Tagged: SEC

SEC vs NYSE

Our good friends at Themis Trading wrote last week about a $14 million settlement between the NYSE and the SEC over a series of violations.

Why care, issuers and investors? Suppose nobody told you the road you take daily to work sat atop a growing sink hole. We’re all responsible for the market that serves us and as such we have a duty to understand it. Do you know how it works?

Credit Haim Bodek for research leading to SEC action. Had not Mr. Bodek, one of the great market-structure experts of the modern era, blown the whistle, we might not know of these problems. Follow him on Twitter: @haimbodek.

Picking up from Joe and Sal at Themis (Note: With permission.  We’ve edited some for length):

The SEC Case Against NYSE

The NYSE case involves five serious violations.  We will list them all here but we want to focus on the fifth violation since we think it is the most egregious one:

1) On July 8, 2015, NYSE and American Negligently Represented That Their Quotations Were Automated When They Were Not.  NYSE and American Negligently Marked Quotations as Automated When They Had “Reason to Believe” They Were Not Capable of Displaying Automated Quotations

2) Arca Improperly Applied Price Collars to Reopening Auctions During August 24, 2015 Market Volatility.  Arca’s failure to have an effective exchange rule regarding the application of price collars to reopening auctions violated Section 19(b)(1) of the Exchange Act.

3) On March 31, 2015, Arca Erroneously Implemented a Regulatory Halt and Failed to Publish Closing Order Imbalance Information. Although Arca intended to suspend trading only on Arca, which would allow trading of Arca-listed securities to continue on other exchanges, Arca inadvertently implemented a “regulatory halt” that stopped trading in the 134 Arca-listed securities on all exchanges.

4) NYSE and American Failed to Comply with Reg SCI’s Business Continuity and Disaster Recovery Requirements. From November 3, 2015 through November 23, 2016, NYSE and American were in violation of the requirements in Rules 1001(a)(1) and 1001(a)(2)(v) of Reg SCI that each SCI entity have policies and procedures reasonably designed to ensure operational capability.

5) NYSE and American’s Rules Failed to State That Pegging Interest Orders Created Possibility of Detection of Prices of Non-Displayed Depth Liquidity.

While we have noted many examples in the past about information leakage by the stock exchanges, this is the first time that the SEC has fined an exchange for leaking confidential client information:

– Floor brokers were permitted to enter “pegging interest” orders (PI) which allowed them to peg their order to the best NYSE quote. They could specify a range of prices for this PI order to be active. If the best NYSE quote was outside the PI range, then the PI order would price at the next level closest to the quote.

– According to the SEC, “A PI’s ability to peg to the price level of a NDRO (non-displayed reserve order) created the possibility that a floor broker, or a customer who submitted a PI through a floor broker, that sent the PI, would be able to detect the presence of same side non-displayed depth liquidity if certain circumstances were present.”

***Notice that the SEC says “a floor broker or a customer who submitted the order through a floor broker”.  This is because it is widely known that some HFT firms rent out the pipes of certain floor brokers and route orders through them to gain parity which is a benefit that floor brokers enjoy.

– PI orders could peg their price to a non-displayed NYSE order that was not part of their best bid or offer.

– The SEC explained how the initiator of the PI order could find out about hidden interest: “the submitter of the PI could potentially use identifying characteristics of its PI to locate it in the market data feed displayed at a price that did not previously have any displayed liquidity (because the NDRO was undisplayed), and if so located, conclude that there was same side non-displayed depth liquidity at that price level.”

NYSE was notified of the information leakage issue in 2013 by a client and chose to do nothing about it.  According to the SEC, “in 2013, NYSE received a complaint from a trader that the price levels of his NDROs, which were entered at prices inferior to the quote and unoccupied by any displayed liquidity, were being joined upon entry, as the trader observed in the exchange depth of book market data feed, by a displayed order.”

Apparently sensing that they had a problem, NYSE submitted a rule change in March 2015 which “modified the functionality of PIs so that they only pegged to price levels occupied by displayable interest.”  The SEC approved this rule change and didn’t appear to take any further action.

