By Roy Sahachaisere
“Free” Market Economy? “Frictionless” Transactions?
Not a chance, Market Efficiency? Protection of the individual lnvestor? Puh-leeze.
These buzzwords of the modern economist are bandied about so emphatically and with such abandon at they are often completely unquestioned assumptions of the public market system. In theory, the current regulatory system is in place to prevent fraud and to make the protection of the individual investor the primary goal. But have you ever made a trade order in a stock at a fixed purchase price, watched it execute, and then been informed by your broker that the trade was executed well ABOVE or BELOW your request? Or, have you ever submitted an order to your broker, only to see it represented on the box for significantly LESS or MORE than the request? These situations happen every day, and if you make trades, it’s probably happened to you.
Did you ever stop to wonder why your orders aren’t being executed at the requested price points? The answer is actually incredibly simple: someone, probably a broker or a market maker, is padding their fee by “skimming” off the top!
It may seem obvious, but whenever there is a seller or a buyer, there has to be a player on the other side in order for the transaction to take place. The lower the transaction cost or the easier it is for that transaction to take place, the closer those come to being truly efficient. However, when “hidden” costs like those mentioned above are embedded within the transactional processes, it becomes impossible for the participants to accurately assess the cost of participation, and therefore efficiency becomes more of a dream than a reality, one of the ostensible participants benefit; not the buyer, the seller, or even the company whose shares are being traded. Only the person facilitating the trade, i.e. the broker, reaps the rewards, and ultimately, I would argue that not even they benefit to the extent that it might appear.
In fact, the more that these inefficiencies are built into the trading markets, the more they increase the barriers for the retail investor, reducing participation levels, and companies watch their stock prices slide. Even worse, lately it seems to be more and more difficult even to make trades in small-caps at all through an online broker. There may be little more frustrating than opening on the trading front line, correctly analyzing relevant data, accurately predicting short-term trends in the market, and then standing by helplessly watching your hard-earned margins shrink as the market catches up because your online trading platform forces you to call a broker to execute your trade. The small-cap markets are becoming so over-regulated that if a compliance officer finds a trade questionable (basically any trade in a micro-cap stock), the investor is required to justify the trade prior to execution. In a dynamic and fast-paced market, such unnecessary delays can entail irrecoverable losses.
With almost no official voice in government, the roughly 5,000 companies with market capitalization under $250 million are being used as the whipping post for negative publicity resulting from highly visible corporate fraud scandals. Admittedly, the reduced oversight in the small and micro-cap markets attracts a small percentage of those who seek to exploit the credulous investor, but the sheer damage created by the staggering levels of corruption of a single Tyco, WorldCom, or Enron cannot possibly be matched by the most unscrupulous of predators in the small-cap world. Yet, the SEC seems determined to protect retail investors from themselves. If the goal of the public markets really was to provide an avenue for companies to access capital, why are there so many barriers? If the goal of the SEC was really to protect the individual investor, why institute so many self-serving measures that protect those who don’t need it? For instance, it seems that it would be much easier to allow investors with certain criteria to trade more actively in small-caps. There is any number of very simple ways to implement such a strategy. Require a deposit of cash. Demand a minimum level of experience. As it stands right now, I personally know a number of very wealthy micro-cap traders who are finding it difficult to trade OTC securities, sometimes even being denied outright.
Theoretically, the purpose of the small-cap exchanges was to provide a platform for companies who lacked a more developed operating history or fundamentals to access the capital markets. But these exchanges have become so regulated that they are unable to serve the functions for which they were intended. Some, like the Microcap Company Political Alliance Corporation (www.microcappac.org) are trying to raise awareness about over regulation of small-caps, but they are facing a long, uphill battle. The same regulating bodies that permit these companies to trade publicly seem inclined to shutdown trading at the drop of a hat. What is the point of allowing them to be traded in the first place if there is so little latitude? If these companies are so poorly structured as to constitute a genuine risk of fraud, don’t allow them to be listed in the first place, if, on the other hand, they are sufficiently viable to pass scrutiny, they should be allowed to access sufficient capital to give them the opportunity to grow and meet the more stringent regulatory requirements of the upper-tier exchanges. That is, after all, the whole point.
Ultimately, the big question is how do you as an investor overcome brokers, commissions, regulatory barriers and other obstacles just to get the chance to do your own homework and risk your own capital in an effort to make money in the markets? The typical retail investor is at a considerable competitive disadvantage in a market system that favors institutional investors and private investors with tremendous capital reserves. The typical individual investor must factor in a cost of doing business that includes brokers padding their commissions with spreads taken before even executing a trade in a thin micro-cap, where every single trade can cost anywhere from 5%-15% (including spreads, ticket fees, and commissions).
What advantage do the makers and broker/dealers have that you don’t? LEVERAGE.
They can take in as much stock as they have leverage for, typically 50 times more than the average retail investor, and they can sell you stock that they don’t even have, as well as buy stock without funds. It’s nice work you can get it. The problem is, you can’t, and you’re working at an inherent disadvantage.
Does that sound “efficient” to you? The solution is simple and straightforward. Change the current trading and regulatory systems that are presently in place and that unduly favor the institutional and wealthy private individual investors. Just how to accomplish; that is another problem entirely. We as individual investors need to make our collective voice known, and demonsrate the need for changes in the current structure. There are those who are actively engaged in efforts to make this happen, but every voice counts in the effort to create a level playing field for the Individual Investor, the engine that drives the public markets.
Happy Trading!
