"Don't Lose Sight of the Forest for the Trees"
Sydney M. Williams
Free markets are important to the success of capitalism. In financial markets, competition plays an integral role. Markets function best when sunlight is allowed. Collusion, whether between businesses to fix pricing, or symbiotic dealings between business and politicians to find means of bypassing regulation in exchange for political gifts, damages capitalism. Rules and commonsense matter; transparency in markets is what provides confidence. And confidence is the single most critical element in the smooth functioning of capital markets.
Wall Street is unique, in that millions of dollars can be traded with no papers to be signed and no lawyer present. We take this for granted. Yet it is remarkable, and it is unlike any other major transaction one makes. Can you imagine buying real estate without a covey of lawyers? Even the purchase of a car consumes reams of paper work. We do so with securities because of the faith investors have in the integrity of largely self-regulated exchanges, with rigorous listing requirements and in the governmental agencies that oversee them. It is a system that dates back to twenty-four brokers trading under a Buttonwood tree outside of 68 Wall Street in 1792, and a system that was strengthened with the creation of the SEC in 1933.
But all that is changing. Listing requirements and self-regulation are no longer as relevant. For every share of a New York Stock Exchange listed stock that trades on the Exchange between three and four shares trade “off board.” They may be dual-listed shares, or they may trade on an electronic exchange. Exchanges, according to Jayanth Varma, a professor of finance at the Indian Institute of Finance in Ahmedabad, India, have become the equivalent of shopping malls for securities. Surveillance by individual markets has become an anachronism. A stock exchange that only sees trades on its market, as Professor Varma writes, “is no match for a market manipulator who trades in multiple cash and derivative exchanges (as well as the OTC markets) and shifts positions across markets to avoid detection.” The flash crash of May 6, 2010 is exhibit A.
The last three decades have seen a proliferation of global markets and a relative decline of the importance of New York. In 1995, the United States had 8000 listed public companies. Today that number is 5000. During those same fifteen years, listings on non-U.S. exchanges expanded from 23,000 to 40,000. In February, the Wall Street Journal, in discussing the announced deal by the Deutsche Börse to purchase the NYSE, wrote that the 171 IPOs in the United States last year were dwarfed by 1,295 overseas .
Blame for the decline in listings since 2002 has generally been laid on Sarbanes-Oxley, which was designed to reduce the opacity of financial reporting and to place the direct responsibility for reported numbers on the backs of senior corporate managements. There is little question that the cost for compliance was far greater on smaller companies than large ones; thus “going public” in traditional ways has become a less attractive alternative for smaller businesses. The Dodd-Frank Bill exempted companies with less than $75 million in public securities from what has become to be known as Sox 404(b). Nevertheless, the passage of Sarbanes-Oxley, in my opinion, has proven to be a situation in which good intentions result in damaging, unintended consequences. Nick Schulz reviews a new book by Henry Nothhaft, in this morning’s Wall Street Journal. In the review, Mr. Schulz writes that, while government estimated that compliance with Sarbanes-Oxley would be $91,000. However, a mobile-internet firm, Danger, Mr. Nothhaft was preparing to go public in 2007 had to spend $3 million to become compliant.
While the U.S. has lost listings to overseas markets, our share of global GDP has remained the same (25%) since 1995, according to an interview in this weekend’s edition of the Wall Street Journal, suggesting a decline in the ratio of the number of public companies to GDP.
Senator Charles Schumer has favored Germany’s Deutsch Börse’s takeover of the NYSE; he says he was motivated solely by his desire of “keeping New York the number one financial center of the world.” Schumer’s comments were in response to Chicago’s rise in the competing derivative’s market. Roger Altman, of Evercore Partners, pointed out, accurately in my opinion, that “the greatest threat to New York is not Chicago. It’s Hong Kong and China by a mile.”
But it is confidence in markets that should be the final arbiter. Regulators and the American investing public are faced with a dilemma: Is it more important to compete more aggressively so that New York can maintain its position as the center of global capitalism, or should a framework be provided (or maintained) that makes listing requirements more difficult, but would ensure standards that diminish the likelihood of fraud or manipulation?
The latter, in my opinion, is the best route. Confidence in markets is the “forest” and global competition is the “trees.” An article in last Thursday’s New York Post was brought to my attention and served to highlight this quandary. The headline read: “Nasdaq aims for direct stock sales.” NASDAQ unveiled a plan in which they would link up with an internet startup, Loyal3 to sell stock directly to consumers via the web, including through social networking site Facebook.
The recommendation is tempting. A consumer purchases a product and deems it of exceptional value; so chooses to invest in the business. Why not treat the request similarly to buying a book on Amazon after reading a flattering review in the Sunday New York Times? My short answer is because dollars for investment are different. When we buy a book, we get a physical copy, unless it is an e-book, in which case it is downloaded in seconds to our Kindle. When one invests in a security, one is looking for a future stream of income that will be used either to pay dividends or interest, or will be used to enhance the value of the enterprise. Billions of dollars are traded daily on exchanges. It is too easy for frauds and thieves to take advantage of the vulnerable and naive. Dollars for investment are not trivial. They have specific purposes, the most important of which are providing for one’s security and retirement.
There seems little doubt that too-high tax rates and excessive regulation have inhibited the growth and development of small businesses, which do most of the hiring. And we all also hope New York maintains its position as the financial capital of the world, but not at the cost of sacrificing confidence in the integrity of markets. Investors can already buy stocks electronically at any hour of the day. But, to let unscrutinized companies issue stock via a Facebook account makes about as much sense as a Congressman exposing himself on Twitter.
