GO
Loading...

Finally! Shining the light on dark pools

In light of the fact that the New York attorney general is investigating Barclay LX , one of the Street's most successful "dark pools," it begs the question: Does current market structure actually encourage this behavior?

If it is true that Barclay's dark pool was "rigged" in their favor, contrary to what they sold to the investment community … if they allowed the predatory high-frequency trading that is alleged … then this should cause the industry to become even more suspicious of all dark venues.

Maricic | iStock / 360 | Getty Images

Can anyone be sure that Goldman Sachs, FBC, Morgan Stanley, Citigroup, etc. or any other dark-pool provider is NOT guilty of the same behavior? I mean, Goldman announced that they were closing their dark pool (in March right after the Michael Lewis book "Flash Boys" hit the market), and in fact today announced that they have been fined $800,000 for violations in their dark pool, saying that they weren't really sure what it added to the "bottom line" – or how much money they actually earned in that venue. ARE YOU KIDDING ME? Lawyers all over the country are licking their chops – some are going to have a field day with this.

Read MoreDark pools in crosshairs after Barclays changes

Contrary to what Michael Lewis or IEX's Brad Katsuyama would have you believe, there have been so many people (myself included) screaming about current market structure and this behavior for a long time. The problem is that the people who have been screaming are the "little guys" — the unconflicted, independent, boutique-like broker/dealers. But who in DC would listen? Not Mary Schapiro, the acting SEC commissioner at the time, not regulators, not elected officials, certainly not the HFT crowd. They would have you believe that we were an annoyance, a displaced set of brokers who were just creating noise.

My sense is that current SEC chair Mary Jo White has taken a much different approach, one that I hope will INCLUDE the little guys – the everyday practitioner, the independent "non-conflicted" broker who navigates the web of complexity that we call the U.S. marketplace.

Reality is that U.S. markets are way to complex – in fact more so than they need to be. Technology, which is supposed to create efficiencies, has allowed for more complexity. Why do we need some 70+ venues to buy/sell names like IBM, KO, JNJ, GE, C, JPM, etc.? It is NOT like you are getting a bargain at one vs. the other. Unlike Nordstrom's vs. Jos A Banks, where a suit will cost you $800 vs. $150 (and you get 3 more for free), stocks do not trade like that…. regulation forces best bid/best offer – and rightly so. So, why do we have 70+ venues to choose from?

Read More10 things people don't get about dark pools: Ross

Competition is one thing, but massive fragmentation is insane. Sub-pennies, payment for order flow, maker/taker model, dark vs. transparent, conflicting order types designed by HFT firms to undermine the transparent market are all at the root of the problem — it is the greed of the investment banks to internalize and weaken the system that have brought us to this point in the conversation.

The U.S. capital markets are here to serve the public good. They are here to serve the investment community. They are here to help companies raise capital to create jobs and grow businesses. They are here to help investors create and generate wealth for a lifetime. They should NOT be demonized for what they are supposed to be, but should be recognized for what they have become and the role that regulators and industry professionals played in its development.

Read MoreHow to play stocks in the second half of 2014

Technology itself is not the problem — it is how we USE technology that is the problem. We have allowed technology to control us vs. us controlling the technology and this is the issue. What should be efficiency has turned into a game of chance, a roll of the dice. The Flash Crash, The Knight debacle, the Facebook fiasco, the BATS IPO implosion – these are only some of the issues that highlight the sensitivity, complexities and system operational risk. This latest revelation will only test investor resolve yet again. Complexity and risk have also contributed to the drop in trading volumes.

The HFTs make their money by "picking off" institutional order flow. They use technology to game the system, they trade 100 share lots for pennies and sub-pennies, stealing millions of dollars from legitimate investors (individuals, mutual funds, pension plans, foundations, hedge funds etc.). They rave about how they create liquidity and are good for the markets. REALLY? They create zero value, they cloud the system, they get in the way, they create unnecessary volatility and execution cost, they steal pennies all day long. But stealing pennies is a big business and Washington knows that. The question is: When will it stop?

Commentary by Kenny Polcari, director of NYSE floor operations at O'Neil Securities. He is also a CNBC contributor, often appearing on "Power Lunch." Follow Kenny on Twitter @kennypolcari and visit him at kennypolcari.com.

Disclosure: The market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O'Neil Securities or its affiliates.

Symbol
Price
 
Change
%Change
GS
---
MS
---
C
---
IBM
---
KO
---
JNJ
---
GE
---
JPM
---
JWN
---
FB
---

Featured

Contact Wall Street

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More