Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?

Authors

Robert P. Bartlett III, University of California
Justin McCrary, Columbia Law SchoolFollow

Document Type

Article

Publication Date

2019

DOI

http://doi.org/10.1561/108.00000039

Abstract

Prevailing research in market microstructure posits that liquidity providers bypass queue lines on exchanges by offering liquidity in dark venues with de minimis sub-penny price improvement, thus exploiting an exception to the penny quote rule. We show that (a) the SEC enforces the quote rule to prevent sub-penny queuejumping in dark pools unless trades are “pegged” to the NBBO midpoint and (b) the documented increase in dark trading due to investor queue-jumping stems from increased midpoint trading. Although encouraging pegged midpoint orders can subject traders to direct feed arbitrage, we estimate that less than 2% of shares traded per year present exploitable trading opportunities for this form of latency arbitrage, yielding annual gross potential profits of less than $20 million.

Disciplines

Business Organizations Law | Finance and Financial Management | Law | Securities Law

Recommended Citation

Robert P. Bartlett III & Justin McCrary, Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?, 4 J. L. Fin. & Acct. 291 (2019).
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/4487