James Dolan, Chief Compliance Officer at Luminex Trading & Analytics LLC

This piece originally appeared in TABBForum on November 21, 2019. You can find the original post here.

A regulatory response to numerous disciplinary actions taken against dark pools, Form ATS-N is an incredibly detailed disclosure form that ultimately is published for public consumption. While the SEC should get credit for combating market abuses, however, the solution it has come up with is not to bar the conflicts of interest and other practices that led to the disciplinary actions in the first place, but to require ATSs to disclose them to you in advance. Worse, as currently designed, Form ATS-N has buried investors with so much information that it becomes almost useless. Here are some of the key sections on which to focus your attention.

You’re an institutional investor or you work for an asset manager that trades NMS equities. In the summer of 2018, the SEC approved a rule requiring ATSs or dark pools that trade NMS equities to respond to a uniform list of questions about how they work – disclosures intended to benefit you and other investors who trade on or through those platforms. With a late push at the end of September and early October of this year, all of these new Form ATS-Ns for active NMS ATSs had been published on the SEC’s EDGAR system.

So, how’s that reading coming along?

Jim, What in God’s name is an ATS-N?

Great question! The Form ATS-N is an incredibly detailed disclosure form that is submitted to the SEC for review and then (if deemed “effective” by the SEC) published for public consumption on the SEC’s EDGAR system. Now, we at Luminex are all about transparency and disclosure: We published our Form ATS, an otherwise non-public SEC filing, on our website as soon as we commenced operations, so that our then-subscribers and other potential subscribers would know, in plain terms, how our ATS operated. In addition, we published – and still publish – a list of all of our subscribers on our public website so that each of our subscribers knows against whom they could be matching in our pool. But as much as we favor disclosure and transparency, we thought the SEC’s ATS-N rule proposal went too far. Here’s why.

OK, Tell Me What Was Wrong with the Rule Proposal, Jim

The ATS-N rule proposal was really a regulatory response to numerous disciplinary actions taken against dark pools in the last 10 to 15 years. I’m not going to recount them all here, but the substance of a lot of them was that investors were never told clearly how their orders would be handled in a particular dark pool or were misled on either how their orders would be executed or as to who would have access to them. Pools that advertised themselves as being composed of “all natural liquidity” were not, pools that stated that they would never disclose customer orders to other business units did so anyway, and pools that said they executed customer orders in their own dark pool actually executed them elsewhere and lied about it.

Before ATS-N, ATS disclosure regulations boiled down to one simple thing: The ATS had to work the way it told its customers that it worked, and in the disciplinary actions above and several others, that wasn’t the case. But while the SEC should get credit for doing something about this situation, the basic solution they’ve come up with is not to bar the conflicts of interest and other practices that led to the disciplinary actions but to require ATSs to disclose them to you in advance! And disclose them to you in such dense, hard-to-read prose that it not only takes a team of well-trained lawyers months to write, it also will likely take teams of well-trained lawyers months to read!

Regulation CVS-Cash-Register-Receipt (Not Its Real Name)

To combat increasingly prevalent abuses, the SEC in 2015 proposed an expansive set of new disclosure obligations that would, in its view, cure all ills. ATSs that traded NMS equities would have to disclose just about everything having to do with their operations, short of which type of Keurig pods they stocked in their kitchens. In February 2016, Luminex filed a comment letter with the SEC supporting the overall transparency objective of the proposal but objecting to what we saw as the over-broad and over-deep disclosures that would be required under the rule if it were adopted as proposed. I believe I can summarize our main concern this way: The ATS-Ns would become the equivalent of a CVS cash register receipt, comically long, and because of that, ignored and serving no purpose.

[Related: “The SEC’s ATS Transparency Rules: What’s the Impact?”]

I joked at the time that the SEC could have also called this rule the Securities Lawyers Preservation Act, because a lot of law firms made a lot of money helping a lot of ATSs with these disclosures. I have been increasingly concerned with what I call “disclosure fatigue” that occurs in the face of filings, prospectuses or offering documents, and even everyday things such as iPhone app user agreements. Do they disclose everything that you might want to know and then some? Um, probably. Do we read every line and every word in all of them or just scroll down to the bottom of the screen and click “I Agree” so we can use the app? I know what I do, and I’m a lawyer!

