Tagged: SEC

Time for Change

Seventy-two years ago today, the United States dropped the second atomic weapon in four days, bringing world war in Asia to dramatic conclusion.

Current relations with North Korea demonstrate the intractability of human nature. While human nature is unchanging, markets are the opposite. Yesterday famed bond investor Jeff Gundlach of DoubleLine Capital declared that his highest conviction trade is a bear bet on the S&P 500 and a bull bet on a higher VIX.

The VIX, the fear gauge, reflects implied volatility in the S&P 500 calculated by the CBOE via options. Everyone is short volatility, Mr. Gundlach says.  It can’t last he says.

Yet intraday volatility – the spread between average high and low prices during the trading day – has reached a staggering 2.9%. That’s 45% beyond the historical average of about 2%.  How can intraday prices reflect savaging by arbitragers while the VIX, predicated on closing prices, signals a placid surface?

One word: Change.  The market has been convulsed by it the past ten years.

Regulation National Market System in 2007 transformed the stock market into a foot race for average price. A year later, the global payments system heaved seismically.  High-frequency trading arced like fireworks on the 4th of July.

For public companies, reporting duties that ramped with Reg FD in 2000 and soared with Sarbanes-Oxley in 2002, were drenched yet more with Dodd-Frank in 2010.

At the same time that companies were being compelled to provide ever more information, investors were shifting by the trillions to indexes and exchange-traded funds that ignore fundamentals. Now, Blackrock, Vanguard and State Street, largely deaf to story, are top ten holders of nearly every US equity.

For public companies it’s been like paying to cater a party for a hundred and having your mom and brother show up. Stuck transfixed, frozen in time from the summer of 1975, was Form 13F.

You didn’t know where I was headed, did you!  Yesterday I had an earnest phone discussion with three professionals from the SEC (I’m leaking this information straight from the source, no anonymity required).  They were good listeners and interlocutors, nice people, and genuinely interested folks.

The discussion happened because I’d earlier sent a note to new SEC Chair Jay Clayton saying there was no more urgent need in the equity market than the modernization of Form 13F. Within a week I heard from two different SEC groups. That says the new SEC chair cares about you, public companies.

I shared my written testimony (thank you, Joe Saluzzi at Themis Trading. None of us would be anywhere without you and Sal.) from the June House Financial Services Committee hearing, highlighting one thing:

It’s been 42 years since we updated disclosure standards for investors.  This is not human nature we’re talking about, something timeless, changeless. It’s keeping up with the times – and we’re not.  The SEC chair who gets these standards current with how markets work is an SEC chair who goes down in history for changing the world.

I said the same to the three SEC staffers. I said, “There is no greater goodwill gesture regulators could extend to companies, which have borne ever higher compliance costs for coming on 20 years now even as the ears of investors have gone deaf, than helping them know in timely fashion who owns, and shorts, shares.”

They said, “Investors will push back.”

I said, “Dodd-Frank orders disclosures of short positions monthly. It hasn’t yet been implemented, and we don’t know what Dodd-Frank will be in coming years. But one thing is clear:  Congress thought monthly short disclosure was fine. Are we then to have long positions disclosed 45 days after quarter-end? That’s cognitively dissonant.”

They didn’t demur.

I said, “Companies fear you, you know that? You need to make it clear that you want them to engage. General counsels are loath to see their companies’ names in the same sentence as your acronym. You need to let them know you want to hear from them.”

They said, “We absolutely want to hear from companies.”

They think there’s merit to a stock market issuer advisory committee, another suggestion we offered Congress in June. This SEC edition wants to see business thrive. It’s the agenda.

Do we realize how great an opportunity for change is in front of us?  It’s that big, public companies. You could know at last, after 42 long years, who owns your shares every month, and who is long or short.  The world the way it is.

How to make it happen?  Not us. We’re market structure experts. Not policy experts. You’ve got to get behind NIRI, our professional association.

I bet if a thousand companies asked the SEC to ask Congress to make 13Fs monthly…it would happen in the next two years.  Maybe one.

