There is a little thing about rats fleeing a sinking ship that people tend not to notice. They simply find a ship that isn’t going down and keep thriving like nothing ever happened.
High-frequency trading and dark pools are in the limelight, following SEC investigations and a lawsuit from the office of the New York Attorney General.
Of course, traders have been raising the alarm about HFT for years and the issues with dark pools have been well documented since their inception.
All it took was congressional attention and a best-selling book to get the perpetually impotent SEC to start doing its job.
Regardless of the billions already made off of retail investors and the nearly criminal complacency of the officials investigating criminal activities, the jig is up.
Goldman escaped with a relatively minor fine of $800,000 for failing to execute trades at the best price. The noise surrounding the Barclays case suggests the fine will be even greater.
I don’t expect much to ultimately come from this based on the deferred prosecution agreements that are all the rage these days.
With profits from banks-turned criminal enterprises barely dented and no C-Suite executives charged, I’d bet you don’t either. But we’ll see how it pans out.
So the HFT traders and others are abandoning ship and heading straight for the dark pools that aren’t feeling the heat.
Rinse and Repeat as Needed
To recap, in the last week of June, New York AG Eric Schneiderman announced a suit against Barclays for “pernicious fraud.”
This came two months after information requests were sent to a number of HFT firms.
The suit claims (I feel obligated to use that word) that Barclays lied to clients about its dark pool, Barclays LX and how the clients would receive the best possible price for trades and limit HFT front-running buy orders.
Instead, it appears to have done the exact opposite. Barclays was encouraging its predatory, parasitic clients to abuse the flow of orders in any way that could produce a skimmed profit.
The AG’s lawsuit document is long and exhaustive, but the general gist of what happened is:
- Barclays claimed to provide ultra-fast trading, when it actually slowed trading to allow several dozen HFT firms to create their own arbitrage trades.
- A sales team division senior Director is quoted saying, “[a]t every sales meeting or product meeting, the main goal they were talking about was to grow the size of [Barclays’ dark pool] to become the largest pool. All the product team’s goals, which would also include their compensation[,] were tied to making the pool bigger.”
- That meant jamming more and more customers into the dark pool, and providing the liquidity to handle the influx. HFT traders were recruited to meet that need.
- Barclays falsified an analysis purporting to show the extent of HFT in its dark pool, then used it as marketing material as a snapshot of activity in it.
- On numerous occasions since 2011, Barclays disclosed detailed, sensitive information to major high frequency trading firms in order to encourage those firms to increase their activity in Barclays’ dark pool. That information, which was not generally supplied to other clients, included data that helped those firms maximize the effectiveness of their aggressive trading strategies in the dark pool.
I’m sure you can see why HFT firms no longer want to be associated with the dark pool. They jumped overboard, and fast:
Volume fell a total of 79% in a week and a half. Institutional investors joined the exodus because they were getting screwed.
As Peter Nielsen, who oversees $4 billion as a senior investment analyst at Saturna Capital Corp. told Bloomberg: “I don’t like secret societies. I don’t like secret trading; it just runs against my personal disposition. I’m a big believer in transparency — huge believer in transparency. Even the word ‘dark pool’ freaks me out.”
He’s right. Investors large and small should be very worried about these secret societies and clandestine deals.
Unfortunately, they are getting hard to avoid. Dark pools account for nearly twice the volume of any of the major exchanges.
The Financial Industry Regulatory Authority recently made data about dark pools available to the public.
Before the New York AG sued, Barclays LX was second only to Credit Suisse’s dark pool for total shares and volume. Now it ranks 12th by size and 10th by volume.
Yet dark pools run by Credit Suisse, UBS, Bank of America’s Merrill Lynch, Deutsche Bank, Morgan Stanley, Goldman Sachs, JPMorgan, KCG, Citigroup, IEX, and ITG all gained more volume.
Investors fled from one dark pool to others with the same flawed model. HFT firms are going to following them.
Avoiding Dark Pools
Unfortunately, there is no easy way to completely ditch dark pools and exposure to HFT predation.
However, there is a little known way to take the core shares in your retirement and trading counts out of the rigged system and off of Wall Street’s radar.
More than 700 companies offer a way around profit skimming middlemen in the market. It is the purest form of a free market. If you want to own a piece of a company, there is a way to buy the shares straight from it. No one else is involved.
These companies offer discounts from the current share price listed on exchanges, which can be as high as 5%. Plus investors avoid dark pools, HFT, and even brokerage fees.
Yet SEC rules and regulations explicitly forbid these companies from disclosing the details to anyone who doesn’t currently own shares.
If the SEC was interested in actually guaranteeing that investors would get the best possible price, this wouldn’t be the case. If wouldn’t let HFT firms abandon one dark pool just to set up shop in another either.
Although these companies cannot say anything to you, we can tell you about them. The Outsiders Club‘s Jimmy Mengel has all the information you’ll need here.
