Journal of Law, Finance, and Accounting > Vol 4 > Issue 2

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

Robert P. Bartlett, III, University of California, Berkeley, USA, Justin McCrary, University of California, Berkeley and Columbia University, USA,
Suggested Citation
Robert P. Bartlett and Justin McCrary (2019), "Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?", Journal of Law, Finance, and Accounting: Vol. 4: No. 2, pp 291-342.

Publication Date: 13 Dec 2019
© 2019 R. P. Bartlett and J. McCrary
JEL Codes: G10, G15, G18, G23, G28, K22
Latency arbitragehigh-frequency tradingdark poolstick sizesmarket structure


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In this article:
1. Introduction 
2. Institutional Details 
3. Dark Trading and the MPV 
4. Midpoint Trading and Direct Feed Arbitrage 
5. Conclusion 
Appendix A: Delisting and Price Clustering Concerns 
Appendix B: Midpoint Trading with Maker-Taker Pricing Controls 


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.