January 25, 2012

Be Vigilant

Good to see you folks in Boston last week. But I needed Denver to thaw me out. It was seventy here last Saturday. I washed the car in T-shirt and flip flops.

If at first you don’t succeed, try, try again. So it goes at the Nasdaq.

Last autumn the exchange proposed to charge small-cap companies fees of up to $100,000 to incentivize market-makers to trade small-cap ETFs, arguing to the SEC that it would infuse thinly traded securities with liquidity. The rule would have required the SEC, FINRA and the exchange itself to reverse longstanding prohibitions on paying market makers to trade securities. For certain exceptions only (of course, exchanges pay billions of dollars in rebates to “liquidity providers” each year).

The SEC promptly rejected the rule-filing. Now it’s back. See it here.

IR folks, do you know the adage about being wise as serpents but meek as doves? Question what you hear from exchanges that rely on data and transactions – not issuers – for revenue and profits. Take nothing at face value. Examine the facts.

First, why liquidity? Berkshire Hathaway Class A shares need no liquidity to achieve a low beta and high institutional retention. So is trading activity in liquid names investment – or something else, such as statistical arbitrage?

Second, understand how ETFs work. To meet fluctuating supply and demand, ETF sponsors create and redeem units daily through authorized participants (APs) consisting of broker-dealers and large institutional investors like Vanguard and Fidelity.

Setting aside that unfair advantage (and stat arb opportunity) for APs, can you create and redeem your shares daily? No. What does incentivizing trading in small-cap ETFs create, then? Arbitrage. Statistical calculations of fluctuation in a set of securities. That’s not investment, it’s noise. Worst, the Nasdaq wants you small-caps to pay for it in your stocks – so it can generate more data and transactional revenue.

Lesson: Exceptions to rules always foster arbitrage. Apply it to any scenario, from taxes, to trading, to regulations.

So express yourselves. If or when this proposal reaches the SEC, go here, find the rule filing, and comment. One public company can change outcomes.

Here’s proof. The letter from ModernIR is referenced in the SEC’s decision to extend discussions about extraordinary market volatility. We were just one voice (none from public companies!) – but every voice counts.

We’ve opined again on market-volatility rules. Please read it. In two pages, we summarize how market rules are depriving public companies of what they want most in trading markets: Differentiation.

Your company should comment, too. So be heard, be seen, and be counted.

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