What is going on moon gang? I'm very very excited to bring you this particular interview because, as we all know, within ape nation at large, there are a whole host of questions between dark pools, payment for order flow, and that's exactly why we are once again bringing on today mr dave lauer an Expert in the subject matter to answer all of our questions. How are you doing today? Dave good man thanks for having me uh more than happy to and i'm sure the ape nation at large is uh beyond excited for this particular discussion. So before we get into it, i find that it's really easy when we're talking about this within this community. There's a bit of a let's say, a trust issue, so i guess, could you give us a little bit of your background and why you feel that you have expertise on this and, like can fairly speak on dark pools and payment for order flow, sure, yeah, um.

So you know i've been involved in markets uh really since well. I was trading as a as a kid but uh during the dot-com bubble, but uh professionally. I've been involved in markets since about 2005. and a lot of that involved building technology for exchanges for brokers who were building alternative trading systems at the time or dark pools, building out technology for high frequency trading desks.

Then i i became a high frequency trader. I'm sure, as many people know, uh briefly worked at citadel in 2009 and then worked at a different high frequency firm in chicago, where i did everything from uh mathematical and quantitative, research and development of trading strategies to software development and implementation of those trading strategies to Running them in production, so i i got a really good experience of sort of the whole pipeline from data and modeling to trading and some experience and sort of the clearing and all of that, especially because i worked on some training strategies that went across border. So there were all sorts of things we had to deal with to do that, so that was sort of the first part of my career and then the second part has been since i left high frequency and um left because for i mean well documented really publicly For ethical reasons, i didn't like what what was happening to the markets um and i had intended on leaving finance entirely. But i ended up kind of getting sucked back in and testifying before.

The senate, um and, and that was in 2012 - and so you know is am i am i like i was asked once am i a manchurian candidate that high frequency sent out to infiltrate things and and um. I can tell you that you know i. I was um scared for my family and my safety at the time um i had rumors that were being spread about me around congress. Um was an intense and insane experience for someone who was really just a software developer um, and so it really made me kind of realize one.

I you know i thought i was doing the right thing and, and i was an independent voice. No one was independent at the time the only people who knew about high-frequency trading were high-frequency traders or stock exchanges or brokers. No one else was out there representing institutional asset managers, so i thought that's really um what i should be doing, and so i uh you know for the 10 years after that i worked on behalf of american retirement funds. Pension plans, mutual funds.

I helped them better route orders and understand how their brokers were treating those orders uh understand how high frequency trading was stepping in the middle uh and, and you know doing unnecessary intermediation how to detect that quantitatively in data, i helped design new exchanges to help sort Of mitigate the impact of high frequency trading through by trying to change the dynamics of the latency race that had been created by the stock exchanges in order to make more money uh from high frequency trading firms, so um, you know all i can say is i've Been doing this for a while i've seen many different parts of the market at a very sort of applied micro level. I've looked at lots of data for lots of different people um some of it. I can't even talk about, but always sort of fighting the good fight and and uh. You know, i think, that's all like all i sort of started in in this community was just trying to help people understand markets and uh.

That's you know what i continued to do on a personal note, i very much appreciate that, and i know speaking for a large amount of members within this community, i'm we definitely appreciate your time and everything that you do and out of, i guess my own curiosity. So obviously you have a whole host of employment and then eventually, you ended up becoming a person who is outspoken, shedding light on. What's going on to, let's call it the community at large, the u.s and world population at large. So was there one day that you really just said like you woke up and you just something i guess like morally, you said was unethical.

Like was just eating away at you and you said like. I need to do something different or was that it wasn't. More of a longer process, how did that actually play out yeah? I you know it was. It was one day it was may 6 2010.

It was the flash crash uh that that definitely was the moment that things started to change. For me, um - and you know this - i think again, like you - can go back because the the stuff um that i said at the time - uh contemporaneous slightly after that about a year after was when i left um, it's all public and documented. So like i, i actually, i left hft about a year after the flash crash um after um, trying to push our the firm that i was working at into a different direction in in terms of like the the policies that were being advocated for um. And when i was told that, since those policies might impact profitability, they weren't the kind of thing that they were interested in pushing for that was kind of my cue to leave.

And so it was funny because i was 31. My wife had just become pregnant and i quit my job and we moved into my mom's house, so i was uh unemployed uh with a pregnant wife, uh and homeless, essentially not home. You know but living at my mom's and - and i said you know i i just want to be done with finance - i don't i don't like this industry at all um and i i started building a storytelling website with a friend of mine, and i told this Story of why i left high frequency trading um and someone from the npr program marketplace, heard it and asked me to come on and tell that story, and it was about. You know the ethical issues that i had with the industry and again this was you know, nine years ago, um and that just kind of kicked everything off.

