Tagged: SEC

Double Standard

Humans are often entertained by illustrations of absurdity through reality.

For instance, Treasury Secretary Jack Lew months ago said he’d like to address tax inversions but lacked authority.  Yesterday, Treasury imposed rules to limit inversions. My reading of Section Two of the U.S. Constitution reveals no lawmaking authority vested in the executive branch.

I could compile a book of examples. I won’t.  Instead, I’ll offer one for the IR chair and the public-company executive suite. In 1975, Congress added Section 13f to the Securities Act to “increase the public availability of information regarding the securities holdings of institutional investors.” I was eight years old then and had no idea I’d spend my adult life working in the capital markets with thus far no update to the provision.

NIRI CEO Jeff Morgan said in his weekly note to members yesterday that the Board had held its annual meeting with the SEC to discuss disclosure. “I am not sure we came to any concrete agreement on how we might traverse down the road to improving disclosure,” Jeff wrote.  He was talking about the burden of it.

In August 2000, the SEC imposed Regulation Fair Disclosure (Reg FD) to “promote the full and fair disclosure of information by publicly traded companies and other issuers.” Following and vastly increasing disclosure-costs was The Sarbanes-Oxley Act of 2002 (SOX as we call it), passed by the U.S. Congress to protect shareholders and the general public from accounting fraud and errors and to improve accuracy in corporate disclosures. I remember that my company spent about $2 million as a small-cap NASDAQ-traded firm with $200 million in revenues complying with Section 404 and other requirements the first year.

I recall an ensuing variety of rules through the Financial Accounting Standards Board and SEC Staff Accounting Bulletins, all adding time, effort, cost and disclosure. (more…)

Big Opportunity

Amazed. Dazed. Perhaps needing a drink.

Thus shown the faces of investor-relations practitioners at yesterday’s NIRI Southwest Regional Conference as Rajeev Ranjan from the Chicago Federal Reserve Bank put up his final slide and pronounced it a graphical representation of market microstructure. It appeared to be some sort of complex engineering schematic.

And it reflects how stocks trade today. Many say, “Ignore high-frequency trading because it’s noise from those who don’t care about fundamentals.” If traders oblivious to fundamentals and uninterested in owning your shares routinely price them and all other equities, how can you rely on prices the market displays that underpin the corporate balance sheet?

Proving that even the SEC is antsy now about this structure, a tick-size study to consider wider trading spreads is nearing finalization. Did you get the memo? No?  Exactly. Public companies have been omitted – but the comment period is coming! If ever public companies needed to speak up, this is the opportunity. With that preamble, we’ve reserved today’s Market Structure Map for yesterday’s blog post from our good friends at Themis Trading. Take it away, Joe and Sal:

 

While we in the trading community continue to debate the merits of HFT and the structural defects in our market structure, there continues to be a group of market constituents that remains silent in the debate – the public companies.  The stock market has undergone dramatic structural changes over the past decade but many of these changes were done without the input of the public company.

Public companies are the reason that the stock market exists, they are what research analysts cover and who bankers seek to do deals with. Without listed public companies, there would be no S&P 500 ETF or E-mini futures contract.  There would be no rebate or latency arbitrage that hinges on microwave networks and football-field-sized data centers.

We’re not quite sure why the public company largely remains silent in the market structure debate.  Possibly, it is because market structure has continued to get more complicated and they fear they are not up to date on the changes.  Or possibly, they feel that in return for annual listing fees, the stock exchanges should be representing their views.  Considering that exchanges now get most of their revenues from data-related services, looking out for public companies seems to be on the back of their to-do list.

While our friend Tim Quast from ModernIR continues to speak out on structural issues on behalf of his public-company clients, it is rare that we see any others in that segment speak out.   However, we recently came across an article written in Canada’s Financial Post by David Beatty, which tackles the issue of market structure and public listings. Mr. Beatty is Chairman of the Board of Canada-based Rubicon Minerals and is also on the Board of Directors for First Service Corporation and Canada Steamship Lines. (more…)

Without Your Knowledge

Facebook collaborated with two respected universities to study your emotional responses when shown different kinds of news. Without your knowledge.

We learned in June, you might recall, that Cornell, the University of California at San Francisco and Facebook delved into the doings and feelings of 700,000 of us folks without so much as a by-your-leave. The aim was unalloyed, as aims often begin when people sit in rooms with statistics and contemplate how to study them.  Do users post negative prose if they’re exposed to adverse news?

It seems innocuous, sure. I’m not knocking the social network and that’s not the point of today’s piece. If you’re sharing your innermost feelings with a community of one billion, your expectation for inclusion on the distribution list for the memo about a psychological study should be a number approaching zero.

Speaking of memos you didn’t get, we wrote two weeks ago that the SEC had in June ordered the stock exchanges and Finra, regulator for brokers, to craft a program for larger tick-sizes in small-caps. The plan is out. Without input from public companies. But you can yet weigh in. We’ll come to it.

