomas Beaumont, “Goldman Reveals Where Bailout Cash Went,” USA Today, July 26, 2010, accessed June 27, 2010,

[iii] Ryan M. Nasch and Eric Beardsley, "The Future of Finance: The Rise of the New Shadow Bank,” Goldman Sachs, March 3, 2015, 4,

[iv] Ibid., 5.

[v] "About Us," The City of London, last modified August 25, 2015, accessed September 10, 2015,

[vi] George Monbiot, “The City’s Stranglehold Makes Britain Look Like an Oh-So-Civilised Mafia State,” The Guardian, September 8, 2015, accessed September 10, 2015,

[vii] Graham Bowley, “Bailout Helps Fuel a New Era of Wall Street Wealth,” The New York Times, October 17, 2009, accessed October 18, 2009,

[viii] Bradley Hope, “Nasdaq Looks to Operate Dark Pools for Banks,” The Wall Street Journal, January 12, 2015, C1.

[ix] Graham Bowley, “Lights Still Bright on Big Board, but Trading Done in 'Dark Pools,’” The International Herald Tribune, October 16, 2009, 17.

[x] Bradley Hope, Emily Glazer, and Christopher M. Matthews, “US Toughens Up on ‘Dark Pools,’” The Wall Street Journal, August 12, 2015, C1, C2.

[xi] Michael Hudson, "The Financial Road to Serfdom: How Bankers Are Using the Debt Crisis to Roll Back the Progressive Era," Naked Capitalism, June 13, 2011, accessed June 15, 2011,

[xii] Ellen Brown, “Computerized Front Running and Financial Fraud,” Global Research, April 23, 2010, accessed April 25, 2010,

[xiii] Tom Lauricella and Jenny Strasburg, "SEC Probes Canceled Trades," The Wall Street Journal, September 2, 2010, A1, A12.

[xiv] Brown, “Computerized Front Running."

[xv] Campbell R. Harvey, “Quote Stuffing,” Nasdaq, 2011, accessed September 13, 2015,



  2. I am rather ignorant of the complexities of the financial world. On the advice of Paul Craig Roberts I have ordered -- Killing the host : how financial parasites and debt bondage destroy the global economy / Michael Hudson. Aside from that I have been following the incident in Oregon where it certainly appears that the police/FBI assassinated a good man on his way to give a talk & planted a stolen gun on him. And according to Professor Francis Boyle Zika has likely been turned into a bio-weapon with the financial assistance of the Bill and Melinda Gates Foundation! Boyle refers to Bill as a genocidist. That seems accurate to me. On the bright side there are intelligent and good people putting out valuable information as well as bad people doing the opposite. NPR today was practically an advertisement for genetically modified mosquitoes.

  3. All the very white sagbrush rebels advocate private property and no commons. They had guns. They brought on the police. Usually a protracted police confrontation with guns ends in trouble. The zika virus is a cover for radiation induced epigenetics and illness from fukushima and all the other radioisotope pollution on earth now.

  4. There are more rogue viruses in the world than people would care to know about. Conditions are not quite bad enough to wit
    that massive epidemics are plagueing the crumbling, so-called developed world. Pollution, chronic health problems, birth defects, and cancer are very much here and plain to see.


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