Suddenly, i'm getting a call from the u.s senate and from the sec and from these guys in new york, building a new stock exchange and iex and - and it kind of showed me that i could get back in and i could push for what i thought was Right um and make a career out of it, which was you know, sort of doubly exciting um, and so i got back into finance because of that hey and look at you now now you're talking to a youtuber who works from his basement, full circle uh. Well, we very much appreciate it, so i think maybe one of the best ways to frame like it is a in in the weeb's discussion about dark pools and about payment for order flow. So maybe the best way to set this up is for the retail trader. We're sitting there whether we're trading from our computer, our phone and we find a stock like amc or gme and we click the buy button.

Can you take us what what happens from there? I click buy. What is the mechanisms that are triggered from there sure um and so first, when you go to click, buy you're, seeing a quote on your screen: you're, seeing a bid and an offer, that's called the nbbo, the national best bid and offer, and it means the highest Priced bid the highest price order to buy on the public stock exchanges and that's an order that is displayed and the lowest price offered lowest priced order to sell across all the stock exchanges. Again, these are displayed orders, someone posts, an order to everyone in the world and they say i want to buy this many shares at this price or i'm going to sell this many shares at this price and they take risk to do that right. They by posting an order you're taking risk, so when you as a retail, um investor or trader, see that nbbo uh, generally you're going to be what's called a price taker.

So the the people that are posting orders on lit exchanges are price makers um and the people crossing the spread buying at the offer selling at the bid. Those are the price takers, so let's just take that example, because that's most of retail trading is is crossing that spread. So you hit the buy button. Uh gme is quoted at an offer of 160.

You say i'm gon na go, buy it at 160 or 180 or 500, whatever it's trading at that day, and you go and, and you hit the buy button and pretty much through most brokers uh. What happens is that order goes to the broker and they are connected to um a couple of what are called internalizers or wholesale market makers. It's but 80 of the trading that takes place in the wholesale market. Making uh sector is citadel or vertu um.

So your uh broker will take that order and send it most likely to one of those two firms. Those guys are getting orders all the time from all sorts of different places. They they are connected to all of these retail brokers. They are connected to every stock exchange.

They are connected to a bunch of dark pools. They have single dealer platforms, uh that act as we're called ping pools. There's they they are managing huge amounts of inventory up and down up and down throughout the whole day. So your order to buy comes in in the simplest example.

Vertu will see that order. They will say i have that guy wants to buy from me and i have inventory to sell to him so uh here you go. Here's your 100 shares because i just uh bought this 100 shares from someone who wanted to sell uh two seconds ago. Now i'm gon na deliver it to you and i that person who sold two seconds ago sold at the bid you're buying at the offer.

I just took very little risk, you know two seconds of inventory risk and i captured the spread, which is the difference between the bid and the offer. I'm happy, that's that's profit, that's the profit, i'm looking for um and so that's sort of the simplest use case. Uh there are situations now the at the the front end of that trade. When someone came in and wanted to sell some inventory, maybe virtue uh was flat and they decided that they thought they were going to be able to offload that inventory quickly.

So they committed capital, they said. Okay, i will buy that from you. I will take on some risk and then this person comes along and they can offload it. So you know, as a market maker they're always trying to manage their inventory, manage their exposure and risk and if they get into situations where they have too much, they can try and lay it off in the on the stock market and the stock exchange, they can Try and lay it off some of it to institutional asset managers, some of them connect through those.

Those single dealer platforms, like i think, uh, virtues, vec or vec link and citadel, is a citadel connect through those systems. There are all sorts of other people that are connected, and, and so you know all day every day, citadel and virtue are trying their best, in theory, to stay flat from an inventory perspective and just make the spread. That's the theory of the internal, this wholesaling and internalization um, and the the reason that brokers send their orders to citadel invert ii in this situation is twofold: sometimes it's for payment for order flow, um and other times it's just because the there's there's uh price improvement Opportunities as far as citadel virtue will show statistically um, and we can get into whether those are good statistics or not, but that you know that's. The case is that they are able to show that um and because the stock market in in terms of exchanges is broken from an incentives and a conflicts of interest perspective, so that uh, these exchanges who are for-profit entities are also called self-regulatory organizations, and that makes Them quasi-governmental, and it means they have immunity, they have legal immunity and so why this is important and the reason i'm bringing it up is because, let's say fidelity wants to buy shares that are going to be in an ipo on the nasdaq, for example um.

If that ipo goes wrong on nasdaq, which has happened in the past, fidelity has no legal recourse against nasdaq, because nasdaq is legally immune. But if fidelity is going through citadel or virtue, then they have recourse. They have a counterparty that they can sue if or they can hold accountable if they need to um. So you know it.

The problem with market structure, which is what we're talking about, is it's very difficult to talk about small parts in isolation, because everything is kind of interwoven uh, and so you can't get into the problems of off exchange trading and payment for order flow which get without Getting into why it even exists, which is you know, this crazy, esoteric, weird legal immunity and access fee issue uh over on the exchange side. So you know i i'm probably rambling a bit here but um, it's it. It is a problem to try and talk about individual issues when everything is sort of interconnected and markets are just relatively complex. Okay, yeah, before we hop into more of those specifics, i don't want to lose anyone here.