Thought of the Day
“Don’t Lose Sight of the Forest for the Trees”
June 6, 2011Free markets are important to the success of capitalism. In financial markets, competition plays an integral role. Markets function best when sunlight is allowed. Collusion, whether between businesses to fix pricing, or symbiotic dealings between business and politicians to find means of bypassing regulation in exchange for political gifts, damages capitalism. Rules and commonsense matter; transparency in markets is what provides confidence. And confidence is the single most critical element in the smooth functioning of capital markets.
Wall Street is unique, in that millions of dollars can be traded with no papers to be signed and no lawyer present. We take this for granted. Yet it is remarkable, and it is unlike any other major transaction one makes. Can you imagine buying real estate without a covey of lawyers? Even the purchase of a car consumes reams of paper work. We do so with securities because of the faith investors have in the integrity of largely self-regulated exchanges, with rigorous listing requirements and in the governmental agencies that oversee them. It is a system that dates back to twenty-four brokers trading under a Buttonwood tree outside of 68 Wall Street in 1792, and a system that was strengthened with the creation of the SEC in 1933.
But all that is changing. Listing requirements and self-regulation are no longer as relevant. For every share of a New York Stock Exchange listed stock that trades on the Exchange between three and four shares trade “off board.” They may be dual-listed shares, or they may trade on an electronic exchange. Exchanges, according to Jayanth Varma, a professor of finance at the Indian Institute of Finance in Ahmedabad, India, have become the equivalent of shopping malls for securities. Surveillance by individual markets has become an anachronism. A stock exchange that only sees trades on its market, as Professor Varma writes, “is no match for a market manipulator who trades in multiple cash and derivative exchanges (as well as the OTC markets) and shifts positions across markets to avoid detection.” The flash crash of May 6, 2010 is exhibit A.
The last three decades have seen a proliferation of global markets and a relative decline of the importance of New York. In 1995, the United States had 8000 listed public companies. Today that number is 5000. During those same fifteen years, listings on non-U.S. exchanges expanded from 23,000 to 40,000. In February, the Wall Street Journal, in discussing the announced deal by the Deutsche Börse to purchase the NYSE, wrote that the 171 IPOs in the United States last year were dwarfed by 1,295 overseas .
Blame for the decline in listings since 2002 has generally been laid on Sarbanes-Oxley, which was designed to reduce the opacity of financial reporting and to place the direct responsibility for reported numbers on the backs of senior corporate managements. There is little question that the cost for compliance was far greater on smaller companies than large ones; thus “going public” in traditional ways has become a less attractive alternative for smaller businesses. The Dodd-Frank Bill exempted companies with less than $75 million in public securities from what has become to be known as Sox 404(b). Nevertheless, the passage of Sarbanes-Oxley, in my opinion, has proven to be a situation in which good intentions result in damaging, unintended consequences. Nick Schulz reviews a new book by Henry Nothhaft, in this morning’s Wall Street Journal. In the review, Mr. Schulz writes that, while government estimated that compliance with Sarbanes-Oxley would be $91,000. However, a mobile-internet firm, Danger, Mr. Nothhaft was preparing to go public in 2007 had to spend $3 million to become compliant.
While the U.S. has lost listings to overseas markets, our share of global GDP has remained the same (25%) since 1995, according to an interview in this weekend’s edition of the Wall Street Journal, suggesting a decline in the ratio of the number of public companies to GDP.
Senator Charles Schumer has favored Germany’s Deutsch Börse’s takeover of the NYSE; he says he was motivated solely by his desire of “keeping New York the number one financial center of the world.” Schumer’s comments were in response to Chicago’s rise in the competing derivative’s market. Roger Altman, of Evercore Partners, pointed out, accurately in my opinion, that “the greatest threat to New York is not Chicago. It’s Hong Kong and China by a mile.”
But it is confidence in markets that should be the final arbiter. Regulators and the American investing public are faced with a dilemma: Is it more important to compete more aggressively so that New York can maintain its position as the center of global capitalism, or should a framework be provided (or maintained) that makes listing requirements more difficult, but would ensure standards that diminish the likelihood of fraud or manipulation?
The latter, in my opinion, is the best route. Confidence in markets is the “forest” and global competition is the “trees.” An article in last Thursday’s New York Post was brought to my attention and served to highlight this quandary. The headline read: “Nasdaq aims for direct stock sales.” NASDAQ unveiled a plan in which they would link up with an internet startup, Loyal3 to sell stock directly to consumers via the web, including through social networking site Facebook.
The recommendation is tempting. A consumer purchases a product and deems it of exceptional value; so chooses to invest in the business. Why not treat the request similarly to buying a book on Amazon after reading a flattering review in the Sunday New York Times? My short answer is because dollars for investment are different. When we buy a book, we get a physical copy, unless it is an e-book, in which case it is downloaded in seconds to our Kindle. When one invests in a security, one is looking for a future stream of income that will be used either to pay dividends or interest, or will be used to enhance the value of the enterprise. Billions of dollars are traded daily on exchanges. It is too easy for frauds and thieves to take advantage of the vulnerable and naive. Dollars for investment are not trivial. They have specific purposes, the most important of which are providing for one’s security and retirement.
There seems little doubt that too-high tax rates and excessive regulation have inhibited the growth and development of small businesses, which do most of the hiring. And we all also hope New York maintains its position as the financial capital of the world, but not at the cost of sacrificing confidence in the integrity of markets. Investors can already buy stocks electronically at any hour of the day. But, to let unscrutinized companies issue stock via a Facebook account makes about as much sense as a Congressman exposing himself on Twitter.
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