November 2, 2016

Total Confusion

The Nasdaq will now run Goldman’s dark pool.

Walk up to any random stranger and blurt that phrase and see what happens. Nasdaq?  Goldman? Dark Pool? You’re crazy?

Bloomberg reported on Halloween that banker Goldman Sachs would turn over management of its so-called dark pool Sigma X to exchange operator Nasdaq. If you work in the equity capital markets (like the investor-relations profession) you need to understand what’s going on.

It requires a history lesson. In 1792, brokers meeting under a downtown New York buttonwood tree to do business realized that sharing customers would mean more buyers and sellers – a market.  They created the New York Stock Exchange, a “farmers market” for stocks, where interested consumers could peruse the “booths” for products they liked.

Fast forward to 1971. A national association of securities dealers created a quotation system for stocks that became the Nasdaq.

Enter Congress.

Four years after eliminating intrinsic value from money by disconnecting it from assets such as gold, the USA was in “Stagflation” (inflation without growth, something that again seems to be gaining purchase in the data) and people were borrowing shares like crazy and using derivatives in totally new ways.

Worried its new paper money lacking substance was going to derail the stock market, Congress in 1975 passed the Section 11 amendments to the Exchange Act to form a National Market System that could be better “managed.”

Before Congress intervened, stocks were traded at the markets where those shares were listed, and markets were owned by brokers.  After Congress took over, markets were gradually separated from the brokers who created them and stocks could trade anywhere (suppose regulators forced Whole Foods to carry Safeway’s private-label products).

Government moves at glacial speed but leaves the same plowed troughs as do vast wedges of frozen water.  It’s only looking behind that you see the scored landscape. Brokers wanted to match buyers and sellers, so they created exchanges. Regulators linked all those exchanges together, undermining competition while claiming to enhance it. Then regulators separated the markets created by brokers from the brokers.

That’s like a Farmers Market that bars farmers. How does the produce get there?

So faced, brokers created new private markets that were dubbed rather unceremoniously “dark pools” because they’re private members-only affairs.  Here’s the bizarre part. Goldman Sachs operates Sigma X because its customers – investors and traders – wanted to get away from the stock market!

Think about that.  In 1792, brokers pooled stock-buying to create a market. Today, customers of brokers want to avoid the stock-buying pools brokers first created, now called exchanges but which today are for-profit businesses selling data and technology and bearing little resemblance to the early stock bazaars.

Why would buyers and sellers choose a stock Speakeasy over a stock shopping mall?  Because mall shoppers can’t tell if they’re getting a deal or screwed.

But now there is so much pressure on brokers to do this or that to comply with rules that they’re afraid to operate markets. Every time they move, a regulator fines them.

In some ways, we’ve come full circle.  Brokers created exchanges.  Stocks traded on exchanges.  Regulators decided brokers were hurting customers and so separated exchanges from the brokers who created them. Now an exchange is taking over the market a broker created as a substitute for the exchange brokers originally created.

Confused? You should be! This is crazy stuff.  There are too many rules, too little transparency, free interaction.  For investor-relations professionals it means more work for your investors trying to buy shares. Markets should make it easier, not harder.  Isn’t that the point?

For forty years, public companies have been spending money and time targeting investors while ignoring the market where those investors buy shares. Effort targeting investors is for naught if they can’t buy or sell stocks efficiently. Have we got it backward?

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