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February 1, 2012

Cover Story: Full Disclosure

By James Armstrong and John D'Antona Jr.

Jeff Estella, investment officer and senior equity trader at MFS Investment Management, said at the 2011 Investment Company Institute Equity Markets Conference in December that with orders heading to multiple destinations, HFTs and others can prey upon large orders and undermine best execution.

"That's the last thing any of us wants to happen," he said. "We ask the broker for more information on the routing logic and venue analysis."

David Mechner, Pragma

Dancing in the Dark

Even when a venue demonstrates some toxicity due to gaming, Estella warns that simply dumping that venue might not always be the correct approach.

"The problem is that the order flow is fluid," he said. "It may have just been two bad actors in each of these venues, and we need to make sure it was not a naive decision to give a scarlet letter to Venue X."

According to Joe Mecane, a senior executive at NYSE Euronext, the topic of order routing is very prevalent in the equities market now.

Mecane said many on the buyside have been trying to understand not only where their orders are being executed, but also where their orders are going and not being executed.

Part of the reason for the focus on order routing has to do with the growth of dark pools. Dark pools have provided a private place to trade where large orders can be easily concealed when compared with the public exchanges.

However, high-frequency traders have been increasingly present in the darker venues, according to Mecane. "Most of the liquidity in dark pools comes from the HFTs," he says.

Rosenblatt Securities, which tracks dark pool volume, said in its latest report that year-over-year the amount of trades executed in dark pools fell about three-quarters of a percent.

Rosenblatt reported that when combined, dark pool and exchange dark volumes are 15.3 percent of U.S. equity trading.

Justin Schack, managing director for market structure at Rosenblatt, said his firm has been urging buyside clients to get more educated about market structure generally and more specifically about what happens to their orders after they hit the send button.

"The role of the buyside trader has changed a lot," Schack said. "Years ago they were regarded as glorified order takers. They would get the order from the PM and just outsource the execution to the sellside. Now what's happened is buyside traders have a lot of electronic tools on their desktops, and there is an illusion of control."