So please correct me: if i'm wrong, when you hit the buy and or sell button, but like let's just say in this example that you're buying you hit the buy and basically we have a mechanism of when you're looking for a seller and the stock market plumbing. We have right now to facilitate finding you a seller because you're trying to buy it happens on a venue and it seems like we have three major types of venue. The first type is a lit exchange, the nasdaq, the new york stock exchange and, i believe, there's about 12 others, 14 in total. So that's one type of venue once again just facilitating connecting a buyer and a seller or a seller to a buyer, and then it sounds.

Those are all exchanges and then it sounds like we have two different types of off exchange. One of these is, i guess, what you're referring to as this duopoly between vertu and also citadel securities, and these are guys who are functioning as market makers, and they, you said the terminology internalizers, so they can facilitate taking the other side of the trade. And then i believe if anyone wants to google this one thing they would be referred to, as is as a non-ats and then your other third option of a venue is an ats alternative trading system and i think a lot of people in this community better know That as a dark bull, so it did. I get that all right, thus far.

There's three major venues lit exchanges, dark pools and then also market makers, uh yeah, that that's that's right on um, so uh, the the other. The other thing is that you could look at. You can look at as lit exchanges, dark pools and then everything else is called otc trading or over-the-counter. If you go on the finra transparency website, you'll see a bunch of ats stuff, which is dark, pools a bunch of otc stuff which is over the counter and that can be sort of a host of systems.

But yeah the the market making and internalizing is the main part of that yeah. Okay, so maybe, let's start with uh. Let's start off with that internalizing and the payment for order flow for the people out there who are just hearing this payment for order flow or the acronym pfof. What is that yeah? So that's um.

It's an inducement for order flow, a monetary inducement for order flow, and so what that means is uh, citadel and vertu will pay retail brokers like e-trade or schwab or robinhood. A certain number of mills per share. Uh, a mill is um a tenth of a cent um. So you know if they're paying 10 mils per share.

That means for every 100 shares they get sent uh they're getting 10 cents. So you know you send them 100. So you, as in robin hood, send uh citadel or virtu 100 share order, citadel or virtue pays you 10 cents for that order, um and then so that's payment for order flow. It also exists uh, to a certain extent, on exchange where exchanges pay rebates, mostly for resting liquidity in a maker, it's what's called a make or taker model, but then there are some that are inverted exchanges where they pay a rebate for people to take liquidity, um And then you have someone like iex who's, unique amongst the exchanges in where they don't change their fee structure or pay any rebates.

They just charge a much smaller amount for both sides of the trade. Okay, why? I guess so? It sounds like they're paying to take the other side of the trade. If i buy on one of those brokerages you just mentioned it could get routed to one of these market makers if they're engaging in payment for order flow as in they really want to take the other side of that trade. Why why why would they do that? Um, the main reason is that you are operating on a completely different time scale as they are um.

So when, when i am a high frequency trading, firm uh, i am trying to understand exactly what's about to happen over the next. Let's call it 50 milliseconds right. So not even half a second 500 milliseconds would be half a second and that's you know that's pretty long time scale for a high frequency. What i'm trying to figure out is okay, right now, it's trading at uh, 180 by 180 spod01 and in the next 50 milliseconds is that is that bid offer going to tick up to 01 by o2, or is it gon na tick down to 99 by by Oo right, and so that's what the high frequency trading firm is trying to figure out what is going to happen on the next tick, and so the thing about your order is that you have no knowledge of what's about to happen on the next tick.

You have no insight or information about what's about to happen even over the next second, but maybe you have a very strong view on what's going to happen over the next week or year, or you know whatever it is you're on a very different time scale than They are, and so what that usually means is. It means that your order flow is non-toxic. It's not subjecting the market maker to what's called adverse selection, so adverse selection is probably the most important term that really nobody's ever heard about or understands, and it is the core of market making and what it means is. I don't want to buy shares in something that is about to tick down, because if i do now, i'm losing money, uh, that's adverse selection.

So if a huge order comes through the pipes, um that is selling a bunch of shares and all these market makers have to buy and that order knows that that price level is about to be cleared out and it's going to tick down. That is called a toxic order and that subjects a market maker to adverse selection. So retail orders do not have a high level of adverse selection, they're profitable to trade against in the very short term, and if you're good - and you don't take on inventory risk as a market maker, then you don't care what happens over the next hour day week Month, okay, so would you say it's accurate to say that basically, market makers have figured out a way to profit off of an asymmetric data advantage. They just see what's going on, they use that data and they not necessarily front run, but because they have superior data.

That's how that's, where they're, making their money yeah they make their money because they've got uh. You know this tremendous investment in infrastructure and computing um and they're able to see feeds that are proprietary and being sold by the exchanges that are very fast faster than the public data feeds right. So the feed that you're seeing on your broker's website is the sip. It's the securities information processor, that's the public market data feed, but the exchanges are selling private market data feeds that are faster uh to these hft firms, they're also selling them to the brokers uh now but um.

