Creating a Stronger Voice for the Buyside

New STANY president hopes for comment letters from more than the usual suspects

Speak up, Mr. and Mrs. Buyside, you’re not effectively making your case. Speak up, or your industry, the IPO market and the rest of the American economy will be hurt.

So says Patrick Armstrong, the new president of the Security Traders Association of New York.

“The buyside needs a stronger voice,” said Armstrong, managing director and head of institutional sales for floor broker Prime Executions, which is an agency-only broker on the floor on the New York Stock Exchange. Prime Executions, a liquidity provider since 1986, trades equities and ETFs for the institutional marketplace.

To achieve that strong voice, Armstrong asserts, more of the industry needs to be involved in the rule comment process and market structure issues. Firms need to become more involved in all sorts of rules, from Regulation NMS to the Sarbanes-Oxley Act to decimalization. More comment letters need to be sent to the Securities and Exchange Commission from more than just the usual suspects.

“As much as I value the big broker-dealers’ opinions and the New York Stock Exchange’s opinions, repeatedly they are the only two parties that always comment to the SEC about rules changes,” Armstrong said.

What opinions is he seeking?

“I want them to tell me their opinion on the direction of our market structure. I believe that those who are for the status quo, those who say everything is fine, are the ones to be wary of,” he said.

Armstrong believes a combination of Reg NMS and other market structure changes has taken “us down a road of unforeseen consequences.” So industry professionals must work to correct these problems, he said.

That means more firms getting very involved in issues such as razor-thin spreads through minimum price variations and making the case that such spreads are hurting the trading industry. STANY, Armstrong noted, wrote a letter on proposed federal legislation that became the Jumpstart Our Business Startups, or JOBS, Act, arguing for widening spreads.

Penny quoting is hurting small and midsize companies before and after they go public, discouraging new IPOs. The state of the IPO market today, STANY said in a recent comment letter, is lamentable.

The combination of regulatory and market factors shocked the system over the last decade, according to one study.

The change from fractions to decimals and “the resultant loss of 96 percent of the economics from trading spreads of most small-cap stocks-from 0.25 per share to 0.01 per share-over the last decade was too much of a shock for the system to bear,” said a 2012 study by David Weild and Edward Kim, both senior advisers, capital markets, with CPA Grant Thornton. The study is titled “Why Are IPOs in the ICU?”

The study argues that market makers no longer exchanged information over the phone, after changes such as decimalization and Regulation NMS. The latter required a structural overall of the securities markets. It required that the best bids and offers, the so-called top of the book, be displayed in all markets. It also required that the best bid not be “traded through or ignored. Markets today cannot execute orders at a price worse than displayed by another market and stocks cannot be quoted in fractions of less than a penny. The study also called for new formulas in the allocation of market data revenues.

These attempts to provide a better deal for the individual investors, the study’s authors contend, inadvertently hurt the IPO market, especially floor brokers, owing to Reg NMS.

“The specialists,” the authors wrote, “finally fell victim to crushing speed when Regulation NMS was implemented in July 2005.”

The market no longer tried to match buyers with sellers on the other side of a trade, Weild and Kim argue. Liquidity “supported by capital commitment was quickly a thing of the past,” they wrote.

Armstrong adds that decimalization also has changed the nature of corporate finance, to the point where less and less research is being done and small and midsize companies.

“In my opinion,” he said, “the reintroduction of a spread would lead to new research products.”

The IPO falloff, Armstrong warns, hurts both the trading industry and the economy. So promoting the birth of companies, especially small and midsize businesses, is going to be a key part of STANY’s agenda over the next year. Armstrong and his group believe the IPO market is not growing nearly fast enough compared with a decade ago.

“Since 2001, the average number of IPOs in the U.S. has dropped drastically,” STANY officials wrote in an Aug. 7, 2013 letter to the SEC.

For example, between 1991 and 1996, IPOs averaged 520. From 1996 to 2001, the number rose to 539. “However,” the letter continues, “since 2001, with the introduction of decimalization, and the passage of the Sarbanes-Oxley Act and Reg NMS, the average number of IPOs in the United States has fallen to 134.”

The danger, the STANY officials believe, is that small and midsize companies will have to turn to other capital sources. Not only will the trading world be hurt, Armstrong argues, but the entire U.S. economy.

Access to capital facilitated by a strong secondary marketplace is fundamental to our economic growth, Armstrong says.

How does STANY aim to change this?

Rgulators, who have many demands on their time, must be convinced to take a closer look at spreads, which, at a penny, are just not big enough to support the introduction of new firms to capital markets, Armstrong and his group claim. They are working to persuade the SEC to run a pilot study with a spread bigger than a penny. Armstrong recommends a nickel.

“That, we believe, would drive more liquidity,” he said. “I think that it would be beneficial to study the nature of trading in secondary and tertiary names.”

And the way to change that and overall market structure, he believes, is through a more effective buyside that makes its case to regulators and lawmakers. That means more comment letters, especially from organizations other than the biggest exchanges, he said.

Although Armstrong is concerned about the state of the IPO market, he doesn’t expect that efforts to push for a securities transaction tax will succeed.

“This is not a time in our economy to discourage people from buying different companies,” he said. “I just have a hard time believing that, once the American public understands that they’re being taxed, that they’ll be in favor of it.”

However, although he believes the seemingly aborted Volcker rule, limiting proprietary trading, is not a threat in the short term, he predicts it is likely to resurface in some different or unique form.

Armstrong, soon to be 41, has a unique history. 

He is the first floor broker president in the history of the 76-year-old organization.

Armstrong notes that the organization was developed by “upstairs” firms, as opposed to people on the floor. It is an organization, Armstrong agrees, that has gone through hard times, but he says is about to turn the corner. 

Armstrong’s path to the business was not a straight one. He came to trading not with a business or investment background, but as someone who as an undergraduate was preparing for medical school.

Then, attempting to pay off some of his student loans before heading to medical school with a routine, lower-rung trading job, he fell in love with the industry and never went back to school, or at least to medical training. Armstrong, who is fascinated by how public companies come into existence, is in the process of studying to become a chartered financial analyst.

“The more I learn about markets,” he said, “the more I want to learn about them. It has been a tremendous journey this last year or so.”

Indeed, in June 2011 he became an executive floor governor of the New York Stock Exchange. At age 38, he was one of the youngest governors in the Big Board’s history.