Widen the MPV and Restore IPO Market, STANY Leader Says

Transaction tax not a threat, but the Volcker rule will resurface

Security Traders Association of New York president Patrick Armstrong of Prime Executions believes rejuvenating the IPO market is a key issue for the trading industry and the American economy. He discussed that, as well as the possibility of a new Volcker rule, with Traders Magazine.
TM: You are concerned about the state of the IPO, especially what you believe is small and midsize companies’ recent lack of access to the capital markets?

Armstrong: Yes, STANY wrote a comment letter in response to the proposed JOBS Act. An important proposal from that is the possibility of widening the minimum pricing variation (MPV).
TM: So it is very important to you and STANY that the Securities and Exchange Commission looks more closely at this area and does more research?
Armstrong: Earlier this year, the SEC held a roundtable discussion about the proposed pilot. I’m very interested in that pilot program. I think it would be beneficial to study the nature of trading in secondary and tertiary names.

TM: So it is very important to you that SEC take a closer look? You seem to feel that the SEC hasn’t done enough research in this area.
Armstrong: Most people aren’t very happy with the state of market structure in the U.S. today. The combination of Regulation NMS, decimalization, and the maker-taker model took us down a road of unforeseen consequences. I still believe we have the best market structure in the world, but we can improve it.
TM: But you believe it is more than MPVs?
Armstrong: Yes, it’s hard to point to any one rule change. What I’m speaking about is a combination of many different rule changes that have gotten us to where we are today. 
TM: And so?
Armstrong: We have to take a macro approach of examining our market structure. We plan to highlight this issue at STANY’s annual conference on April 25. The conference will be titled “Our Financial Markets: Where Shall the Pendulum Swing?”
TM: What do you want traders to tell you?
Armstrong: 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. 
TM: But you do think the IPO market is not where it should be…
Armstrong: Well, I’m most worried about smaller companies.
TM: Why?
Armstrong: Smaller companies, those that trade only 40,000 to 100,000 shares or so a day, face problems. There are not enough analysts covering them anymore. That doesn’t drive people to that equity product for people to buy and sell; there used to be a bigger spread, where a market maker could offer a little more liquidity because of that spread. And because of decimalization in these names, it’s changed the nature of corporate finance. In my opinion, the reintroduction of a spread would lead to new research products.
TM: So what is your fear? That smaller companies will go elsewhere to find capital? 
Armstrong: Yes, or they will just remain private, which could inhibit job growth and cap-ex.
TM: And so?
Armstrong: This is critical for all of us. Having an exchange where small companies can list and grow is very important to our economy. 
TM: Are you saying it could be one of the reasons for what some believe is a weak recovery?
Armstrong: Some of our stalled growth could be directly due to some of the changes to the marketplace in the last five years. Access to capital facilitated by a strong secondary marketplace is fundamental to our economic growth.
TM: This is a critical issue for your term as president of STANY?
Armstrong: Yes, we want small companies with great ideas to grow.
TM: OK, but since you are a critic of the penny MPV, does that mean there is an optimum number?
Armstrong: I think we should look at a nickel for some issues, possibly wider for others.
TM: Why a nickel?
Armstrong: Because the prices that most of these companies trade at is somewhere near the $10 to $20 range. You really have to look at the de minimis amount compared as a percentage of the entire cost of a share. Berkshire Hathaway is $120,000 a share. It trades in a penny market. Does that make sense? No, it doesn’t. 
TM: So what is the effect of the small spread?
Armstrong: I think that because of the small spread, companies are unable to attract interest to buy their stock. There’s not enough liquidity in the name for people to feel as though they could build a position. And that is partly due to our changes in market structure.
TM: And that is…
Armstrong: That is personal opinion, not STANY.
TM: This is you speaking an executive of Prime Executions.
Armstrong: Right.
TM: You are afraid that some countries are getting ahead of us in this area?
Armstrong: You could certainly make an argument for that. But I still believe the United States offers more opportunity for any company, more than any other place in the world.
TM: Do you think the buyside has felt that it has been ignored?
Armstrong: I think it is in the nature of buyside people to keep quiet, when a fund is trying to build a position. A good trader does that quietly and efficiently to move into position, so there is no inefficient leakage.
TM: And so…
Armstrong: I think that kind of translates into not going to the SEC to talk to them about what’s wrong with the marketplace. I think that’s starting to change, and I only want to encourage that.
TM: Well, let’s go to the law guiding the regulators. Have they misinterpreted parts of the Dodd-Frank Act, which is the implication of some of the letters STANY has sent to the SEC?