It’s time for change.

ETFs and Arbitrage

The biggest risk to an arbitrager is a runaway market.

Let me frame that statement with backstory. I consider it our mission to help you understand market behavior. The biggest currently is arbitrage – taking advantage of price-differences. Insert that phrase wherever you see the word.  We mean that much of the money behind volume is doing that.  Yesterday eleven of the 25 most active stocks were Exchange-Traded Funds (ETFs). Four were American Depositary Receipts (ADRs).

Both these and high-frequency trading turn on taking advantage of price-differences. Both offer the capacity to capitalize on changing prices – ADRs relative to ordinary-share conversions, and ETFs relative to the net asset value of the ETF and the prices of components. In a sense both are stock-backed securities built on conversions.

For high-speed traders, arbitrage lies in the act of setting prices at different markets. Rules require trades to match between the best bid to buy and offer to sell (called the NBBO). Generally exchanges pay traders to sell and charge them to buy.

In fact, the SEC suspended an NYSE rule because it may permit traders to take advantage of price-differences (something we’ve long contended). We’ll come to that at the end.

Next, ETFs are constructed on arbitrage – price-differences. Say Blackrock sponsors an ETF to track a technology index. Blackrock sells a bunch of ETF shares to a broker like Morgan Stanley, which provides Blackrock with either commensurate stocks comprising the tech index or a substitute, principally cash, and sells ETF shares to the public.

If there’s demand, Morgan Stanley creates more ETF shares in exchange for components or cash, and then sells them. Conversely, if people are selling the ETF, Morgan Stanley buys the ETF shares and sells them back to Blackrock, which pays with stocks or cash.

The trick is keeping assets and stock-prices of components aligned. ETFs post asset positions daily. Divergences create both risk and opportunity for the sponsor and the broker alike. Blackrock cites its derivatives-hedging strategies as a standard risk associated with ETF investing. I’m convinced that a key reason why ETFs have low management fees is that the components can be lent, shorted, or leveraged with derivatives so as to contribute to returns for both the sponsor and the broker.

On the flip side, if markets are volatile as they have been post-Brexit and really since latter 2014, either party could lose money on unexpected moves. So both hedge.

For arbitragers, a perfect market is one with little direction and lots of volatility. Despite this week’s move to new market highs, there remains statistically little real market movement in the past two years. If a market is up or down 2% daily, does it over time gain, lose or stay the same?

Run it in Excel. You’ll see that a market declines over time. Thus arbitragers short securities using rapid tactics to minimize time-decay. If you want a distraction, Google “ETF arbitrage shorting” and read how traders short leveraged ETFs to make money without respect to the market at large.

In fact, this is the root problem: Taking advantage of price-differences is by nature a short-term strategy. Sixteen of the most actively traded 25 stocks yesterday (64% of the total!) were priced heavily by arbitrage, some by high-speed traders and some by investors and the market-makers for ETFs.

Offering further support for arbitrage ubiquity, the market is routinely 45-50% short on a given day. Short volume this week dipped below 45% for the first time since December, perhaps signaling an arbitrage squeeze and certainly offering evidence that arbitragers hate a runaway market.

If the market rises on arbitrage, it means parties SUPPLYING hedges are losing money. Those are big banks and hedge funds and insurance companies. Who’d take the market on a run to undermine arbitrage that’s eating away at balance sheets (big banks and hedge funds have suffered)?  Counterparties.

In our behavioral data Active investment is down and counterparties have been weak too, likely cutting back on participation. That comports with fund data showing net outflows of $70-$80 billion from US equities this year even as the market reverts to highs. The only two behaviors up the past 50 trading days are Fast Trading (arbitrage) and Asset Allocation (market-makers and brokers for ETFs and other quantitative vehicles). Yet more evidence. And both are principally quantitative.

Assemble these statistics and you see why the market seems oblivious to everything from US racial unrest, to a bankrupt Puerto Rico, to foundering global growth and teetering banks.  The market is running on arbitrage.