There are four groups, not three as we’d initially thought. The three test groups will contain about 400 entities each with prices over $2, volume under a million shares, and market-cap of $5 billion or less, and will study trading in five-cent increments.

Lest you suppose this is the backwater of the market, there are only 754 large-cap companies in the Wilshire 5000.  Not enough to constitute two test groups. Most of the stocks trading publicly fit criteria for this proposed program.

That makes this plan more than a test. It’s a functional repudiation of Regulation National Market System. But instead of admitting its errors, the SEC simply ordered the exchanges to propose an alternative, thus permitting regulators to sidestep responsibility for screwing up 80% of the marketplace. (more…)

The Big News

With crowning dreams of California Chrome and the unfortunately tinny conclusion to the equine trifecta dominating news, you might have missed what counted last week.

There was Liquidnet, operator of a members-only trading market for the buyside (a “dark pool”), paying $2m to settle SEC charges it shared confidential client information through its Infrared ID program at the NYSE and a couple other applications.

There was Wedbush, clearing firm for high-frequency traders, facing SEC charges that it inadequately policed how clients used its brokerage desk to directly and anonymously trade stocks (called sponsored access or direct market access for you word collectors).

Big news, both. But not The Big One.

No, I learned the big news first from Karen (our chief operating officer and my beloved spouse), who emailed a link saying, “Read this.” Not much later, Joe Saluzzi (NIRI National was fortunate to have Joe as my fireside-chat guest yesterday afternoon on whether markets are both broken and rigged) emailed snippets and said , “From Chair White speech…”

He meant Mary Jo White, SEC chair. She’d addressed the Sandler O’Neil Global Exchange and Brokerage conference June 5. And she said, drum-roll please:

“The secondary markets exist for investors and public companies, and their interests must be paramount.” (more…)

Flash Boys

I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.

Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”

Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.

If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.

The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.

Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.

Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.

These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules. (more…)

The Long and Short

In the timeless 1987 movie The Princess Bride, Vizzini the Sicilian, played riotously with a lisp by Wallace Shawn, keeps declaring things “inconceivable!”

Swordsman Inigo Montoya, portrayed then by Homeland’s Mandy Patinkin, finally says, “You keep using that word. I do not think it means what you think it means.”

You could say the same for short interest. It’s not what you think it means. Stay with me to the end, and you’ll see.

On August 2, 2012, Knight Capital Group’s algorithms failed. Monday at TABB Forum, Anthony Masso, CEO at trading risk-analytics provider Succession Systems, described how the SEC’s recent settlement with Knight successor KCG Holdings clarified a risk standard called the Market Access Rule. It requires brokers to have systems that forestall actions that may imperil themselves or others in the market. I’d paraphrase the law this way: “We order you to take whatever actions are necessary to prevent bad stuff. Thank you.”

That’s not what got my attention. The settlement reveals details about Knight’s errant trades. The broker bought, or went long, $3.5 billion of stocks; and shorted, or sold, about $3.2 billion. In less than an hour, its systems executed four million trades in 174 different stocks to create these positions.

This one tidbit is a tumbler unlocking vast secrets about market behavior. Knight’s algorithms were observably designed to build long and short positions of similar size principally to supply the storefronts of the stock market. When these positions failed to modulate, markets rushed into the vacuum, crushing Knight’s balance sheet.

Here’s the delicate balance in proprietary high-speed trading. Get it wrong by less than 10% and you’re done. Knight got it wrong. This same fragile trestle trains markets over the chasm each day. We’re all riding the rail.

ModernIR tracks short volume using algorithms. The daily average the past 50 days marketwide is 41%, not far off long/short equilibrium. Combined volumes on exchanges and dark pools total about 6.3 billion shares daily, meaning 2.5 billion shares each day are short.

Short interest in the S&P 500 is nearer 5% on average, though components can reach levels that roughly match daily short volume. The difference between interest and volume is that volume is just borrowed, while interest remains sold and outstanding.

Our data show that 11% of public companies have short volume above 50% of total volume. The highest in our client base the last five days was 61%. We’ve seen levels reach 85%, meaning nearly nine of every ten trades involved short shares – rented trading inventory. The lowest we saw was in a series of Class B shares trading just a few thousand per day where still 15% were short.

Elevated short interest can mean speculators are betting on a downturn. But it could as well be searing daytime demand for trading “inventory” – bowling shoes to put on for the day, for the game, traders and intermediaries finding renting cheaper than owning.

What concerns me is that short volume by definition in Regulation T is credit. So the market is heavily dependent on borrowing, just like the entire global financial system.

You have to see volume differently. Half of it is borrowed. Rented. Bowling shoes. High short interest is a product of frenetic demand on short horizons – not a certificate guaranteeing imminent pressure.

But realize that a hiccup in long/short balances can move your shares sharply – and it’s got nothing to do with ownership, or even shorting in the conventional sense. Inconceivable? No. And you know now what I mean.