What made the SEC go back and take another look at this issue?  It looks like our old friend Haim Bodek was responsible for this with another whistle blower case. According to this press release, Haim continues to protect investors and haunt the exchanges.

Themis Concludes: The question now becomes what do we, as investors and clients of NYSE, do about this?  Should NYSE simply get away with neglecting their regulatory responsibilities?  Should they be able to pay the $14 million and just continue doing business like nothing happened? Or, should issuers and long-term investors shift their business to an exchange like IEX which seeks to protect them and not favor one class of client over another?

MODERNIR EDITORIAL NOTE:  Thanks, Joe and Sal! Issuers, you should expect honest markets free of predatory practices that distort your stock price and create risk. Two of the instances producing fines occurred in the summer of 2015 when ETFs nearly imploded. The stock market is overly dependent on intermediaries that during crises may vanish.  By then it’s too late.  We need an Issuer Advisory Committee for markets.

Euphoria

The legal community was euphoric Tuesday on word stock exchanges listing your shares, public companies, aren’t immune from lawsuits claiming rules favor high-speed traders.

Bloomberg reported (news breaking so no updated link yet but case history is here) that a federal appeals court has overturned a lower ruling protecting exchanges from suits brought by investors and brokers claiming they were disadvantaged in markets through exchange practices ranging from data feeds to complex order types giving fast machines an edge.

The lawsuits hinge, I’m gathering, on a requirement in the Securities Act that exchange rules not discriminate against any constituency.

It’s something public companies should recognize. You’re an exchange constituency. If investors and traders have an expectation of advanced services, what about public companies?  You’re still calling people to ask why shares are up or down. You could do that in 1932, before the Securities Act passed Congress.

It’s conceivable that 2018 could be a great year for public companies in the way 2017 has been a great year for investors. Few (save Carl Icahn and some others) imagined on Nov 7, 2016 stocks were about to soar.  Euphoria now seems to abound like pot shops here in Denver on what we call the Green Mile from Alameda to Evans south on Broadway.

For companies it’s terrific when shares soar too (though LFIN, which debuted the 13th at roughly $5 and announced the 15th it was buying some blockchain outfit and then promptly roared to $130 and $4 billion of market cap without any revenue and via 21 volatility trading halts, is not exactly the sort of soaring that’s sustainable).

What’s needed more than slamming into the ceiling of all-time high Shiller PE ratios (not there yet but closing) is better disclosure.

Since 1975 not one thing has been modified in 13F investor disclosures. Back then we had rotary phones, human beings executed trades, and on May Day that year an obscure investment firm formed in Malvern, PA, calling itself The Vanguard Group.

Step forward to today and investors are still reporting holdings 45 days after quarter-end while Vanguard manages trillions, markets relentlessly morph, and high-speed firms rent 100 shares of your stock, trade it 5,000 times, volume is 500,000 shares, you think it’s big holders, and at the end of the day they own nothing.

Seem appropriate to you, this mismatch?  It’s decidedly not euphoric that public companies have been left out. One could say discriminated against?  Hm. SEC, are you listening?

So maybe in 2018 we can fix it. No need for Congress to act. Dodd-Frank did that in 2010 by creating a mandate for monthly short-position disclosures. Should long positions be disclosed 45 days after quarter-end? Or instead how about disclosing both long and short positions monthly?

That’s still well slower than machines but it would get us into the 21st century. How about it, SEC? Is this the Era of Transparency or is it just the Era of Euphoria?

Speaking of which, will euphoria last? So long as money pumps into Exchange Traded Funds, which don’t create any new shares of public companies but instead create shares of ETFs that reflect dollars chasing the same shrinking set of public companies that currently exists, yes. That’s a euphoric condition.

It’s also inflation. The reason the market behaves like Shangri-La is because the entire market is leveraged like a…well, like a currency that expands far more rapidly than the underlying economy.  Federal Reserve, are you paying attention?