What’s the good news, you ask?  The SEC is aware of rising risk. It suspended an NYSE rule-filing on fees at the exchange’s Amex Options market after concluding the structure may incentivize arbitrage.  The SEC is scrutinizing leveraged ETFs and could end them.

But most important is the timeless self-regulation of knowledge. If we’re all aware of what’s driving the market then maybe the arbitragers will be their own undoing without taking the rest of us with them.

Your Voice

I debated high-frequency trader Remco Lenterman on market structure for two hours.

Legendary financial writer Kate Welling (longtime Barron’s managing editor) moderated.  Your executives should be reading Kate so propose to your CFO or CEO that you get a subscription to wellingonwallstreet.com. The blow-by-blow with Remco is called Mano-a-Mano but the reason to read is Kate’s timely financial reporting.

Speaking of market structure, yesterday the SEC’s Equity Market Structure Advisory Committee (EMSAC…makes one think of a giant room-sized flashing and whirring machine) met on matters like high-frequency trading and exchange-traded funds.

Public companies have a friend or two there (IEX’s Brad Katsuyama, folks from Invesco and T Rowe Price) but no emissaries. Suppose we were starting a country to be of, for, and by the people but the cadre creating it weren’t letting the people vote?

It makes one think the party convening the committee (the SEC) can’t handle the truth.  After all, it was the person heading that body, Mary Jo White, who proclaimed in May that the equity market exists for investors and issuers and their interests must be paramount.  It’s a funny way to show it.

And now the NYSE and the Nasdaq, left off too, are protesting. BATS is on while listing only ETFs. The Nasdaq generates most of its revenue from data and technology services, not listings.  Intercontinental Exchange, parent of the NYSE, yesterday bought Interactive Data Corp, a giant data vendor, for $5.6 billion.

How long have we been saying the exchanges are in the data and technology businesses? They’re shareholder-owned entities that understand market structure and how to make money under its rules. That’s not bad but it means they’re not your advocates (yet you get the majority of your IR tools through them, which should give you pause).

On CNBC yesterday morning the Squawk Box crew was talking about one of our clients whose revenues near $2 billion were a million dollars – to the third decimal point in effect – shy of estimates. Droves of sellsiders have shifted to the IR chair, suggesting diminishing impact from equity research and yet that stock moved 8% intraday between high and low prices.

What long-term investor cares if a company’s revenues are $2.983 billion or $2.984 billion (numbers massaged for anonymity)? So how can it be rational?

I hear it now:  “It’s not the number but the trend.”  “It’s the color.”  “Revenues weren’t the issue but the guidance was.”

You’re making the point for me. IR professionals have vast and detailed knowledge of our fundamentals as public companies, as we should.  We know each nuance in the numbers, as we should.  We understand the particulate minutia of variances in flux analysis. As we should.

But we don’t get the mechanics of how shares are bought and sold, or by whom. We don’t know how many can be consumed without moving price.  We trust somehow the stock market works and it’s somebody else’s responsibility to ensure that it does.

Ask yourselves:  Would we trust our sales and revenues to a black box? Then why do we trust our balance sheets – underpinned by equity – to one?

Read my debate with Remco Lenterman about what constitutes liquidity and what sets price today (throw in with the c-suite on a subscription to wellingonwallstreet.com).

We picked two of scores of reporting clients this week and checked tick data at the open. Prices for both were set by one traded share.  Suppose you’re the CEO with a stake worth $300 million. We’ve got one of those reporting tomorrow.  What if the first trade is for one share, valued at say $80, and it shaves 8% off market-cap? That’s $24 million lost in that moment, on paper, for your CEO on a trade for $80.

Now you can say, “You’re caught up in the microsecond, Quast. You need to think long-term.”

Or you could wonder, “Why is that possible?  And is it good for long-term money?”

