Dark Pool Problems May Be Wake-Up Call, Buysider Says

David DeVito, head of trading at Madison Investment Advisors, a money management firm based in Madison, Wis. with $15 billion in assets, said he thinks that news unfolding in recent weeks about what was happening inside certain dark pools should make the buyside realize it has to be more aggressive in finding out what is happening in the dark. DeVito spoke to Traders recently about market fears, policing pools and what the buyside can do to protect itself.

Traders: The news of the case filed by the New York Attorney General against Barclays LX, the second-largest dark pool in the nation, in regards to some its marketing methods to customers of its dark pool took the market by surprise. What do you think the impact will be?

DeVito: Certainly, Barclays raised eyebrows and may have confirmed many people’s worst fears about what was going on in some dark pools. But I think it’s also true that Barclays may not be the only one, and this is the first shot across the bow.
In fact, it may be beneficial to the other dark pools, too-those that need to may clean up their ship if they see that someone is watching them.

Traders: Have your investing clients been more questioning to you about what’s happening in dark pools and specifically how you handle them?

DeVito: Yes, since the Barclays case has been in the news, I have clients, mostly boards of directors and due diligence professionals, asking specific questions about Barclays and how we use dark pools in our trading.

For our part, we use dark pools that have demonstrated a consistently high average execution size. And, even then, we are always monitoring what’s going on as best we can.If some of the market’s biggest fears are being confirmed with what may be going on inside of some dark pools, how can the buyside protect itself: First, the buyside cannot rely on the sellside to police this activity-they are not doing it well. The buyside needs to do more of its own due diligence about what is happening in these pools.

Traders: Is that something the buyside could do itself or could outsource?
DeVito: For a smaller firm, that would be a tremendous allocation of cost and time, and few have the resources to do it right.
But it could be outsourced. There is a tremendous amount of research and analysis that goes in to post-trade, but examining routing is just as important, if not more. A consulting firm could come in and analyze routing of orders, how they were filled, or track price movement. That would be valuable service that trading desks might want to use.

Traders: Beyond protection, what can the buyside really do about dark pools?
DeVito: I think the buyside has more power in this situation than they realize.
The buyside needs to vote with its feet with some of these dark pool operators, and I think we should be rewarding other people for doing business the right way.