Past all that, I think there’s plenty of reason for euphoria not only about better disclosure in 2018 but in the current season. Good things are happening economically.  There’s a lot of eggnog ahead.  Bowl games to watch while consuming adult beverages.  Chestnuts roasting on an open fire.

But euphoria wears off. We’ll talk about that next year.  Have an awesome holiday season!

Paid Access

A day ski pass to Vail will now set you back $160-$190. It’s rich but I’m glad the SEC isn’t studying skiing access fees. It is however about to consider trading access fees and you should know, public companies and investors. These are the gears of the market.

We all probably suppose stock exchanges make money by owning turf and controlling access. Right? Pete Seibert, Earl Eaton and their Denver investors had a similar ski vision when in 1962 they bought a hunk of Colorado mountain down from the pass through which Charles Vail had run Highway 6. Control turf, charge for access.

In stock trading it started that way too. The Buttonwood Agreement by 24 brokers in 1792 that became the NYSE was carving out turf. Brokers agreed to give each other first look at customer orders and to charge a minimum commission.

This became the stock-exchange model. To trade at one, you had to have access, like a ski pass. Floor firms were called two-dollar brokers, the minimum commission. If you wanted to offer customers more services – say, beer at Fraunces Tavern with a stock trade – you could charge more. But not less.  No undercutting on price.

In the ski business, Nederland, Loveland, Wolf Creek and other ski slopes along the continental divide will undercut, letting you in for half Vail’s cost – but Vail wraps world-class value-adds around its access fees, like Mountain Standard and The Sebastian.

Suppose all the ski resorts could charge only a maximum rate for passes and were forced to send their customers to any mountain having a better price.  It would be inconvenient for travelers arriving in Vail via I-70 to learn that, no, the best ski price is now at Purgatory in Durango, five hours by car.

And it would be like today’s stock market (save for speed). The three big exchange groups, plus the newest entrant IEX, and tiny Chicago Stock Exchange, comprising currently 12 separate market centers, can charge a maximum price of $0.30/100 shares for access to trade. And still they all undercut on price.

That’s because rules require trades to match between the marketwide Best Bid or Offer (BBO) – the best price. As Vail would do in our imaginary scenario, exchanges must continually send their customers to another exchange with the best price.

How to set the best price? You can only cut price so much.  More people will still go to Vail because it’s close to Denver on the Interstate, than to Purgatory, halfway between Montrose, CO and Farmington, NM off highway 550.

Now suppose Purgatory paid to chopper you in from Vail. It might not move you out of The Sebastian, but you’d again have the stock exchanges today. While access fees are capped (and undercut), exchanges can pay traders to bring orders to them.

That’s called a rebate. Exchanges pay brokers incentives to set prices because if they can’t attract the BBO part of the time, they don’t match trades, don’t capture market share, can’t generate valuable data to sell to brokers (Only IEX is eschewing rebates).

The problem for investors and companies is that trades motivated by rebates are like shill bids at art auctions (which by the way are prohibited). They set the best price for everybody else yet the shill bidder doesn’t want to own the painting – or the shares. That’s high-frequency trading. It’s 40% of market volume on average and can be 60%.

Bloomberg reported yesterday the SEC is planning to study access fees through a pilot trading program next year. We’re encouraged that it may include a group of securities with no rebates. But the initial framework begun in 2016 under Mary Jo White aimed to lower access fees, and the study right now contains those plans.

Why? Exchanges are already lowering them. How about setting a floor on access fees so exchanges can make a decent return matching trades and don’t have to engage in surreptitious incentive programs to compete? I got the idea from the Buttonwood Agreement and 200 years of history.

Say all exchanges charge baseline access fees. If this exchange or that wants to wrap more value around fees – better data or more technology or beer – they can charge more.

Whatever happens, we hope (and I asked Chairman Clayton by email) the SEC makes an issuer committee part of the process. Without your shares, public companies, there’s no market. We should have a say. That’s why we have to know how it works!

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…)