SEC Chief: About ‘Half of Our Markets’ Go to Dark Pools

SEC Chairman Gary Gensler attended the European Parliament ECON Committee meeting on Wednesday, where he answered questions about FinTech and monetary affairs. Within his discussion, he highlighted issues regarding stock trading and dark pools, noting around half of the US stock market is traded through these methods, rather than lit exchanges. 

Dark Pools are Dominating the Financial World

In the committee meeting, Gensler offered new information about the current dark pool crisis plaguing the institutional trading world. He said:

“[We are] seeing a great deal of concentration, really found around this small handful of market makers that are buying a significant portion of the retail activity in the US. And we have approximately half of our market now not going to the lit exchanges; they are going to the dark pools and the wholesalers (who are also dark). So there are some inherent conflicts.”

Essentially, he is noting dark pools, or privately managed marketplaces where institutions trade stocks without prying eyes, have become commonplace. So commonplace, in fact, they make up around 50% of all market activity in the US. 

These unregulated environments have been known about for some time, with one even being organized by Citadel Securities. However, it was unclear until now just how rampant they had become. This revelation by Gensler speaks volumes about the ethical practices of American institutional traders. 

Gensler further mentions “inherent conflicts” arising from these pools. This is because the organizers of such pools may have trading connections they can use to their advantage, and even engage in insider trading. This is all possible because dark pools are practically unmonitored.

They have been one of Gensler’s main focuses during his tenure as SEC Chair, as he views them as manipulative. This also echos the overarching theme of the US SEC, which is one of abject transparency. Coincidentally, fears around transparency and manipulation are one of the reasons why Bitcoin ETFs keep getting put on hold. 

Wholesalers and PFOFs are Harming Traders

Gensler unpacked the situation further, saying:

“We have a practice that has taken on more meaning in the last few years in the US where brokers, or I should really say wholesalers, are buying order flow from trading apps. So, when you go online and you trade [on your phone or your computer] it is retail public; that order may be bought by a wholesaler and, and there’s 3-5 buying most of that order flow. The inherent conflict is, whether somebody’s paying $0.02 or a penny and a half or something, the current share of that order flow is not going to a lit transparent stock exchange, and orders are not competing against other orders. Instead, one wholesaler is buying a significant portion”.

In other words, there are a select handful of organizations, referred to as wholesalers, who are purchasing substantial quantities of order flow, and then selling it to other institutional traders. Most importantly, these transactions are not happening on regulated and accessible platforms– they are happening behind closed doors, in environments that do not follow SEC guidelines or laws. 

For those who are unaware, a payment for order flow (PFOF) model is where brokerage firms sell users’ order flows and order data to high-frequency trading companies before the user’s order has even been fulfilled. This tiny space of time between the brokerage firm selling the order flow data, and the user’s order being fulfilled is enough for a high-frequency trading company to take action and place orders themselves.

PFOF has been controversial since its creation, founded by the former Chairman of NASDAQ and infamous fraudster, Bernie Madoff, in the early 90s. However, it has recently been in the spotlight again, with the SEC suggesting incoming crackdowns on this behavior. 

In fact, just days ago, Gensler spoke about PFOF again, and suggested a full ban may come into action. News of which tanked Robinhood’s shares dramatically, as the company is known to profit largely from this activity. 

What’s important to note is Gensler states there are essentially 3-5 wholesalers who are buying all these order flows up, making for a huge ethical disaster. These institutional wholesalers essentially gain a stronghold over market activity, especially for stocks that are commonly traded by retail investors who favor commission-free platforms, such as Robinhood. 

Altogether, this paints a damning picture of the US trading landscape. The financial markets are being tightly controlled by an unbelievably small handful of institutions, acting behind closed doors and without proper regulations. To find out approximately 50% of US trades are in dark pools, and 3-5 corporations are buying most order flows, is disheartening for all retail investors—and the integrity of the American stock market.

Do you think the SEC will be able to successfully clamp down on dark pools? Let us know in the comments below.