SEC considers broader market surveillance

WASHINGTON — Federal regulators may establish a consolidated surveillance system for all markets as trading platforms rapidly proliferate and often cater to selected wealthy investors.

A central issue is whether ordinary investors are unfairly disadvantaged by trading systems that don’t publicly provide price quotes and other trading practices.

James Brigagliano, an official at the Securities and Exchange Commission responsible for market oversight, said a combined monitoring system “has to be an important element” of the SEC’s work on new regulations for a swiftly evolving marketplace.

“Something could be missed” under the current system of fragmented oversight of markets, which is split among the SEC, the Financial Industry Regulatory Authority and other regulators. In the case of some trading venues, oversight doesn’t exist.

Brigagliano testified Wednesday at a Senate subcommittee hearing examining the rise of so-called “dark pools,” flash orders and high-frequency trading.

The SEC last week proposed new rules for dark pools that would require more stock quotes to be displayed. The agency also recently proposed a ban on flash orders, which give traders a split-second edge in buying or selling stocks. A flash order refers to certain members of exchanges — often large institutions — buying and selling information about ongoing stock trades milliseconds before that information is made public.

Critics of dark pools maintain that they have “created a two-tiered market, in which only some investors in dark pools but not the general public have information about the best available prices,” said Sen. Jack Reed, D-R.I., chairman of the Senate Banking subcommittee on securities.

But operators of the pools contend they indirectly benefit retail investors by providing speed and efficiency for their users — including mutual funds through which millions of ordinary Americans invest.

An array of representatives at the hearing — from Nasdaq OMX, Credit Suisse, TD Ameritrade and others — mostly agreed with Sen. Charles Schumer that consolidated market surveillance was desirable.

Schumer, a New York Democrat, has asked the SEC to subject dark pools to a stricter set of regulations that’s closer to the regime for the major exchanges. He also wants the SEC to establish a marketwide surveillance system — for which the alternative trading systems would contribute some of the cost.

When investors place an order to buy or sell a stock on an exchange, the order is normally displayed for the public to view. With some dark pools, investors can signal their interest in buying or selling a stock but that indication of interest is communicated only to a small group of market participants.

That means investors who operate within the dark pool have access to information about potential trades which other investors using public quotes do not, the SEC says.

The new SEC proposal would require indications of interest to be treated like other stock quotes and subject to the same disclosure rules.

Alternative trading systems have grown to 29 from 10 in 2002 and now account for an estimated 7.2 percent of all share volume. The largest dark pools are Credit Suisse Group’s CrossFinder, Knight Link, Goldman Sachs Group Inc.’s Sigma X, Getco and LeveL, according to the TABB Group, an analytical firm based in Westborough, Mass. Others are Liquidnet Inc. in New York and London-based Turquoise Trading Ltd., a European system established by Citigroup Inc., Goldman Sachs, France’s Societe Generale SA and other major banks.