Darker Than the Abyss of a Deep Pool

The notorious dark pools of Wall Street are becoming even more obscure.

A decade after significant controversies that led to various enforcement actions and regulatory restrictions, these off-exchange trading platforms are advertising an even more opaque method for buying and selling stocks.

These platforms are introducing what they call private rooms—exclusive areas that take the primary advantage of dark pools—the ability to conceal large equity transactions to prevent price impacts—and incorporate exclusivity by defining exactly who can participate in each trade.

Established within the dark pools themselves, these rooms operate independently and remain invisible to anyone not granted access, raising concerns regarding market transparency and fragmentation. However, with over half of U.S. stock trading now occurring outside public exchanges, the demand is robust among firms looking to control their trading relationships, often to enhance the efficiency of specific orders.

David Cannizzo, the head of electronic trading at Raymond James and Associates, describes it as, “shopping when you know precisely what you want, and from whom and where you are buying or selling, rather than going to Walmart on Black Friday. You’re setting the terms of engagement.”

Currently, it’s unclear exactly how many private rooms exist or the volume of activity flowing through them. Operators of alternative trading systems (ATS)—the formal designation for dark pools—indicate that these rooms currently account for a minority of their trading volumes, as demand growth is relatively recent.

However, their adoption is swiftly rising, with users ranging from broker-dealers and market makers to hedge funds and asset managers. This trend has led private-room volumes at one major ATS—IntelligentCross, based in Stamford, Connecticut—to surpass the total trading activity at nine competing dark-pool operators.

Dark pools derive their name from the fact that trades occur away from the visible “lit” public exchanges, which helps shield order details from the broader market, thus preventing adverse price movements before trades can be finalized. Nevertheless, a downside remains: anyone within a pool can trade, yet the parties involved in a trade are unknown to each other. Private rooms enhance this level of confidentiality.

Roman Ginis, CEO of Imperative Execution, which oversees IntelligentCross, states, “It’s about exercising control over the liquidity with which a broker wishes to engage to improve execution quality.”

There are numerous motivations for firms to utilize private rooms. For instance, CastleOak Securities, a New York-based minority-owned brokerage, seeks to trade with like-minded organizations and utilizes a private room offered by the ATS provider OneChronos.

Carlos Cabana, head of equity sales and trading at CastleOak, refers to the room as a “diversity pool,” given that its participants are all minority-operated brokerage firms. While CastleOak may not know exactly who is on the opposing side of each trade, it is assured that it will be among roughly ten counterparties that fit certain ownership and investment criteria.

“Imagine it as an apartment hosting a party with a specific purpose and only invited guests,” says Cabana.

With CastleOak increasingly relying on the diversity pool, OneChronos has become its third most-utilized trading venue, trailing only the New York Stock Exchange and Nasdaq, according to Cabana.

Execution Excellence

Private rooms are known by various names, including hosted pools, restricted-access rooms, ATS pools, and custom counterparty groups. Their popularity is surging in the fast-paced modern market, offering firms a means to avoid losing out to competitors who may have quicker execution or better information access.

For example, many brokers and market makers are keen to transact with retail investors. These smaller, less volatile trades typically do not influence prices, so a market maker does not experience an adverse price shift when it agrees to fulfill an order, as might occur with other types of counterparties.

Brokers sending orders to private rooms usually anticipate filling the order at the national best bid and offer (NBBO) midpoint (assuming the room’s rules dictate this, which is generally the case). If the order is not executed in the room at this rate, it can shift to the broader ATS, allowing multiple other parties to compete in filling it. Additionally, if a broker has unpleasant experiences with a particular private room, it can switch to another in the future, effectively evading those counterparties.

“The challenge we face is identifying favorable versus unfavorable liquidity,” explains Jatin Suryawanshi, global head of quantitative strategy at Jefferies, who estimates that 15 out of every 100 shares executed by the firm’s algorithms currently flow through a room. “Using private rooms allows you to prioritize whom you wish to engage with.”

The growth of private rooms has surged as stock trading migrates away from public exchanges, and their usage becomes more widespread. They were introduced at the ATS firm LeveL almost 18 years ago, initially allowing firms to match their own orders in a process called internalization. This later expanded to include various forms of segmentation, including bi-lateral and multi-lateral agreements, where one party agrees to trade with another, or multiple parties have the choice to solely interact with one another, all within the same ATS.

