Dark pools remind me of revenue sharing.  Not much good can come from business practices or products with descriptive titles of this nature.

Whereas an avalanche of class action litigation has shed light on the practice known as revenue-sharing, New York Attorney General Eric Schneiderman, Barclays Faces New York Lawsuit Over Dark Pool and High-Frequency Trading, has focused the spot light on dark pools by filing a law suit against Barclays over its private stock trading platform… otherwise known as dark pools.

The law suit essentially claims that certain high-frequency traders were favored over other participants in the pool and that various practices were not properly disclosed.

Many of the other banks and financial services firms run similar “platforms”, so the entire financial industry has a stake in the litigation.  Schneiderman is not the only regulator involved, the SEC, charged with maintaining integrity in the financial markets, is also a key player.

And so … here goes another financial services industry free-for-all.   Mind you, these dark pools are big revenue producers, so the stakes are high.

The issues are serious and complex for Wall Street, however, I am much more interested in the fiduciary issues at stake.

Make no mistake about it, plan fiduciaries have oversight responsibility for the trading of securities held by the plan.  At a minimum, the trading practices must be reasonable, prudent and, generally, managers are required to seek “best execution.”  And, of course, this analysis must includes a review of trading costs and expenses.

The challenge and tension revolves around the fact that fiduciaries require transparency, whereas the name dark pools suggests the opposite — opacity.

At the outset, Fiduciaries need to determine whether plan assets were traded through these dark pools.  If the answer is yes, then a whole series of questions follow:

Did the plan assets get best execution?

Are other pool participants advantaged over the plan assets?

What fees are charged for trading in the pools?

Are these fees reasonable?

Are the fiduciaries assured that trading via the pools did not constitute a prohibited transaction?

How are pool operators compensated?

Are there any conflicts of interest?

Has the fiduciary been monitoring these trading practices on a regular basis?

This is merely an initial list of questions.  But, posing the questions is the easy part.  Understanding the answers is far more challenging.  In my many years of serving as the General Counsel of a global investment management firm, no area was more confusing or harder to get my arms around than the issues related to the trading desk.  Traders use a lingo and jargon that is all their own.  Sometimes getting satisfactory answers in this area requires the best of prosecutorial skills.  It can be tough going.

If they haven’t already, Fiduciaries are best advised that they begin asking these questions.  If they do not, certainly class action lawyers and the Department of Labor, most certainly will.

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