You know the the the the speed advantage is real. These guys have computers, co-located in data centers next to exchange matching engines. They use lasers and microwave technology to send data wirelessly even faster than through fiber optics, because when you send a data through a fiber optic line, it bounces off the glass inside the wire and that can add nanoseconds or maybe even a microsecond of latency. Whereas if you send it straight through the air, it doesn't bounce off anything and so even line of sight, it's faster than fiber optics and and that's the level of engineering that's taking place.

You know when i was in it. I was managing a system that could trade in 40 microseconds. That was my average response time for when i would get a message into my server and when my software would send an order out, i mean 40. Microseconds is a completely different time scale than humans operate.

On and so yeah you know the these guys use all of this technology and all of these data feeds to operate at a very different time scale. When you're saying different, though what is retail operating at, are we on days hours minutes like you're? I see that these people are moving way faster. What's retail moving at i mean you know, look just the amount of time it takes you to click that mouse button, that's hundreds of milliseconds! So already it's just a completely different time, scale um and it it's very variable too right. So uh.

That's what makes a market is that everyone's operating with a different theory and a different thesis and and and they see things playing out in different ways and and their disagreements as to who's right and the way to test it. Is you put your money in and you know you're right, you make money, you're wrong, you lose money and it's kind of the beauty of markets and - and so you know, i think, from a retail perspective, if you're a retail investor, i mean your your timeline might Be 30 years right, um if you're a retail trader, even even if your timeline is 15 minutes, that's an eternity uh relative to these high frequency trading systems. Okay and when you're talking about that you're, just talking about like our career of like a trade or something like that of like the time scale, we're looking at and interested being involved in the market versus the time scale that they're interested in being actively in that Trade yeah. These are when i talk time scales, i'm i'm talking about like holding periods right, so maybe hft is holding a inventory like they're net long or net short again for milliseconds, maybe seconds, but you know you're going to be holding inventory.

I don't you know. If you're, if you're the most active trader, retail trader still doing point and click, it's still going to be minutes, you know and the less active investors could hold something for months or years. Okay, so payment for order flow, they're, basically, brokerages are getting paid to route. Their orders to these market makers opposed to a dark pool or a lit exchange.

It's going right to either, let's just say, citadel or virtue, but i mean when i read about it. I think i've read that it's banned in the uk, it's banned in canada, and i think it's um its birth has some connections to bernie madoff like so something's messing up here like obviously, some people are not like countries are not happy with it. It's connection to madoff like we're familiar with that story, so, like obviously something's going a bit awry here when even we're having this conversation now kind of like asking what it is and it's efficacy, it's pros. It's cons.

Yeah most countries have taken the stand that, when a broker is routing an order, the only thing that they should care about is the execution quality of the that they're delivering to their client execution. Quality can mean price improvement. It can mean timeliness of execution. It can mean a bunch of different factors and that's usually up to the discretion of the broker, but most important thing is that the broker is acting as an agent.

This is sort of like an you find this all over. It's called you know the principal agent problem, uh and and when incentives are not aligned between the broker acting as agent, they might act as principle for themselves, which means they might seek to reduce or minimize their fees or maximize the rebates, regardless of the quality of The execution that the end client ultimately gets and those other countries have said that we're going to outlaw this, because we want to address that conflict of interest and we want to make sure brokers are getting the best trades possible for their clients. And yes in the us, we have not, and you know it. I think it gets to the idea that some very politically powerful people make a very large amount of money, doing this um and that's sort of the nature of the u.s political system.

So if they're um, maybe this isn't the most accurate term, but if they're front-running their client like, if, if we have one particular market maker, who cares not necessarily about their clients, execution quality and just cares about them. Making money themselves on the trade um is that the only detriment of payment for order flow to our system of like just some guys, like they're, skinning off like a portion of penny, or does it go even deeper than that in terms of its uh detrimental aspects? To the stock market system at large, oh yeah, it's it's detrimental to the market. Let me start before i get to that. Let me just read you a quote: the practice of payment for order flow, creates serious conflicts of interest and should be banned.

Internalization without meaningful price improvement, reduces competition limits. Price discovery leads to market fragmentation and should be banned. Payment for order flow is a practice that, on its face, is at odds with the broker dealer's obligations to its customers. A broker dealer has a fiduciary obligation to obtain the best execution reasonably available for its customers orders.

We do not believe that a broker dealer that accepts payment for order flow and does not pass such payments on to its customers can consistently fulfill its best execution obligations. You know who said that i don't like the scc or something citadel. What would the saying for that even be like the pot calling the pot black like they're, like basically talking crap on themselves? When did they say that they said the commission, speaking of the sec, should ban payment for order flow all together, um? This was from 15 years ago uh in or oh no sorry now, 17 years ago, this was in 2004., so before they were in to payment for order flow citadel believed that it should be banned. Um.

The same can be said for virtue. They were against it before they were for it um. So you know, let's, when you hear arguments on the other side um and they denigrate those of us who have been fighting against payment forward of law. I've been in this i mean you can look honestly like back at my congressional testimony in 2012 is when i started talking about this and they will denigrate us and they will say we don't care about markets and uh.

