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Equity market structure caters to interests of the few

30

August, 2010

David Weild knows a little something about our capital markets.  He was previously Vice Chairman of Nasdaq and now runs his own firm, Capital Markets Advisory.  He is also a senior advisor To Grant Thornton.  David and his partner, Ed Kim, have written extensively about how there has been an IPO crisis going on in this country for the past few years (check out their latest paper here http://www.gt.com/staticfiles//GTCom/Public%20companies%20and%20capital%20markets/Files/IPO%20crisis%20-%20June%202010%20-%20FINAL.pdf).  Below is a letter to the editor that David wrote to the FT today.  We couldn’t agree more with him.

Equity market structure caters to interests of the few

Published: August 30 2010 03:10 | Last updated: August 30 2010 03:10

From Mr David Weild IV.

Sir, Larry Tabb (“Fixing the equity markets not such an easy task”, Insight August 26) diverts attention from equity market structure issues, high frequency trading, derivatives and the May 6 flash crash with a smokescreen of wider economic reasons for investors withdrawing in droves. But just like the credit crisis was induced by market structure (for example, no money down mortgages, unsustainable teaser rates, lowered underwriting standards and so on) and caused grievous harm to the US economy, it would be naive to assume that equity market structure cannot harm the US economy. It can. It has. It will.

Once upon a time, US market structure provided economic incentives to employ people in the business of providing high quality research, committing capital to create liquidity, and putting salesmen on the phone with investors to discuss individual stocks. Fundamental investors dominated the market and valued stocks. By contrast, today’s low commission, penny spread, fragmented and hidden markets destroyed economic incentives to support stock selection. Wall Street research budgets were slashed, analysts fled to hedge funds, stockbrokers became asset allocators, and capital was pulled from trading desks draining liquidity from small cap stocks.

Today, market structure has induced an era dominated by derivative interests and computerised trading – where stock index funds, exchange-traded funds and stock index futures replace the need to value individual stocks, while computers arbitrage these “derivative” securities against their underlying stocks; where computers don’t care whether the stock is Intel or Exxon or General Electric; where computers put orders a penny in front of your order to leverage your intent to their advantage.

More people are realising, to paraphrase the famous expression, that “It’s the market, stupid.” Recently, Mark Grier, vice chairman of Prudential Financial, in testimony at the Securities and Exchange Commission panel discussions on equity market structure, stated that he believes that Prudential Financial’s stock price is increasingly detached from its fundamental value.

The US stock market is in secular decline: we have 40 per cent fewer public companies today than at the peak in 1997. When SEC Commissioner Kathleen L. Casey asked a panel of trading experts during the SEC panel discussions on equity market structure: “Have small cap stocks experienced liquidity benefits from electronic trading?” almost to a person these experts said: “No, they have not.” This is troubling because 70 per cent of public companies are smaller than $250m in market value – smaller than “small cap”.

Increasingly, it is clear, the stock market caters to the interests of a few – large trading concerns and large investment banks – while undermining the interests of small public companies, small broker dealers, fundamental investors, the US economy and jobs. Sound familiar?

David Weild IV,

Chairman and Chief Executive,

Capital Markets Advisory Partners

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