It’s easier for a camel to pass through the eye of a needle than for rational investors to price a stock at the open in today’s market structure.  But we have the power to change that condition by demanding to be part of the conversation. It starts with caring about market structure – because you don’t want the CEO coming back to you later asking, “Why didn’t you tell me?”

Somebody from among us must be on that SEC committee, whirring lights and all.

Trading Through

Memorial Day is a time for reflection.

We marked it by viewing American Sniper, introspective cinema on prolonged war.  There comes a point along that continuum where people begin to feel helpless, caught by something they can neither fix nor change.

That of course got me thinking about the first Equity Market Structure Advisory Committee meeting, convened May 13 without anyone from the issuer community on hand.  Chair Mary Jo White tasked the team with weighing Rule 611.

Fight the eye-glaze urge that overwhelms at mere sight of the name. If you’re a participant in the equity market as all public companies are, you need to know how the market for traded shares works.

Rule 611 is one of four key tenets of Regulation National Market System, the regime behind our current terrific marketplace, and says trades cannot occur at prices worse than those displayed at another market in the national system. We say Order Protection Rule or Trade Through Rule because it prohibits “trading through” a better price.

The thinking was if brokers were jobbing clients with inferior prices, how do you stop it? The old-fashioned way of doing that is how you buy a car. You do some comparison-shopping, and enterprising folks create apps like TrueCar (which is what ECNs were!).

Perhaps concluding that humans buying and selling stocks are just too busy to take responsibility for getting a good deal themselves, the SEC decreed that all orders capable of setting market prices must be automated and displayed by exchanges. As the memo’s authors write, “If a broker-dealer routes an order to a trading venue that cannot execute the order at the best price, the venue cannot simply execute the order at an inferior price.”

This is why algorithmic and high-frequency trading exploded. But the SEC deserves credit here. In an unusually blunt and rather readable treatise prepared for Committee members, the SEC admits its rules “significantly affect equity market structure.”

What the SEC really wanted through Rule 611 was more limit orders, or stock-trades at defined prices instead of whatever one is best at the moment. “The SEC believed,” the memo says, “that greater use of displayed limit orders would improve the price discovery process and contribute to increased liquidity and depth.”

The opposite happened, and the SEC is again forthright, saying “limit orders interact with a much smaller percentage of volume today than they did prior to Rule 611. This development may suggest that Rule 611 has not achieved the objective…”

Supporting that conclusion, earlier this year Fidelity and fellow investing giants said they will launch a marketplace for stocks called Luminex Trading & Analytics. Other members are Blackrock, Bank of New York Mellon, Capital Group, Invesco Ltd., JPMorgan Asset Management, MFS Investment Management, State Street Global Advisors and T. Rowe Price Group Inc. The cadre manages assets topping $15 trillion.

These are your owners. The stock market isn’t working for them. The SEC is talking about it – even admitting errors. All the major exchanges in the past year – NYSE, Nasdaq, BATS Global Markets – have proposed big changes.  IEX, famed from Flash Boys, is working to create a radically different exchange model.

Yet 90% of CEOs and CFOs at great American public companies don’t know investors are unsatisfied or that everyone else in the equity market is talking about fixes. That’s not because they can’t grasp it. They don’t know because IR isn’t explaining it.  You can’t expect exchanges to do it. They serve multiple constituencies and we’re the least economically meaningful, to be frank.

This can be the Golden Age of IR if we seize the opportunity to command a role in market-evolution. IR sells products – shares of your stock. If they were widgets, we’d know every intimate detail about the widget market (executives would expect nothing less).

So why not the stock market? (Hint: We can help you drive this organizational change!)

Chasing Spoofers

Apparently the market is very unstable.

This is the message regulators are unwittingly sending with news yesterday that UK futures trader Navinder Singh Sarao working from home in West London has been arrested for precipitating an epochal US stock-market crash.

On May 6, 2010, the global economy wore a lugubrious face. The Greeks had just turned their pockets out and said, “We’re bollocks, mate.”  (Thankfully, that problem has gone away.  Oh. Wait.) The Euro was on a steep approach with the earth. Securities markets were like a kindergarten class after two hours without some electronic amusement device.