The ceo of vertu on twitter last week called me, anti-retail um, so that that was nice of him, but you know i'm just repeating arguments that they've made themselves almost verbatim um now to get into whether there are systemic issues. The the very simple answer is yes: when you take that order flow, the retail order flow that is profitable for market makers to trade against it so profitable that they will pay for the privilege of interacting with it and you remove that order flow from the stock Exchange where price discovery actually happens, as the the president of the nazi said uh, you know it distorts the prices on the exchange, because the exchange prices cannot accurately reflect supply and demand, and so what that means is that the only orders that make it to the Exchange are those highly toxic orders, the ones with high adverse selection. So it means that market makers struggle to make money on exchange and, if they struggle to make money on exchange, you go from narrow and tight spreads to wide spreads. Market makers have to widen the spread to make more money and that's what she's talking about uh.

So there was a good study that came out recently. That said, diverting all of that flow off exchange has widened, spreads by 25 or more so, that costs pension plans and mutual fund companies billions of dollars a year in extra execution costs and - and it makes these you know it - makes it harder for these underfunded pension Plans to meet retirement savings needs for their firefighters and their plumbers, and, and you know the all of these workers that that depended on these pension plans. This is why i got into the issue in the first place, because that just seems wrong and all i'm arguing is that that order flow should go to the exchange, and you should have open competition for order flow. Get all the market makers competing over the order flow, it would narrow spreads retail would still have excellent outcomes, but so would the rest of the market.

Oh well, if so feel free um. If, if you had a magic wand right now at this moment and could get rid of payment for order flow, would you uh? I would not get rid of payment for order flow because, as i was trying to explain before it's it's something that, if you just got rid of the payments, you wouldn't fix the problem. So fidelity doesn't accept payment for order flow as an example, but they still route to citadel and vertu. So there are two main reasons: one is this exchange immunity issue and the other is that citadel vertu offer better price improvement than what you can get on exchange.

So what you need to do is not ban payment for order flow per se, and that should be one part of a broad set of changes in markets uh. The main thing i would like to adopt a rule similar to canada's dark trading rules. I think they're an excellent model for a very simple and elegant rule, and all it says, is if you're going to execute something off exchange. You have to provide material price improvement and the definition of material price improvement means a tick if the spread is more than a tick, wide or half a tick midpoint.

If the spread is a tick wide or you can also execute off exchange, if you're executing large block orders like an institution, would um that's a very sort of elegant rule, it's simple: it means that uh dark trading in canada is only around eight percent of the Stock market uh rather than 44, which is what it is in the u.s okay. So you think it's it's a two-prong approach of not only getting rid of payment for order flow, but also somehow stopping all the massive amount of orders that are getting routed to the duopoly of citadel and virtue. In the current i guess regulations we have you'd prefer to see it being closer to like the canadian market. You think it's a better representation of fair market.

I guess price discovery is maybe the best way to put it. That's right: it's more efficient, um and, and some there have been good studies that show that execution costs in markets. Uh that don't have this level of off exchange trading are lower uh than in the us um, and you know i i want to make it very clear: dark pools are important and dark pools are good. Retail retail orders do not go to dark pools.

Retail orders have nothing to do with dark pools whatsoever. Dark pools are for institutional asset managers and, if i, as a pension plan, want to go, buy a million shares of microsoft. If i put that order onto an exchange, the price is going to go crazy. If i put that order into a dark pool, i might find that another institution somewhere who comes along and wants to sell that million shares and that's a very good outcome.

That's why we need dark pools uh, you know, but again it should be a small fraction of trading. Eight percent is a great number uh right right now versus 43 of off exchange trading, which includes both dark pools and this retail otc market. I was reading some things recently that is specific to the amc and gme community, that uh, like i've, been seeing off, exchange off, lit exchange between dark pools and also these market makers that sometimes the volume 60 70 80 percent. Um yeah like to my understanding.

By definition, i thought this dark pool thing: inherently they were less regulated. Can it be good when such a high majority of trades are executed in, by definition, a less regulated environment? No, i i think it's awful and - and i think that you don't even you - don't - need anything nefarious to be going on to understand that 70 of amc, for example, being executed off exchange is damaging the market. It's damaging the spread in amc and it's making it so people have to pay more um. Now, when you see something like that, when you see 70 of amc trades off exchange, if you get into the numbers, you will find 90 percent 89 or 90 percent of that is otc, that's citadel vertu and the this internalization system.

It's only 10 of that number. That's actually in dark pools, and so it really is a very small part. The whole darkfool thing is a very small part. I i think i i keep calling it a red herring.

The dark pool is not the issue um. We want dark pools, um to be less regulated. That's the point of the dark pool, because that way you get more creative models. You get these.

