OPINION -- Protecting the integrity of our markets
Source: The News Journal
By Ted Kaufman
November 16, 2009
Our stock markets are changing rapidly -- and not necessarily for the better. We run the risk of developing a two-tier market system, one that favors professional high-frequency traders over the long-term investor. Worse, perhaps, is that we may already have lost the ability of small companies to access the markets for capital to innovate, create jobs and grow.The culprit: unbridled technological development.
Technology has brought many positive developments to the stock market. But it has moved so rapidly that we now have a trader's market, not an investor's market. And technological developments have far outpaced the ability of regulators to monitor.Traders who buy and sell stocks in milliseconds -- capitalizing everywhere on minute price differentials in a highly fragmented marketplace -- now predominate over value investors.
Liquidity as an end seems to have trumped the need for transparency and fairness.Only timely and effective regulatory examination, which leads to clear and enforceable rules, can maintain the integrity of the U.S. capital markets, an essential component of our nation's success.
We've gone from an era dominated by a duopoly of the New York Stock Exchange and Nasdaq to a highly fragmented market of more than 60 trading centers. So-called dark pools have flourished, growing from 1.5 percent to 12 percent of market trades in under five years.Competition for orders is intense -- and leads to increasingly problematic results.
When trading centers pay brokers to move orders their way -- even though brokers are required to seek the "best execution" price -- it's all too easy to question the result.
Moreover, in just a few short years, high-frequency trading has skyrocketed from 30 to 70 percent of the daily volume.Our recent history teaches us that when markets develop too rapidly, when they are not transparent, and when they are not effectively regulated or fair -- a breakdown can trigger a disaster.
Furthermore, where are the initial public offerings? According to a September 2009 study by Grant Thornton, the trend since the mid-1990s is ever- decreasing IPOs and ever-fewer publicly listed companies. In the first five years of the 1990s -- even before the dot.com bubble -- an average of 520 IPOs were issued each year, the vast majority for less than $50 million each. But from 2001 to 2008, the average number of IPOs shrank to 122; and the average price had increased far in excess of $50 million.
In contrast, just last week, the highly anticipated opening of Shenzhen's Nasdaq-style stock exchange is already being seen as a watershed moment for China's capital markets, providing new opportunities for Chinese investors and an alternative source of financing for upstart companies.
Here in the U.S., gone are the quartet of investment banks that in the 1990s catered to emerging growth companies -- known as the "Four Horsemen." And every day it seems we get new high- frequency trading firms whose automated algorithms are not concerned with the fundamental valuations of underlying stocks.
The result is that investors, issuers and the economy have all been harmed. Wall Street -- fixated on its endless quest to feed on tiny, incremental trading profits -- no longer provides the fundamental sell-side analysis, underwriting and sales force that is necessary to support and create value in small-cap stocks.As the SEC's chairman, Mary Schapiro, acknowledged just last month: "I believe we need a deeper understanding of the strategies and activities of high frequency traders and the potential impact on our markets and investors of so many transactions occurring so quickly." We need the SEC to undertake that review quickly and with urgency.
Technology should not dictate our regulatory destiny; rather our regulatory policy should provide the framework under which technology operates.Our foremost goal must be to restore the markets to their highest and best purposes: serving the interests of long-term investors, establishing prices that allocate resources to their most productive uses, and enabling companies to raise capital to create new products, new ideas and new jobs.