OK, Jim – These Disclosures Are Out There Now – How Do We Read the #@$%! Things?

So we lost the battle on the breadth and depth of these disclosures. Every NMS equity ATS that didn’t close up shop in the wake of these new disclosure obligations (five ATSs filed forms with the SEC to suspend their operations between April and September 2019, something we warned was possible in our 2016 comment letter) spent an incredible amount of time preparing their filings and working with the SEC’s Trading & Markets staff to ensure that their answers were consistent and responsive. There are now about 30 of these responses, and they are incredibly long. What is an investor or an asset manager supposed to do? Luminex is here to help!

What you and your firm may be interested in may vary depending on the issues that concern you, but what follows below are some key aspects to this disclosure regime that we all have to live with now. Below we point you to the location of all of the filings and some key information that could be very important to you as you decide where to route your orders, which is the whole point of this exercise to begin with, right? Call this the Cliffs Notes version of the Form ATS-Ns. (As with Cliffs Notes when you took English in high school, this will give you the gist of the plot and the main characters, but you should probably read the whole book if you want to get an A.)

So, Where Do I Find These Things?

I give the SEC a lot of credit for putting all the Form ATS-Ns in one handy spot. I may have significant issues with the usability of the SEC’s EDGAR system for those who have to submit filings through it like we do, but the fact remains that this site is one-stop-shopping for every Form ATS-N. You can find a listing of and links to all current Form ATS-Ns right here. In addition, all NMS equity ATSs are required by rule to post a link to their filings on the SEC’s ATS-N website on their individual public websites. The location of these links may vary depending on the layout of the particular ATS’s website, but here is where you can find that link on the Luminex public website.

First Recommended Area of Focus: Conflicts of Interest and How the ATS Protects Your Data

Part II of Form ATS-N is called “Activities of the Broker-Dealer Operator and its Affiliates.” We recommend that you focus on a couple of key sections here:

  1. Is the venue unconflicted?Item 1 of this section asks whether the broker-dealer that operates the ATS is able to enter orders in that ATS alongside its customers.
  2. What about whether affiliates of the broker-dealer operator are also in the pool?Item 2 of this section covers whether you might run into ATS affiliates as you trade in its pool.
  3. How does the venue protect your data?Item 7 of Part II covers (in a very specific, highly granular way) how the ATS protects confidential client trading information.

Second Recommended Area of Focus: How Does the Thing Work?

The guts of how ATSs work are in Part III. We’d recommend that you focus your attention on Item 7, with respect to Order Types and Attributes, and Item 11, with respect to Trading Services, Facilities and Rules. These two sections, in my experience, are among the lengthiest and most detailed of any of the ATS-N sections. Item 11 will describe how the various order types in the ATS work and interact with each other.

Another area of interest to you may be in Item 13, on Segmentation. This section covers whether the ATS allows different classifications of customers either to choose to – or choose not to – interact with other classifications of customers. If you want to know if you’re being exposed to the whole dark pool or if you’re being put at the equivalent of the kids table at Thanksgiving, then this section is a good place to look to see where you’re sitting.

Wrap It Up, Jim – We Have Other Things to Do

See? Even this summary is long! We are not arguing the point that investors should know how the venues to which they route their orders actually work. Our concern in our 2016 comment letter is our concern today in late 2019: that as currently designed, Form ATS-N has buried investors with so much information that only the hardiest souls will bother to read it all. While well-intentioned, providing this much disclosure to the investors for whom it was designed becomes useless. But by pointing you to some of the key sections, we hope you’ll at least be able to understand some of the most important facets of the operations of the venues to which you may be sending orders.

Beyond this, unfortunately, I don’t know how we put this genie back in the bottle in terms of making ATS-Ns more useful for investors, but as this rule matures and ATSs gain more experience with it, we at Luminex will provide further input to the SEC that we hope will make these disclosures more targeted and more useful to you.

TabbFORUM is an open community that provides a platform for capital markets professionals to share their ideas and thought leadership with their peers. The views and opinions expressed are solely those of the author(s). They do not necessarily reflect the opinions of TABB Group, its analysts, TabbFORUM and its editors, or their employees, affiliates and partners.

James Dolan
Chief Compliance Officer, Chief Legal Officer and Chief Information Security Officer
Luminex Trading & Analytics LLC