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11:53 AM
Adam Sussman
Adam Sussman

On the Pipeline Fiasco and Our Addiction to Anonymity

An industry that has lost a good deal of the public's trust now has yet one more reason not to trust its own.

Even in the hands of a beneficent writer, characters lying about their conduct to turn a dime never turn out well. And even when authors instill their characters with the most altruistic intentions (see Gone Baby Gone ), the power of falsehood inevitably eats away at the original intent and causes great harm. Decisions made to cover up or recover from the original sin eventually overshadow the entire endeavor.

The reality of the Pipeline Trading Systems situation is less dramatic but no less disheartening. It's hard to see how a company can bounce back from this. Yes, the company has been de-emphasizing its dark pool business for quite a while, but how will its clients react to this news? A lot of buy side head traders are going to have to answer to their boards and explain the due diligence they conducted and what they could have done to avoid being misled.

It's not just bad news for the company and its employees and clients. It's bad for everyone. An industry that has lost a good deal of the public's trust now has yet one more reason not to trust its own. Other dark pool operators are going to have to disclose a lot more (publicly or privately) about the type of activity in their pool and the firm's relationship with those entities. I expect the Securities and Exchange Commission to revive its dark pool reporting proposal shortly.

To be sure, there is nothing wrong with seeding liquidity on a new trading platform with proprietary capital. Much of the liquidity at the most active dark pools are from the parent company's proprietary trading group. When I was at Datek Online we established a prop desk for the sole reason of fulfilling our 60-second guarantee of a fill on a marketable order (I know, it sounds ridiculous now). We never made much in trading profits but it was almost always cheaper to get in and out of a position than to pass up the $9.99 commission. But we weren't promising people unconflicted agency executions. (Datek had its own legal issues, but that's another story).

I could also see how lawyers might argue that the relationship between the proprietary trading desk and the dark pool is no different than the types of structures at larger investment banks. But clearly, the SEC felt a very serious line had been crossed in terms of the way the business was marketed and how it was operated. (The affiliate was not disclosed as part of the dark pool's operation on Form ATS).

One of the underlying issues in this scenario is the tension between anonymity (arm's length transactions) and trust (partnerships). In a market structure designed to bring all of its participants together to facilitate price discovery, anonymity becomes a defining feature. However, it is too easy to abuse anonymity; it becomes an excuse to avoid disclosure.

Ask a trading platform that you trade with and they say their refusal to reveal that information is proof that you can trust them not to reveal your trades. And yet, if your entire reason for trading on the platform is based on a fabrication that only disclosure can reveal, maybe it's time to rethink our addiction to anonymity.

Skepticism is healthy, but the word itself was a call for empirical evidence to understand our surrounding world. We need more mechanisms (or a mechanism) where information can be shared and the parties held accountable for how they interact with that information. As a starter, dark pool operators should make their Form ATS available to the public.

Adam Sussman is a partner and director of research at Tabb Group. For additional commentary on the capital markets, visit Tabb Forum.

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