(The article featured below is a selection from Federal Securities Law Reporter, which is available to subscribers of that publication.)

SEC Proposes Rules to Improve Transparency Surrounding Dark Pools

The SEC voted to seek comments on proposals to bring greater transparency to dark pools of liquidity, the use of which has been increasing in recent years. Dark pools, which are private trading systems in which participants transact trades outside of the public markets, have increased in number from about 10 in 2002 to about 29 in 2009. Their combined trading volume represents more than seven percent of the total share volume in shares that trade on the major U.S. stock markets. The comment period will be open for 90 days.

In opening remarks, Chairman Mary Schapiro explained that the largest dark pools are sponsored by securities firms to execute the orders of their customers and the proprietary orders of the firms. The SECs focus is on dark pools that transmit electronic messages to a limited group of market participants to signal an interest in buying or selling a security. When the message has sufficient information to permit others to trade, it is called an actionable indication of interest, or IOI. Ms. Schapiro said the lack of transparency for all market participants could create a two-tiered market that deprives the public of information about share prices and liquidity. The SEC is proposing to require that actionable IOIs be treated the same as other quotes and be subject to the same disclosure rules that apply to quotations.

A second proposal would lower the trading volume threshold applicable to alternative trading systems for displaying best-priced orders. Currently, if an ATS displays orders to more than one person, it must display its best-priced orders to the public when its trading volume for a stock is five percent or more. The SECs proposal would lower that percentage to .25 percent for ATSs, including dark pools that use actionable IOIs.

Both proposals would exclude certain narrowly targeted IOIs related to orders for $200,000 or more which are communicated only to those who are reasonably believed to have the contra-side trading interest of equally large size. This will allow for the efficient trading in sizes larger than the average size of trades in the public markets.

A third proposal would require the same post-trade transparency for dark pools and other ATSs as required for registered exchanges, including real-time disclosure of the identity of the dark pool that executed the trade. The proposal would exclude reports of trades of $200,000 or more to prevent the potential for the misuse of information about the buying and selling interests of investors engaged in the trades.

Ms. Schapiro asked the staff to conduct a broad review of the equity market structure to determine whether it has kept pace with technological developments and practices. The review will also address the benefits and drawbacks of dark pools. The staff is also reviewing the increase in high-frequency electronic trading strategies, broker arrangements that can give customers direct access to the markets and exchange co-location services that provide speed advantages to customers in obtaining market data and executing trades.

Commissioner Troy Paredes voted to support the issuance of the proposals but said he had significant reservations. He was concerned that the proposals may frustrate the more comprehensive review of market structure issues. The proposals could have been deferred and instead been part of a concept release the Commission is expected to consider regarding market structure issues, he said.