Stocks dropped on Friday, after the dismal employment report for March forced investors to rethink the recent rally. Stock prices have been driven up by easy money from the Federal Reserve, but the jobs picture indicates that little of the Fed’s largess has made its way to Main Street, where unemployment remains high.
And those are not the only sobering realities. Trading in today’s market has increasingly migrated away from public exchanges, like the New York Stock Exchange, to private trading venues, mostly operated by big banks, as recently reported by Nathaniel Popper in The Times. Off-exchange platforms include “dark pools” that let traders post orders that are hidden from the rest of the market. They also have “internalizers,” including firms like Citigroup, which pay retail brokers for the opportunity to handle trades before the orders reach a public exchange.
Off-exchange trading can make sense for institutional investors whose block trades might move market prices. It also appeals to investors who have been shocked by technological mishaps on public exchanges. But with some 40 percent of stock trades now occurring off-exchange, there is mounting evidence that the shift is obscuring the true prices of stocks, raising the cost of trading and, by extension,damaging investor confidence.
Yet the response from American regulators largely has been to watch and wait. The inaction is in contrast to recent moves by Canada and Australia to limit dark trading. Under new Canadian rules, brokers can fill customers’ orders through dark pools only if the prices are much better than those on a public exchange. Since the rules took effect last fall, it appears that dark pool trading in Canada has dropped sharply.
There is also concern that banks that operate off-exchange venues may be giving advance word to the banks’ own traders or selected clients about how dark-pool customers trade. The Financial Industry Regulatory Authority, the industry self-regulator, has been looking into possible breaches but has not yet determined if information was improperly shared.
Potential interactions between the off-exchange venues and the high-speed, computer-driven trading that now dominates the stock market are also cause for worry, because increasingly complex systems can malfunction in unexpected and catastrophic ways.
The market cannot be efficient if many orders never see the light of day. An inefficient market is neither fair nor stable, which makes a strong regulatory response to protect investors imperative.