By afternoon that day, major measures were off 2% and traders were in a growing state of unease. The Wall Street Journal’s Scott Patterson writing reflectively in June 2012, interviewed Dave Cummings, founder of seminal high-frequency firm TradeBot. Heavy volume was scrambling trading systems, Patterson wrote, leading to disparities in prices quoted on various exchanges. The decline became so sharp, Cummings told Patterson, that he worried it wasn’t going to right itself. If the data was bad, TradeBot would be spreading contagion like a virus.

Ah, but wait. Regulators now say mass global algorithmic pandemonium May 6, 2010 was just reaction to layered stock-futures spoofing out of Hounslow, a London borough featuring Osterly Park, Kew Bridge and a big Sikh community. If you think the Commodity Futures Trading Commission’s revelry over finding the cause of the Flash Crash just north of the Thames and west of Wimbledon stretches the bounds of credulity, you should.

Mr. Sarao is accused of plying “dynamic layering” in e-mini S&P 500 futures, a derivatives contract traded electronically representing a percentage of a standard futures contract. It’s called an ideal beginner’s derivative because it’s highly liquid, trades around the clock at the Chicago Mercantile Exchange, and offers attractive economics. (more…)

Compensation Model

What do you get paid to do?

That’s the question the SEC may soon pose to high-frequency traders, according to a story from Bloomberg yesterday.

“The maker-taker compensation model is very much in the core of what our market structure review folks are looking at,” said SEC Chair Mary Jo White.

If you’re the CFO or investor-relations officer for a public company, you should want an answer too. Because there’s belief silence from public companies about market structure indicates agreement.

Suppose I said, “In one minute, describe your business, its key drivers and how you differentiate yourself for investors.”  I bet most of you could.

What if I asked, “How do your shares trade and where, who trades them, and how are they priced?”

“I don’t even know what ‘maker-taker’ means,” you might mumble.

It’s convention in IR to ignore the stock but that ethos has led a generation of investor-relations professionals to think they don’t need to know how the stock market functions.

“I don’t want my executives watching the stock,” you say.  “If we run a good business, the rest will take care of itself.”

The largest institutional investors in the US equity market, Blackrock and Vanguard, are asset allocators. They’re not Benjamin Graham, the intelligent investor. They track benchmarks because that’s what they’re paid to do.

Active investors are paid to find good businesses, deals, and yet nearly 90% don’t outperform indexes. Stock-pickers are not less intelligent than mathematical models. But they seek outliers in a market that rewards conformity.

Follow me, here. The biggest investors use models, sending trades through the biggest brokers, which are required to meet “best-execution standards,” a wonky way to say “give investors good results,” which is determined by performance-averages across the market – which are being driven by the biggest investors and their brokers.

Thus Blackrock and Vanguard and their brokers perpetuate standards of conformity created by regulators.  Company story becomes secondary to indexes and Exchange-Traded Funds,  investment vehicles dependent on conformity. (more…)

Listing

Why do you need an exchange?

Between the Tiber River and the Piazza del Quirinale in Rome sit the remains of Trajan’s Market, built around 100 AD by that Roman emperor famed for militaristically expanding the empire to its zenith.

Considered the world’s first covered multistory shopping mall, Trajan’s Market, designed by Greek Damascan architect Apollodorus, ingeniously and conveniently clustered vendors and shoppers. Thus that era’s real estate industry saw the importance of location, a timeless lesson.

Taking queue from the ancients, our financial forebears on Broad Street in New York City similarly fashioned a marketplace in 1792, after for some time trading stocks under a buttonwood tree. The bazaar they birthed called the New York Stock Exchange aggregated the investors with cash and the growth enterprises needing it. Investing leapt toward the modern era.

That worked well until exuberance and mushrooming Federal Reserve currency supplies collided in 1929. Then the government said, “All right, everybody, out of the pool.”