Follow the Line

“All this is not a product of nature.”

No I’m not referring to the display, as it were, by Miley Cyrus at the Video Music Awards. If the shortest distance between two points is a straight line, what do you call a stock market with 13 exchanges, forty broker-operated alternative systems, 4,300 FINRA-regulated brokers and dealers, 2,000 order types, a complex routing scheme for moving millions of quotes per second and all the associated messaging traffic at light speed (oh yeah, and hopefully some investing too)?

Well, not a straight line. The Wall Street Journal’s Holman Jenkins wrote a compelling opinion last weekend on the Nasdaq data outage Aug 22, which he titled “How to Think About the Nasdaq Freeze,” and from whence I borrowed today’s opening salvo. You should read it.

As you’ve heard – at length on CNBC – the Nasdaq halted trading for three hours last Thursday due to a connectivity issue that led to failure propagating the marketwide data stream providing consolidated quotes in Nasdaq securities.

The WSJ’s Jenkins argues that whatever the root cause of this latest in a long line of troubling market mishaps, “complexity breeds snafus.” The market where your investors compete to demonstrate belief in the story you deliver is a tangled web. (more…)

Market Electrolysis

Have you seen those Pure Michigan ads? Compelling. Summer in Colorado could be a brand too, as these views of Hanging Lake near Glenwood Springs and Vail at morning last week attest. We seize every chance to savor the high country.

Speaking of chance, high-frequency trading (HFT) is back in the news. When you read about HFT in the financial press, it refers to stock orders from proprietary traders (firms using their own money rather than executing orders for customers) using powerful machines to trade in fractions of seconds.

But that description propagates an incorrect perception of what’s happening. It’s a vision of anonymous and rapacious rapscallions hiding behind banks of computers and cackling evilly while out-sprinting hapless investors from trade to trade, looting financial markets.

The truth is simpler and less execrable. Investor relations pros, you need to understand not just what HFT is, but why it exists and what’s both good and bad about it.

I was just reading a blog post by John Tamny extolling the virtues of HFT. Mr. Tamny is a regular commentator on TV financial programs, a free-market kind of guy. I routinely encounter folks opposed to “banning” HFT because it’s free-market behavior. (more…)

Data Darkness

There’s apparently a reality TV show called “Dating in the Dark.”

It must lack the cachet of Survivor or The Bachelor because you don’t hear much about it. The gist is that a number of people of opposite sexes wander around in utter blackness falling in love. You wonder how that’s superior to the displayed market – so to speak.

But in the equity market, dating in the dark is a big deal. I’m talking about how stock orders find each other. Take Coca-Cola (KO), which reported yesterday. From July 8-12, according to Fidessa’s Fragulator, 25.6% of trades occurred on KO’s listing exchange, the NYSE. But 29.4% were on the FINRA NYSE tape, a reporting facility for trades between brokers rather than on exchanges.

The remaining 44% of KO’s trading mostly met in displayed markets at the Nasdaq, BATS and Direct Edge, and the NYSE’s derivatives-centric platform called NYSE Arca, formerly the ECN Archipelago.

Why does this matter to you, IR professionals? It’s important to understand what’s happening. This is the market you manage – the equity market for your shares.

So, FINRA – the Financial Industry Regulatory Authority – is trying to address concerns that a large amount of stock-dating in the dark is bad for markets. That volume of KO’s on the FINRA NYSE tape? It’s “dark pool” trading, where buyers and sellers meet secretly and anonymously through brokers acting like millionaire matchmakers.

Last week FINRA sent a proposal to its members that would create new reporting rules for dark pools. If adopted, alternative trading systems, or facilities where the principal function is matching trades but the regulatory structure is one for broker-dealers rather than the regime exchanges operate under, would report their trades to FINRA on a delayed basis using a unique market-participant identifier. That way, FINRA would know what trades and volume occurred in each facility to better identify market-manipulation. (more…)

The Trading Edge

If stocks trade on moving averages, why do high-frequency firms hire math whizzes?

Providing some form of answer, Thomson Reuters will cease publishing the University of Michigan’s twice-monthly consumer-confidence survey two seconds early to premium data customers including high-speed traders, following pressure from New York attorney general Eric Schneiderman.

Do you have an investment horizon of two seconds? If you don’t, is the early provision of data the problem, or is it a market structure that makes information more valuable if it’s received first?

New York Times writer Nathaniel Popper quoted me in a piece July 8 on the widely publicized controversy. Most everyone said something like, “It’s about time they stopped leaking information to the privileged.”

I said the market had devolved into a footrace. There’s nothing wrong with information asymmetry. Look at the Buttonwood Agreement in 1792 between 24 brokers who formed the NYSE. It set a minimum commission so none would undercut others on price, and required that all give each other preference on trades. Well, isn’t that a first look? Unique and valuable information is the bedrock of capital-formation. (more…)