In 2012, Wall Street Journal reporter, Scott Patterson, released his 354-page prescient overview of U.S. market structure titled, Dark Pools: High Speed Traders, A.I. Bandits, and the Threat to the Global Financial System. (For those whose computer prowess is limited to turning on a laptop, like millions of fellow Americans, "A.I." means artificial intelligence-- machines teaching themselves to think like humans, but faster.)
Patterson comes to an epiphany on page 339 of his book, writing in the notes section: "The title of this book doesn't entirely refer to what is technically known in the financial industry as a 'dark pool.' Narrowly defined, dark pool refers to a trading venue that masks buy and sell orders from the public market. Rather, I argue in this book that the entire United States stock market has become one vast dark pool. Orders are hidden in every part of the market. And the complex algorithm AI-based trading systems that control the ebb and flow of the market are cloaked in secrecy. Investors-- and our esteemed regulators-- are entirely in the dark because the market is dark." (The italics in this excerpt are as they appear in the hardcover book.)
We totally agree with Patterson that U.S. markets are the darkest they have ever been in history-- from their early origins in the bright sunlight under the Buttonwood tree at 68 Wall to today's secretive, unregulated stock exchanges known as dark pools that trade in private across America-- the lights have gone out. And as each light has flickered and dimmed, public confidence has drained from the system, leaving it today as the unsafe battlefield of hedge funds, high frequency traders and dark pool operators.
Wall Street and its sycophants began this journey into darkness with their push to run their own private justice system on Wall Street in the 1980s. Called mandatory arbitration, Wall Street was given a green light by the U.S. Supreme Court in its 1987 decision, Shearson/American Express v. McMahon. Since then, cases filed by both customers and employees against Wall Street firms, which could shed critical light and serve as an early warning system on patterns of fraud and abuses, have been removed from the sunlight of open courtrooms into the dark shadows of a private justice system that claimants believe is rigged against them.
Once able to function as its own judge and jury in a justice system designed by its own Wall Street lawyers, the industry was effectively able to keep many of its crimes shielded from the press for years-- until they collapsed in massive losses and brought subpoenas.
After its coddlers gave Wall Street its own court system, removed from the prying eyes of the nation's justice system and the press, Wall Street was ready to begin repealing every other layer of investor protection that had been enacted after Wall Street's wholesale looting of the country in the late 20s and early 30s. The most dangerous repeal, of course, was the repeal of the Glass-Steagall Act which had barred Wall Street firms that gambled in stocks from owning insured deposit banks. Today, the largest trading houses on Wall Street are under the same corporate umbrella as the nation's largest banks: JPMorgan owns Chase bank; Citigroup owns Citibank; Bank of America owns Merrill Lynch.
In JPMorgan's London Whale episode, the firm taught us why Wall Street trading houses were so engaged for decades in lobbying to repeal the Glass-Steagall Act. JPMorgan had used hundreds of billions of dollars of its Chase bank depositors' funds to make high-risk bets in derivatives in London. It lost those bets to the tune of $6.2 billion. In the years when JPMorgan had won those bets with depositor funds, it kept the profits for the house and richly rewarded its executives with outsized compensation and bonuses. Simply stated, the repeal of Glass-Steagall allowed the use of other people's money to enshrine heads-we-win/tails-you-lose on Wall Street.
That brings us to today's dark pools functioning as unregulated stock exchanges which JPMorgan, Citigroup, and Bank of America are also allowed to own and operate along with more than three dozen other firms.
Last week, the SEC brought and settled a case against one of Citigroup's dark pools, LavaFlow, for the improper use of customer information. One sentence of the SEC's order was a real shocker. The SEC wrote:
"As of December 31, 2013, the LavaFlow ECN was the largest ECN and the largest ATS as measured by dollar volume executed with over $361 billion in total dollar volume of executions for the fourth quarter of 2013."
ATS stands for Alternative Trading System, synonymous with dark pool most of the time. Few people on Wall Street know that Citigroup is operating the largest dark pool. As recently as July 22, Bloomberg News reported that Credit Suisse "operates Wall Street's largest dark pool."
Wall Street On Parade spent weeks digging through government filings to compile this frightening look into Citigroup's dark pools and the sea of darkness that has swallowed what was once the pride of a nation-- U.S. markets.
Citigroup-- the bank that was propped up after its crash in 2008 with $45 billion of TARP funds, over $300 billion in asset guarantees and more than $2 trillion in low-cost loans from the New York Fed, is now effectively an unregulated stock exchange operating in the dark and annualizing at over $1 trillion in dollar volume in stock transactions. Simultaneously, it is operating insured deposits banks spread across America-- all at a time when it has flunked its stress test with the Federal Reserve, which doesn't have confidence in it to manage its affairs in a sharp downturn.
Citigroup's previous dark operations-- hiding tens of billions of dollars of debt off its balance sheet-- contributed to the bank's collapse in 2008 and its stock losing 60 percent of its value in just the week of November 17-21, 2008. Its regulators were too busy schmoozing with it to see the disaster that was about to befall the bank and the nation.
Under the current market and regulatory structure and lack of meaningful, transparent probes by the U.S. Department of Justice, the public has a very solid basis for distrusting Wall Street.