Goldman Sachs Hires Nasdaq to Run Its Sigma X Dark Pool

(Bloomberg) -- Goldman Sachs Group Inc. hired exchange owner Nasdaq Inc. to run its Sigma X stock-trading system, outsourcing day-to-day operations of its dark pool following an industrywide regulatory crackdown and amid escalating costs.

Nasdaq will provide the underlying technology and additional surveillance for Goldman Sachs's market, which is the 11th-largest dark pool in the U.S. The agreement is subject to regulatory approval. Spokespeople for both companies confirmed that a deal had been reached.

Banks began building dark pools, or private markets for trading stocks, more than a decade ago to save money on transaction costs, but they've become a headache. New U.S. rules require stock markets to work harder to prevent technological malfunctions. Goldman Sachs was fined last year for recordkeeping errors involving Sigma X, while rivals Credit Suisse Group AG, Barclays Plc and UBS Group AG have been penalized by regulators for alleged violations at their dark pools. Goldman Sachs will continue to own the pool and answer to regulators.

“This partnership allows Goldman Sachs to capitalize on the expertise and experience of a scale provider of exchange technology,” Galvin said in an e-mailed statement.

The deal with Goldman Sachs could be an auspicious sign for Nasdaq, which has spent years working on “Ocean,” its dark pool hosting service. Exchange operators like Nasdaq have watched profits from cash equities trading tumble over the past decade, forcing them to expand beyond just running their own stock markets. With the Goldman Sachs deal, Nasdaq can leverage years of experience building the underlying technology for stock trading.

Nasdaq executives explained their offering to investors earlier this year, saying that the company was in talks with banks and brokers to provide the service. “It's a big opportunity I think for us to provide technology,” Tom Wittman, Nasdaq's global head of equities, said at the company's investor day in March.

To learn more about dark pools, click here.

The largest U.S. dark pools must comply with a rule called Regulation Systems Compliance and Integrity, or Reg SCI, which mandates stock markets prove they aren't susceptible to computer breakdowns. Though Sigma X is currently too small to be constrained by that regulation, if it got big enough, it would be covered because of the Nasdaq deal.

Dark pools emerged as a way for money managers to trade large blocks of stock without tipping the rest of the market off to their positions. Banks built their own so they could avoid paying stock exchanges to execute trades. There are dozens of the venues that together handle about 15 percent of U.S. volume, according to Rosenblatt Securities Inc., a shift into the dark that critics say threatens transparency.

Sigma X's share of U.S. trading reached a high of 1.8 percent in 2010, but declined to 0.5 percent in September, according to data compiled by Rosenblatt. Estimated total revenue for U.S. dark pools, including those run by independent brokers, is about $350 million to $380 million annually, according to Tabb Group LLC.

The public image of dark pools has suffered in recent years. Last year, Goldman Sachs agreed to pay $1.8 million to settle the Financial Industry Regulatory Authority's claims that the bank transmitted inaccurate or incomplete trading information to regulators over a period of eight years. The fine came in the same year the firm made upgrades to its dark pool and hired Raj Mahajan as head of its equity electronic-execution business, which was its first partner-level hire in a decade.

In January, Barclays and Credit Suisse agreed to pay $70 million and $84.3 million, respectively, to settle allegations from state and federal regulators that they misled investors over how they managed their dark pools. UBS paid a $14.4 million penalty in 2015 because of a lack of disclosures about how its dark pool operated.

To contact the reporter on this story: Annie Massa in New York at amassa12@bloomberg.net. To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net.