With the Securities Act of 1933 and the Securities Exchange Act of 1934, the government sought to introduce safety to markets by eradicating fun and frivolity.  No longer would stock brokers hold court without a king, insouciantly supposing they could match buyers and sellers on merits without a bunch of paperwork with alphanumeric identifiers that governments so prefer.

As a result, some 82 years after Government ordered everybody to stand in lines and fill out forms, public companies in these here United States in 2015 need an exchange to list shares if they want the public to trade them (there are exceptions on the smaller end, the over-the-counter market, which has many thousands more companies than the big National Market System – but that’s a story for another time).

The question now is does it matter where you list your shares? We can prove in less than a blink of an eye that location, location, location is irrelevant (that should be our first clue that something is amiss) today in the equity market.

No, really.  We can show you in a split-second.  If you’ve never seen it, watch these ten milliseconds (the blink of an eye is about 300 milliseconds) of MRK trading compiled by data firm Nanex and posted to Youtube. (more…)

The Committee

I’ve learned lots about politics the last couple weeks.

In June 2014, SEC Chair Mary Jo White said:  “We must evaluate all issues through the prism of the best interest of investors and the facilitation of capital formation for public companies. The secondary markets exist for investors and public companies, and their interests must be paramount.”

You remember that?  We wrote here about it, thinking perhaps for once a regulator wasn’t gazing over the heads of all the public companies in the room.

Last autumn, SEC Commissioner Kara Stein’s office asked me to join Chair White’s proposed Market Structure Advisory Committee, a group meant to help the SEC formulate inclusive policies. Energized by SEC rhetoric, I said I’d do it.

As time passed, we had wind through relationships in the capital markets of intense lobbying around the committee. We decided we’d do something contrary to my nature:  Keep our mouths shut.

On January 13 this year, the SEC revealed the members and I was not among them. I felt some relief, supposing CEOs of public companies with names weightier than ours had been added instead.

Then I read the list. The first person named was the co-CEO of a quantitative proprietary high-frequency-trading outfit. The head of Exchange-Traded Funds (ETF) for a broker was there, as was a former NYSE executive now at Barclays, the firm sued by the New York attorney general over trading practices. Four professors made the cut, one an ex-Senator.  People from Convergex, Citadel, Bloomberg Tradebook – all dark pools, or alternative-trading systems run by brokers. Heck, the corporate secretary for AARP somehow got on a market-structure committee. Really. (more…)

Lava Cools

Euclid could have been a hedge-fund manager.

The Greek mathematician and father of differential geometry defined our understanding of three-dimensional shapes in roughly 280 BC. Thanks to Euclid we know what a cube is, and that right angles are all equal.

In 1982, mathematician James Simon started a money-management firm that would seek superior returns not by studying business strategies and financial statements but instead through adhering to mathematical and statistical methods, especially differential geometry. Today secretive Renaissance Technologies, called RenTech by most, manages $37 billion, mainly for its principals. Jim Simons retired in 2009 with an estimated personal fortune of $12.5 billion. Math works.

In 1999, two years after the SEC passed rules on handling trades and set regulations for alternative trading systems that today we call “dark pools,” Richard Korhammer and his engineering colleagues started a direct-access platform they named Lava Trading, a subtle nod to differential geometry and the construction of surfaces. Everything, including equity markets has a surface, and in stocks it’s the top of the book. But below it, in what’s not displayed, is where the action lies.

In 2003, Lava filed a patent on its technique for aggregating market data and placing some trades while hiding others – the top of the book versus the rest of the orders. Differential geometry. The firm became the market-share leader in direct access, a way to describe how investors could skip the stock exchanges to trade with each other.

In 2004, Citigroup spearheaded a dark-pool invasion by big brokers, buying Lava Trading for some $500 million and making it an independent unit. LavaFlow Inc. became known for its market-participant ID (MPID), a four-letter identifier traders use to see who’s driving orders.  Goldman Sachs’s primary MPID is GSCO.  Morgan Stanley’s, MSCO.