Responding to client demands, IntelligentCross began to offer its variant of private rooms about a year and a half ago, while OneChronos joined this trend last year.

Private rooms are generally not sought after by large banks or brokers with the resources to create their own ATS or single-dealer platforms. These are another type of off-exchange trading venue where the operator acts as the counterparty for every trade.

For smaller entities, constructing and managing an ATS or SDP, complying with regulatory reporting obligations, and establishing necessary connections can be overly costly and cumbersome. Thus, arranging a private room within an established ATS is a viable alternative.

“There are several factors leading firms to outsource these activities instead of managing them internally,” explains Steve Miele, CEO of Kezar Markets, which owns LeveL. “This might include costs or overhead that they don’t want to shoulder if we can build and expand it using the existing network.”

At IntelligentCross, the majority of current rooms cater to institutional brokers lacking the capacity to execute similar activities internally. According to Suryawanshi, Jefferies utilizes a private room where it interacts with seven other brokers who do not possess their own ATS but hold institutional orders.

“These rooms are established at the request of a subscriber, who acts as the host and invites others to join their book,” states Ginis at Imperative Execution.

Dark Disclosure

Not every ATS is eager to adopt private rooms. New York-based PureStream offers “pools” that function like rooms but are disclosed to all subscribers when established, allowing participation from anyone. Effectively, the pool is open to all.

To date, there has been no request to create a pool at PureStream, resulting in no volume in so-called sub-pools, according to CEO Armando Diaz. He mentions that the provision of private rooms not accessible to all subscribers raises regulatory concerns. “The more the host regulates the room, the more they resemble an ATS, thus inviting regulatory risk,” he states.

One of the principal criticisms of private rooms is that they may generate phantom liquidity, as transactions occurring within a room are aggregated with the total activity reported by the dark pool’s parent, creating a distorted perception of market depth due to reported trading volumes that include activity unavailable to those outside the room.

ATS are regulated trading venues supervised by the Securities and Exchange Commission (SEC), which enhanced its oversight of such venues in 2018 by imposing additional disclosure requirements. Now, each dark pool must submit a form, ATS-N, summarizing its specific trading mechanics.

These publicly available forms provide various details, including whether private rooms are offered. However, they do not disclose the number of existing rooms or the identities of those involved, and differing language and disclosure levels can render it challenging to ascertain if an ATS is indeed hosting any rooms.

“There are no regulations requiring ATS to disclose the identity of single-dealer rooms or their volumes,” noted Larry Tabb, head of market structure at Bloomberg Intelligence, in a May memo. He adds that while the Financial Industry Regulatory Authority (Finra) effectively reports ATS volume on a post-execution basis, there are no rules aiding analysts or users in differentiating the proportion of ATS volume executed in the open pool vs. the private room, or the segments executed using segmentation strategies.

Concerns about transparency are not new to dark pools. Their opacity led to significant media attention and regulatory investigation a decade ago as there were suspicions that they provided high-frequency traders with advantages over other investors—an issue partially ignited by the bestselling book Flash Boys.

Representatives for both Finra and the SEC have opted not to provide comment.

‘Growth Mode’

For users, private rooms serve as a convenient tool, yet remain just one option among many. Hosted pools currently account for a low single-digit percentage of IntelligentCross’s overall volume—about 5.4% on average last year—because they are still in the early stage of adoption, according to Ginis. “It will take time for brokers to optimize for this,” he states.

The CEO of OneChronos Capital Markets, Vlad Khandros, mentions that their rooms currently represent less than 5% of the volume since “it’s a more recent development for us, so it’s still in growth mode.” However, there is strong demand. “We’ve seen increased interest from both retail and institutional brokers,” Khandros asserts. “The focus on execution quality will continue to escalate.”

LeveL has chosen not to reveal the number of rooms it operates or the associated activity levels, with Miele indicating that the lack of industry-wide guidelines for categorizing rooms means quantifying could be misleading.

Mark Gurliacci, senior vice president and senior quantitative trader at AllianceBernstein, estimates that up to 75% of the firm’s activity currently occurs off-exchange, including in private rooms. While this is only a small fraction of their trading at the moment, he believes it is poised for growth.

“Numerous firms are setting up private rooms these days,” states Gurliacci, a former NYSE employee. “They are innovative and are here to stay. There’s more happening there than most are aware of.”

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