These really interesting efforts um there. There are some that do like uh frequent micro auctions, and there are some that specialize in block trading and there are others that now are trading around the clock and and so dark pools are an area for the market to be creative. I think broker-owned dark pools are a bad idea for a whole host of other reasons that have nothing again to do with retail and which the new york attorney general's office and finra really crack down on a few years ago in terms of the conflicts of interest. It resulted in hundreds of millions of dollars of fines, but again that that's that's sort of a different issue from this retail internalization issue, which is just it's it's completely different and it makes no sense.

There is no good argument for taking that order. Flow off exchange. Other than you have two two sets of firms: the internalizers and the retail brokers, who make a lot of money because of it, and they will bring out statistics, for example, that show price improvement. But remember if the spread is 25 wider or more, then those price improvement statistics are a joke because you know if if this would be the spread, if retail made it to exchange - and this is the spread with it being internalized - and this is how much you Price improve you're still worse off than if the spread was tighter and all of those orders was going on were going on exchange.

Okay, maybe it would be beneficial for people who are like this is the first time hearing about dark pools, which was remember earlier. In the conversation we were talking about three separate venues lit exchanges, market makers. This is that third, one ats alternative trading system, aka dark pool. What's your quick explanation of what that is and why we have one uh just to really tie this together for the ats side of the dark? Yes, you mean yeah ats side of off exchange trading.

Ats's, alternative trading systems are dark pools, but eight reg ats, from 1998 um didn't start out as a dark pool regulation. Actually, arca and island were created under reg ats, as ecns back then electronic crossing networks, and they were displayed. So just because you have a venue that is filed under reg ats and you have to be a broker dealer to operate. That which means that, no matter what you're regulated by finra, it doesn't mean it has to be a dark pool, but back then they were displayed and they would post quotes.

But but then those like island and uh, inet and arca were swallowed up by nazi and nasdaq when reg nms came about in 2007.. So now, generally, everything that is operated under reg ats is an alternative trading system is a dark pool that doesn't display orders. Although the long term stock exchange is trying to change that with a new display facility, but basically, as i explained before, dark pools are really meant for both creativity and different models and for institutions to post large orders to try and find a counterparty. And you have non-profit dark pools, like luminex and in europe, the plato partnership which are just sort of founded and built by asset managers to try and match up when when one wants to sell and the other wants to buy.

It's unfortunately rare that that actually happens. But when it does it's a great outcome for it for people who own, you know, shares in mutual funds or who have money and pension plans. Okay. So basically, the pitched utility of a dark pool is that these large players like trying to buy a lot of size or sell a lot of size are inherently trying to do it without showing the position beforehand.

Like you just don't see the big wall, you don't see a buy one, you don't see a cell wall like it's just they're sitting there aka in the dark and they're just hoping to get filled. Um i feel like there might be some confusion, then, because there's a lot of assumption that it somehow doesn't impact the price does trading on a dark pool, whether always or even most of the time or are there some caveats? Does it impact the price of an equity? Yes, and it's very important what you just said does trading impact the price? Yes trading, every trade impacts the price, whether it's in a material way or not, whether it's measurable or not, every single trade impacts the price. So this is a very important distinction. There's a difference between posting, an order on a dark pool versus an exchange posting.

An order on a dark pool does not impact the price posting. An order on an exchange can impact the price. Okay trading does impact the price and trading it doesn't matter where it happens. It doesn't matter it's on exchange on a dark pool or otc.

Every trade that happens in the market gets printed to the ticker tape or to the market. Data feed and every single trade is recorded and public, and so every time there is a trade every computer that is listening to that market data feed gets the the notification that there was a trade it categorizes. You know did that with with that trade on the offer or close to the offer, so it was a buy. Was that trade on the bid or close to the bid? So it was a cell? Was it a midpoint? It's every computer, hundreds, thousands of computers all around the world.

Listening to this information, trying to figure out what that means for supply and demand, what that means are there lots of? Is there lots of buying activity taking place? Okay, you're going to start to see the price move right. Is there lots of selling activity? The price is going to start to drop, that's all based on looking at trading data and classifying it and putting it through. You know these mathematical models to try and understand. Uh, what it means and whether there is you know some signal in that trading data that can be used and profited from basically okay.

So i i really like this distinction between posting, a trade of like saying, hey, i'm trying to buy i'm trying to sell and then actually trading executing the trade. When you actually execute. Is there any delay in impact on price, a material impact? Can it be delayed seconds minutes hours days or is it instantaneous, so the the rule is that all trades have to be reported within 10 seconds, and that is a time period that has come down dramatically over the years. In fact, something that i pushed hard for recently to bring it down from 30 seconds to 10 seconds, and so the rule is, it all, has to be disseminated within 10 seconds.

In practice, it's usually relatively instantaneous that within milliseconds that trade gets reported um. So that is for almost every single trade in the market, they're reported instantaneously worst case within 10 seconds. There are. It is possible that some trades get reported late now what that means? There are valid reasons for late reported trades uh, for example.

Everything we're talking about is assuming electronic trading and execution and for 99 of the market, that's how it works, not how it used to be right. It used to be you call someone up on the phone yeah. I got 50 000 shares of microsoft, all right i'll. Take it down at you, know this price, okay, trade and then they'll.

