Monday, January 12, 2015

Is Dark Trading Ethical?

Dark trading” has a subterranean connotation, as if it were done by slithering snakes in the river Styx. In actuality, the term refers to trading in stocks that is done on computers that are less public than the exchanges. That is to say, the bid-and-ask quotations on a given computer network are known only to participants on it, and not to the traders on the public exchanges. Ethically, the public-private dichotomy is relevant. I submit that it reflects a wider trend in American society.

In the third quarter of 2014, the average daily volume of dark shares was 2.56 billion, accounting for 45 percent of the total average daily share volume in the United States, according to the TABB Group.[1]  Besides technological advancement, the proliferation of trading venues is behind the growth, according to Sayena Mostowfi at the TABB Group.[2] The fact that most of the expansion is in the form of private, or limited-access computer networks rather than additional public exchanges presents an ethical dilemma that has wider societal implications. Out of the 300 venues, only 13 were registered exchanges—the vast majority being alternative trading systems or broker-dealer platforms.[3]  Leaving aside questions such as how efficiency and the public quotes are impacted, I want to discuss the ethical implications of the increasingly salient insider vs. outsider dichotomy.

Even as the New York Times acknowledges that more computer networks might increase efficiency, the paper suggests that while “dark trading can benefit some insiders, it may cost the market as a whole.”[4] Private benefit may eclipse the common good, resulting in an unbalanced system. Perhaps the explosion in “privateness” in trading is a reaction to the increased scale of the public—meaning the stock market as a whole in the U.S.

The trend may be entirely natural. In American society at the time, “gated communities” were becoming increasingly popular as a means of erecting barriers to crime. Moreover, the sheer amorphous content of a mass public does not satisfy the human need for meaning in a lived context. For the vast majority of the species’ 1.8 million year existence, the iterations of natural selection fashioned the human brain when a given person had contact with less than 150 people. Hence, the expanded number of strangers with whom a typical person in a large city comes in contact presents problems for us. It is entirely natural, in other words, to seek environments in which the number of strangers is kept below 150.

In terms of dark trading, the human self-protective attempt to create a privateness in the midst of a huge publicness is only part of the story, however. The creation of the computer networks is also informed by the desire to achieve better trades than are available on the public exchanges.  In other words, the insiders want to come out better as a result of being members of the private networks. The morality of seeking to shore up advantages that are not available to all market participants can be distinguished from that of creating financial “gated communities.”  Even though both motives are to be found in human nature, evolutionarily speaking, the ethics of psychic self-protection and economizing can be distinguished such that only one is normatively blameworthy.

I submit that economizing to the extent that the public good is compromised is blameworthy (whereas seeking private gain without such a generalized cost is not), whereas seeking a psychological comfort zone by limiting interpersonal interactions to a number of people in line with the bounds established naturally when humans lived in small clans is salubrious.  Societally, the construction of gated communities may seem elitist, but the human motive may not be so arrogant; similarity of characteristics may be one means in which we try to keep within the bounds of contact with less than 150 strangers.  While the motive to exploit the public good and thus put it at risk for private gain is also natural, the systemic risk renders that motive blameworthy and thus appropriately restricted.

In conclusion, the proliferation of privately-accessible trading networks is not in itself unethical; the normative problem kicks in if the networks compromise the viability of the stock market as a whole. That is to say, if the functioning of the public exchanges is compromised or thwarted due to the separate prices on private networks, regulators are justified in stepping in keep the private networks from having such an effect.  



[1] Anna Bernasek, “The Rise of Trading in the Dark,” The New York Times, January 11, 2015.
[2] Ibid.
[3] Ibid.
[4] Ibid., italics added.