Lava’s was FLOW, and FLOW was everywhere. It’s still big. For the week ended Nov 10, FINRA ranked LavaFlow sixth among dark pools behind Credit Suisse, UBS, Deutsche Bank, and the star of Michael Lewis’s hit market-structure tell-all, Flash Boys, IEX.  Combine FLOW with Citi’s two other dark pools and Citi ranked third.

But Citi is chilling LavaFlow, hardening the surface, shutting it down.  In July this year, the SEC fined LavaFlow a record $5 million for permitting a smart order router, computer code that makes buy/sell decisions with high-speed data, to use confidential customer information in trading decisions.

The SEC said these orders totaled 400 million shares over three years. Citi dark pools match that much every two weeks so the allegations concerned roughly 1% of it, a rounding error.

Pulling out of a market where you’re ranked 3rd of 36 seems extreme. But it reflects facts that you must know in the IR chair. First, the stock market isn’t a “market” anymore, and brokers know it. A market by definition is aggregated buy/sell interest, and the stock market today is the opposite of that.

Number two, rather than admit the rules they made in 1997 birthed dark pools and shattered the stock market, regulators are going to regulate dark pools out of existence, and Citi sees it coming. If you think that’s good, remember how we got here to begin.

Third and perhaps most important, Citi ranks second in another market: Derivatives. Bloomberg reported in September this year that Citi has grown its derivatives business nearly 70% since the nadir of the financial crisis and now serves open derivatives contracts worth $62 trillion, second behind market-leader JP Morgan ($68 trillion). It’s the largest counterparty for interest-rate swaps, the biggest derivatives segment.  In derivatives, Citi IS the aggregator.

It fits what we see in equities. When energy stocks took a breathtaking hit the past few trading days following OPEC’s decision to maintain production levels, the behavioral shift was in hedging. The magnitude of movement in prices says it wasn’t driven by real ownership but notional value.

Notional value can reflect tremendous demand or its utter absence in the space of heartbeats because it’s not actual ownership.  We saw stocks drop 30% or more in two days without any meaningful movement in investment behavior.

This is what institutions are doing. It reflects the uncertainty of everything, everywhere. A great deal more money than most realize is putting and taking interest in stocks through derivatives like swaps. That fact is increasingly setting your share-price.  For Citi, the money is in this aggregation, not in equity fragmentation.

Sizing Ticks

Ticks are blood-sucking insects, about how regulators have viewed spreads between stock prices.

Country singer Brad Paisley sings that he’d like to walk you through a field of wildflowers and check you for ticks. As a kid in tick country on Oregon’s Snake River breaks, I pulled plasma-bloated fatsos off my skin and watched my grandmother touch match-reddened tweezers to protuberant tick buttocks on my grandfather’s scalp.

Now the Securities and Exchange Commission is studying ticks. It’s in regulatory parlance SEC Release No. 73511, File No. 4-657.  You can comment by email at rule-comments@sec.gov, or on the website, here (include “File No. 4-657” in any case).

Fittingly, we’re in New York this week where ticks began, a timely escape from the season’s first deep freeze in Denver.  Your stock trades in penny increments, or ticks, thanks to rules created by the SEC in the 20th century.

The belief then was that brokers were charging too much with wide spreads in securities that jobbed small investors. Shrink ticks to desiccated carcasses and mom and pop would win went the reasoning. Fifteen years after slimming ticks, the SEC has ordered a study on widening them. The SEC didn’t say it made a mistake last century. It just told exchanges, “See if there’s a better way.”

I’ve read File No. 4-657 from introduction to footnotes and definitions.  We’ve summarized before but hitting highlights, the exchanges have proposed three clusters and a control group comprising effectively all the 1,750-ish small-caps in the market. Stocks will quote in five-cent spreads but trade anywhere between, or trade in five-cent spreads, or trade at five-cent spreads with a “trade-at” rule, this latter blasted by brokers because it prohibits undercutting prices at exchanges. (more…)