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December 6, 2006

SEC's New Market Reg Chief Has Dark Pools in Focus

By Nina Mehta

The Securities and Exchange Commission needs to ramp up its understanding of undisplayed markets, or dark liquidity pools. It also needs to improve its insight into how these systems operate, according to Erik Sirri, the SEC's new director of the Division of Market Regulation.

The SEC must "understand how [dark pools] work and what benefit they bring to investors," Sirri said in his first public speech after joining the SEC. He spoke at an Investment Company Institute conference on the equities market in late September in New York.

Dark liquidity pools are alternative trading systems that cross orders anonymously without publishing public bids and offers. Executions occurring in these pools are priced derivatively off of public market prices.

Sirri said he does not have concerns about dark liquidity pools at this time, but that the presence of these venues "brings up serious policy considerations [and] transparency issues." He also observed that traders using these systems may find them to be helpful execution tools.

As these systems proliferate and draw more volume, the SEC must understand whether the primary benefits they provide investors are anonymity, the ability to negotiate trades away from the displayed market, the opportunity to trade at a single size and time, or other factors, Sirri said.

There are currently over 30 systems that enable institutions to cross orders anonymously, without displaying bids and offers. The two newest are Level ATS and BIDS Trading, each of which is owned by a consortium of broker-dealers. Additional ATSs are in the works.

While some market participants worry that dark pools fragment liquidity, Sirri noted that this "segmentation" of the equities market reveals something about the trading needs of institutions.

Sirri, who served as the SEC's chief economist in the late 1990s, said crossing systems are designed to yield lower overall trading costs for their participants. The rise of these systems may also be fueled by the desire of institutional investors to protect their proprietary trading information, he said.