Quick fixes on Wall Street and their ramifications
May 9, 2002
By Bill Singer,
Partner, Broker-Dealer Practice Group
Duane Morris LLP. (NYC)
e-mail:
bsinger@rrbdlaw.com
http://www.rrbdlaw.com
During the past few days I have received a number of
inquiries from the press concerning my “take” on the recently announced NASD and
NYSE rule changes pertaining to Research Analyst Conflicts of Interest (NYSE
Rules “Communications with the Public” and 472 “Reporting Requirements,” and
NASD Rule 2711 “Research Analysts and Research Reports”). As the substance of
those rule changes has been well-reported, I will not delve further into that
aspect in this commentary. What I do not perceive as having been adequately
considered is the ultimate impact of these regulations.
In the mid-70s, largely as a result of Charles Schwab’s innovative concept of
discounted brokerage commissions, Wall Street’s pundits proclaimed the death of
life as we knew it. If you look up some of the articles from those supposedly
dire days, the mere idea of eliminating the then existing fixed commission
structure (one price suits all) for discounted commissions (free market pricing)
was cited as heralding the end of the securities industry. Essentially, the
theory was that fixed commissions provided for a stable, profitable Wall Street,
which, in turn, promoted a healthier economy. It is one of those stimulating
exercises in academic postulating to ruminate as to whether the past 30 years of
stock market activity would have been better absent the influence of discount
commissions. Ultimately, however, we live in the world we’re in.
The era of discount commissions brought many new investors to the table, and, it
stimulated more transactions. If anything, discounted commissions injected
volatility into somewhat somnolent markets. Similarly, the lower costs likely
stimulated the development of online brokerages. Consequently, we were then
confronted with the second great revolution on Wall Street: the emergence of the
Internet. And, with the appearance of online trading, the markets witnessed the
introduction of electronic executions, ECNs, and, a whole host of attendant
innovations. Unfortunately, just as the powers that be united against the
discount brokerage concept, those same forces coalesced against the SOES
bandits, day-trading, direct-access execution, ECNs, and Internet BDs.
From my standpoint the combination of discount commissions and Internet trading
constitute the two most dynamic changes to the stock markets since the invention
of the stock ticker. The influence of those two changes on the character of Wall
Street is not fully understood. For generations Wall Street was essentially
about the control of information. Up until perhaps the last decade, the control
of information was squarely in the securities industry’s court. You wanted to
price a stock; you called your stockbroker. And that individual, an employee of
a broker-dealer, would enter the symbols into a fairly expensive machine (that
is for the consumer to buy, assuming such a purchase was even possible) and the
quote would be given to you over the phone. Wanted to know about an upcoming
IPO? Again, call your broker, he or she might send you the firm’s research
report or fill you in on so-called shoptalk. Remember that there was a time in
the not too distant past when the only source of information about Wall Street
was the Wall Street Journal.
In decades since past, Wall Street was about the closing prices in the evening
papers. Intra-day was not an issue. The size of the bid versus the size of the
ask was not relevant. Most investors entered a market order, accepted whatever
execution they got (not really having the ability to ascertain the prevalent
market at the time), and observed a buy-and-die strategy. There wasn’t any CNNfn.
There wasn’t any CNBC. And there wasn’t any Internet at your fingertips.
But as discount commissions made it more affordable for private citizens to
trade, and as the Internet effectively put a trading cockpit in every home and
office, the public wanted more information and wanted it quicker. So, cable
television produced content to satisfy the clamor. And god knows how many
websites, good and bad, sprang up to provide online data. Gone were the days
when you held the phone waiting for your stockbroker to give you a quote. Gone
were the days when you had to rely upon BD manufactured research. All the
information you needed was at the tips of your fingers on your PC keyboard.
Then the markets collapsed and the Dot.com stocks went bust, and we read about
Enron and Arthur Andersen. And then New York Attorney General Spitzer went
public with his investigation about the integrity of research analysts. Upon the
demise of the Bull Market, many investorswere left with a PC, a monthly Internet
Service Provider bill, and a lot of worthless stock. It was one hell of a party,
and one hell of a hangover.
