The SEC And A Dark Pool That Is Not Dark Enough

by Dorsey & Whitney LLP

High speed trading, dark pools and similar market structure issues have become hotly debated topics. Former CFTC Commissioner Bart Chilton gave several speeches discussion the subjects and proposed that high speed traders be required to register. SEC Chair Mary Jo White discussed these questions in her recent address titled “Enhancing Our Equity Market Structure.” FINRA announced last week an initiative to disclose certain statistics on a delayed basis regarding dark pools. Authors Michal Lewis, who wrote Flash Boys, and Scott Patterson, who authored Dark Pools, both discussed these topics and called the markets “rigged.” All of this is generating studies and possibly proposed new rules.

Some issue can be resolved under existing rules as illustrated by the recent settlement in In the Matter of Liquidnet, Inc., Adm. Proc. File No. 3-15912 (June 6, 2014). The issue in this proceeding was straight forward – the dark pool was not dark enough.

Liquidnet is a registered broker dealer which operates to a block trading alternative trading system or ATS, as a dark pool. Its members are primarily large institutional investors who do not want their actions in the market place known. A key feature of the Liquidnet ATS is its “blotter-scraping” functionality under which members grant electronic access to their OMS. It contains real time information about their trading intentions.

Members of Liquidnet’s dark pool are assured of “complete anonymity.” This assurance is incorporated into the subscriptions agreement and the rules.

In 2009 Liquidnet launched a new service, its ECM initiative, which eventually developed into a stand-alone business unit. It was designed to introduce Liquidnet as an execution venue for corporate issuers and others. A key feature would permit members to execute transactions in size. Another feature was a desk top application for issuers called InfraRed. It aggregated historical data in the Liquidnet system as a smoothed ratio of “buy” liquidity to “sell” liquidity, caped at a specific ratio.

From the time ECM was launched, through 2011, its employees had access to the confidential member trading information in the Liquidnet system. This included the identity of each member who indicated interest in purchasing or selling and the number of specific shares. This violated Rule 301(b)(1) of Regulation ATS which requires that the pool operator establish adequate safeguards and procedures to protect subscribers’ confidential trading information.

ECM also used member data in marketing the service. That data was incorporated into presentations for corporate issuers. It included descriptive characteristics of pool members that had recently indicated interest in buying or selling the issuer’s stocks. ECM also contacted issuers to discuss recent trends in their stock which sometimes included member descriptive characteristics. Pool members did not consent to the use of their information in this manner which was inconsistent with the representations made to them.

Liquidnet also used confidential information about members’ indications in sales tools. In some instances Liquidnet generated alerts called Ships Passing that discussed missed execution opportunities between member algorithmic orders and member indications. In other instances members were contacted about Liquididnet’s recent dominance in certain stocks. In describing this information to a member, Liquidnet did not disclose that the decision to contact the firm was based in part on the member’s past or current indications of interest for the stock.

The Order alleges violations of Securities Act Section 17(a)(2). Rule 301(b)(2) of Regulation ATS, which requires that pool operators file amendments on Form ATS, was also violated by not filing amendments regarding ECM, a material change in operations. And, Rule 301(b)(10) of Regulation ATS, which requires the operator to establish adequate safeguards and procedures to protect subscribers’ confidential trading information, was also not followed.

In resolving the proceeding the Commission considered the prompt remedial actions of the Respondent, which included development of a program that provides members with direct control over the use of their data within the Liquidnet system. Liquidnet consented to the entry of a cease and desist order based on the Section and Rules cited in the Order and to the entry of a censure. It also agreed to pay a fine of $2 million.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dorsey & Whitney LLP | Attorney Advertising

Written by:

Dorsey & Whitney LLP

Dorsey & Whitney LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.