They call the game. You know we call the back office, the trade happened. Okay, all right we're going to get to it. You know, and it would take minutes hours, maybe uh.

That still happens from time to time. So there is some manual trading uh and it is not. They do not have the same kind of rules. They're allowed to report it a little later there are.

There are other kinds of trades um, like options trades where uh you can have like the x you, you can have a mo. What's called a multi-legged options: trade where you can have one two. Three, i'm sorry, two three four different legs you know you've got puts here calls here different durations, different strikes, that kind of thing, because you've constructed a butterfly or you know whatever it is, and it could be that one or more of those legs actually gets executed And and converted into shares from options - and there are what finra needs is they need all of that to kind of be reported at the same time and interconnected so that they can surveil that kind of trading activity. So there are certain exceptions, for you know: legs of complex options, trades um.

There are other small exceptions, but i i haven't done the math. I would be surprised if there was anything more than you know less than one percent of all trading that got reported late. I i would be surprised if it wasn't 99 of all trades and all shares uh get reported in that 10 second window and nearly all of them. You know within milliseconds, okay, uh rewinding a little bit.

You were talking about dark pools being for institutions. I remember at one point i think i was on interactive brokers and i actually saw a route option that i could route to a dark bull so are dark pools exclusively for institutions or just most commonly used by institutions right they're, not exclusively and and yeah interactive Brokers offer some more advanced routing, um and others do too um. You know, for example, it's still mostly for institutions like rias. Even if they don't manage a ton of money, they might get access to the retail broker's router.

The order router and some of those can hit dark pools, but, generally speaking, it's for institutions, but it you know these are. These are facilities that welcome retail trading. They would love more retail orders coming through because of that adverse election toxicity issue i discussed before, and so you know, but someone like interactive brokers, which is more for professional traders like if you talk to someone on wall street and you ask how do they manage Their personal trading account most of the time, they're going to say interactive brokers because of that kind of stuff. Like that, it's more advanced you can customize it more.

You can uh, you know you have access to more destinations and they have order routers that you can use okay, understandable so um with it. I mean at one point you said: dark bulls are good and then, like the other part, you said the fact that we have so much off exchange which is dark, pools and also market makers. That's very very bad, but do you think it's bad specific to dark pools if it's pitch in this concept that most of them are supposed to be these sizeable block trades, but the data is almost seems to be the contrary, where we're seeing a lot of volume, But it seems to be like a lot of little trades like yeah. Is that problematic? It well see? That's generally speaking, uh indicative of retail trades, and so that's the otc training and you can do the math because you can go on the finra website and you can look at you know otc trading versus ats trading.

Now i i do think it's problematic what you see in dark pools. Is you see um? I could actually uh. I think i have this up somewhere um. You can see an average trade size off exchange uh.

The average trade size off exchange in july was 245 shares. Now the average trade size on exchange uh was 132 shares, so the trades are bigger off exchange, but if you dissect that, actually i think we can look at this. So i'm just let me look at these numbers real quick! So here is ats trading and there are a group of atss where the average trade size is very small, so ubs, uh goldman, sigma credit, swiss cross, finder jpmx. Those are all between 100 and 150 shares average trade size.

But if you look at ats training um, so that was not ats, you were referring to dark pools right there. Yes, so those are dark, pools! Um! Let me see where's uh, you know, i don't have good otc numbers, but when i looked at, for example, gamestop um a couple months ago i was seeing average trade sizes in like 20 shares 30 shares. So those are all that's all those individual retail orders coming in and being executed immediately like they get executed right when they come in, and so you see very tiny trade sizes. Because of that - and that was specific, though, to market makers - we're not talking about dark pools, we're talking about like otc otc trading, exactly okay yeah.

So is there actually data, though, suggesting that dark pool trades are of lower volume, because right now we're expecting that they should be higher if they're being utilized in the way that we expect it to be so there? There is a set of dark pools that specialize in block trades, so there's bids there's block cross, there's liquid net, so bids average block size is 25 000 shares block cross average block size is 20 000 shares liquid net 25 000 shares so um there. There are a group of dark pools that uh do specialize in that block trading. The the problem is with these uh broker-owned dark pools like what i was talking about before goldman credit, swiss ubs uh, morgan stanley. There are all sorts of issues that we haven't even touched, the surface of in terms of the conflict of interest, where, if i as an institutional asset manager, go to morgan stanley - and i say here's - my million share order to buy microsoft and they're going to put That in their own dark pool, where there's very low chance of finding a natural counterparty to execute the whole block and a very high chance that it's just going to be picked apart by lots of little orders.

As hft firms are trying to profile. Uh supply and demand in the dark fools by pinging into them and doing all sorts of other things you know, and then morgan stanley is also routing part of that order out to other dark pools, pinging those it's very complicated, it's it's kind of a mess um, But again, it kind of has nothing to do with retail. That's all uh! Those are all issues in on the institutional side and again you know if people are interested in that, i would tell you go look at what the new york attorney general did um. I think about in 2015 or thereabouts um.