In observing the recent news about Wall Street, I’m struck by one common theme.
The public’s trust and confidence has been shattered. Just as the cocktail party
talk of a few years ago was about buying stock, now it seems to be about how
much everyone lost and how they’re putting their cash (or what’s left of it)
back into their home. The once reliable cash-on-the-sidelines is simply not
coming back as quickly as before. Having been once burned, the investors are
twice as wise.
What the public seems to be seeking is reliable, accurate information. Sure,
they “thought” they had all the information they needed at their fingertips ---
the great equalizer, as it were. But, the public soon learned two facts. One,
having all the information you want is not the same as knowing what to do with
it. Two, not all the information they had was honest. The tapes released in the
Spitzer investigation seem to underscore that.
If one reads between the emerging lines on the Andersen
scandal, Congress and its constituents seem determined to put the “public” back
into Certified Public Accountant. For better or worse, the trend seems to be
towards CPAs who work “at” an accounting firm but who really work “for” the
public. The economy needs to have this constant. Whether or not it is feasible,
whether or not CPA firms can survive economically under such a regime, remain to
be seen.
That’s what I see inherent in the recently approved NASD and NYSE analyst rules.
The trend seems clear. Congress, regulators, and the public want analysts
working “at” a brokerage firm but not “for” that employer; essentially, the
movement is to make analysts Certified Public Analysts --- maybe not such a bad
idea. But where does the trend stop? The next logical step would seem to be to
apply the same characterization to stockbrokers. Accordingly, the nearly
three-quarters of a million registered representatives on Wall Street would
become veritable free agents: registered with a BD but beholden to the public.
One would logically anticipate that such a broker’s compensation would
eventually transform from commission-based to something more in keeping with the
new allegiance. Perhaps, compensation would be derived as a percentage of
profits.
Ultimately, this wave of change will roll over the landscape of Wall Street and
carry all before it. It seems inevitable that market makers and specialist
(professionals interposed between the markets and the investing public) will
come under similar pressure. Private investors will seek direct access to the
markets and demand the elimination of requirements that orders be executed
through member firms. We’re already beginning to see the emergence of this trend
with the survival (if not growth) of several ECNs and with the increasing
financial difficulties faced by many NASDAQ market makers. Of course, if you
eliminate or reduce the predominate role of market makers and specialists, that
raises the ticklish question of what becomes of the stock exchanges and
over-the-counter associations? In a fully democratized marketplace with direct
access afforded to private investors, what is the value of a seat or membership?
Similarly, if you reduce the revenues generated by such exchanges and
associations, how will the industry afford to maintain its self-regulatory
organizations?
What often gets lost in this rush to storm the barricades of
Wall Street and bring democracy to the process, is that free markets aren't
necessarily based upon the premise that everything's free. If we
dismantle the traditional structure of broker-dealers, where will the money come
from to support Investment Banking. Keep in mind that there's a great deal
of expense prior to the final IPO. Who will replace that function?
Assuming a deal goes public but the role of professional market makers and
specialists has been reduced or eliminated, who will provide for an orderly
aftermarket? It's easy enough to dismiss the bona fides of Wall
Street, but we've already seen some of the excesses of so called open markets.
Does anyone believe that the online forums and chat rooms are fonts of quality
information and intelligence? Fraudsters and scammers populate the
Internet and cause great damage to public companies and their investors.
Lest my commentary be misunderstood, I neither advocate nor oppose the
observations I have made. I’m simply calling it as I see it. Regardless of how
well intentioned the rule proposals (or any investigative settlements) are, we
are meddling with primordial forces on Wall Street. For better or for worse, the
likely changes underway will in large measure doom the dinosaurs now kings of
our stock markets. Hopefully, someone is giving the future some thought. Wall
Street has made its bed and must now sleep in it --- short-sheeted, bed-bugged,
and all. However, in their zeal to remedy whatever problems are perceived,
public advocates and politicians would be well advised to exercise some
restraint. This is not the time for amateur hour. Sort of makes you wonder
whether we’re buying a couple of really cute Tribbles.