It was very excellent, expose on what darkfools were doing at the time and the the crimes that were being committed, and there were some very large fines paid uh. Unfortunately, i guess i shouldn't use the term crimes because no one actually went to jail um, despite all of the massive amounts of fraud good, but that's sort of just wall street right, yeah, uh, one thing uh. I guess talking about this dark pool and set it on that. I was reading about citadel connect, which you referred to earlier, and i remember reading on one article that apparently it said that they don't even have to report their volume.

Is that true, like when you're saying everything's reported yeah? That's not true um, so a citadel connect and vertu offers this vec and vec link. These are called single dealer platforms, so they operate otc they're, not dark pools and the in the industry. We all. We often call them ping pools or stp platforms, and it it's a bit complicated to get into it.

But the most important thing to understand is: it is just one of the facilities that these guys operate for otc trading and everything that happens in them. Every trade that happens is printed to the tape. Every trade that is printed to the tape gets included in finra's transparency reporting, so those trades are being printed to the the trade reporting facility. The otc those trades show up in the otc reports on finra's website and all of it goes to the consolidated audit trail that that finra is now operating for surveillance purposes, to try and find people that are manipulating markets and that kind of thing.

So it is less regulated than ats's, less regulated than dark pools for sure um, but it is not unregulated and everything is reported and i'm not defending these things in any way, shape or form. As should be clear, i think all of this stuff should go away. I think markets are too complex. I think this amount of off exchange trading in the retail space is problematic for reasons i've already explained um, but i'm just trying to explain how these things work, and i know there was some reuters article going around from many years ago, which had bad information in It and that people are using as a source, and i you know i just think - that's the kind of thing that it's not right and you know, let's understand the thing that we're fighting against.

That's that's my thought. Okay, so maybe uh, maybe two quick, like kind of rapid fire question so in the amc, gme eight nation community, a hot topic is naked. Shorting does payment for order flow, which are clearly against and then dark pools which you do have sometimes some issues and other times not so many issues in does naked shorting. Is it made easier by payment for order flow or dark pools, but not in any way that i can think of, and i i often get hit for phrasing things like that um and and people say oh you're just describing how things should work, not how they Actually, work, that's most, certainly not true, i'm intimately familiar with how these systems all work in practice, but when you think about naked shorting, that's something that takes place in the back office.

Everything we're talking about right now is what's called the front office, that's where trading happens. The back office is where clearing settlement, reconciliation happens and, and so that's just a fundamentally different thing than um all of this trading on exchange off exchange, whatever it is now um. It can be made easier by the fact that these firms are what are called bona fide market makers, and there is a market-making exemption to reg show which says that they can short stocks without having located shares to borrow. But that doesn't have anything to do with.

Where that trading is taking place, that exemption is equally valid on exchange on dark pools off exchange. So when i try and say that you know, don't don't worry about that from a naked shorting perspective. That's all i'm talking about naked shorting happens in the back office when someone is short and they're unable to deliver shares. That's that has nothing to do with where that trade took place.

Okay, so let's just make this very clear, obviously naked shorting. It does happen. It's problematic, these just aren't the causes of it; it just happens somewhere else in the stock market plumbing world. That's right, okay, and in a very similar realm between dark pools and payment for order flow, and maybe this is necessary to split up into two ones.

Is it possible for these that you can think of mechanically for them to somehow stye me or stop a short squeeze in a stock um? So i have spent a good amount of time. Analyzing market data looking for market manipulation, um and all of the analysis that i've done is from lit trading, because when you go to manipulate markets, you're, usually using both orders and trades. And if you look at all the enforcement actions, it's all generally focused on market manipulation in on exchange. So when i, when i talk about this particular issue, i i can only talk to my experience.

Could you do things off exchange to try to change the appearance of supply and demand? I i think it would be very hard, like i said when it, when you as a retail trader, send the order to your broker. You get that execution back in milliseconds right. It happens very quickly um, so i can't think of the mechanism by which you know. For example, i've heard this theory of people blocking up orders um to then you know make it so that the the buys happen off exchange and the cells happen on exchange.

That would be a serious enforcement issue and finra has all that data. They would see something like that that it would be so blatant. You know it wouldn't be subtle, so i all i can say is i don't necessarily see the mechanism, i'm not saying it doesn't happen, but from my experience in market manipulation you don't need that because you can manipulate markets on exchange. You know you can spoof and layer all over the place, um and i've measured it happening on exchange so uh.

You know, i don't. I don't know in terms of off exchange what what would be taking place, but the problem is, we can't see. So you know we have no no way of speaking to it, um from a data perspective and - and i you know, that's what i do - i'm grounded in data and math, and so if i can't see data for something i'm hesitant to to make claims that i Can't back up or prove gotcha. So when i was kind of researching you and looking into your twitter, that seemed like, of course, you were you've, had comments on dark pools, you're vehemently against payment for order flow, and one of the other things that we really haven't touched on is that you seem.