Armstrong: Here’s the problem: The SEC is overtasked by Dodd-Frank. And probably doesn’t have the resources for the projects Congress has asked them to do. And on top of being a regulator, I’m very interested to see what Mary Jo White (the new head of the SEC) is going to bring to the table.
TM: Why and how should there be more buyside involvement in the rule comment process?
Armstrong: As much as I value other venues’ opinions and the New York Stock Exchange’s opinion, repeatedly they are the only parties that always comment to the SEC about rules changes. The buyside needs their voice, and STANY would like to be their voice.
TM: You believe that one way to prove your case that MPVs are hurting the IPO market is to get regulators to reconsider the issue.
Armstrong: There are a number of buyside participants who have come out in favor of a pilot. We need more of this type of mechanism. The buyside needs to have more of this in Washington.
TM: But you also believe that the buyside needs to better represented in Washington.
Armstrong: The buyside needs a voice. And I think we have begun to see that.
TM: As president of STANY, you are unusual in several ways. One, you are the first floor broker to be its president, and you are relatively young for the post.
Armstrong: I’m privileged to be the president of STANY, a 76-year-old organization that has been a mainstay of the financial industry in New York City, and I’m proud to be associated with it.
TM: First floor broker president of STANY. Isn’t that unusual?
Armstrong: Yes, the organization was developed by “upstairs” firms, as opposed to people on the floor. There are many participants from different exchanges who are currently members of STANY.
TM: But over the last few years, that organization has gone through hard times. It once had around 2,000 members.
Armstrong: Yes, some would tell you it has been in decline. But I don’t believe that.
TM: And now you have?
Armstrong: Now we have about 750 members.
TM: It was as low as 700. But you believe you are reversing that decline and you have plans to get going upward on a long-term basis?
Armstrong: The industry as a whole has lost many participants, but we have definitely stemmed that tide. I am working on getting membership back up, and particularly the buyside community, to come back. That’s a big goal of mine this year.
TM: How?
Armstrong: By continuing to have outstanding content in my conferences. The last two years, you have seen a vast improvement in both the level of content and the participation of my panelists. These are must-attend events.
TM: Must-attend events for this year’s STANY conference?
Armstrong: I’m going to have Art Cashin, Mary Ann Bartels, Tony Dwyer and Paul Richards discuss the market from a macro point of view of what’s going on. I’m going to have an exchange panel that will include Joe Mecane of the NYSE, Brad Vopni from Nasdaq, Chris Isaacson from BATS and Bryan Harkins of Direct Edge. Larry Tabb will lead this discussion, and they will be talking about our landscape, what their exchanges are feeling and what rules changes are happening.
TM: And what else?
Armstrong: We’re going to have a Canadian panel. We’re going to talk about how Canada has changed their rules set to address high-frequency trading and dark pools and what effect that has on their marketplace. There will be many other panels as well for our attendees.
TM: Since you’re the first floor broker president in STANY’s history, is there some significance to this? Maybe it’s time to pay more attention to the needs of floor brokers or maybe you’re trying to redefine how floor brokers are viewed?
Armstrong: Well, the floor has definitely shrunk in size as far as population. But in terms of what we’re able to do today compared with a pre-Reg NMS world, we now have an incredible set of tools available to us to execute order flow. I employ the NYSE technology and the best of other technologies to achieve best execution for my customers. While NYSE’s market share has declined from increased competition, people still tend to forget that when you compare each venue’s market share against each other directly, the NYSE is the single largest piece more than 98 percent of the time.
TM: So does your election signal a recognition by the industry that the floor is catching up to other venues?
Armstrong: I think it is very interesting that STANY chose for me to step up now.
TM: Why?
Armstrong: After only my third year on the board, I was surprised to get the call, but the executive committee felt strongly that I was the choice. I believe there is recognition that there are problems in our current structure, and as a floor broker who adapted and survived great change to the floor of the NYSE, I may have some unique insight into our future.
TM: There’s one issue you have not mentioned that has caused anxiety in this industry at various times and to which the industry has devoted much time lobbying. That is the securities transaction tax, which is being adopted by several European countries.
Armstrong: I don’t think it’s the right answer.
TM: OK, but let’s examine why some people are arguing. They’re saying the problems of the trading industry were big factors in what went wrong in 2007-2008 and now the industry should play a part in cleaning up the mess, which has left the business with a less volume and the government with less tax revenue.
Armstrong: The problem with that is that you’re taxing mom and pop via a transaction. You’re just taxing the American people for the problems that occurred with the financial institutions. That’s just not the right approach.
TM: The tax is counterproductive?
Armstrong: And this is not a time in our economy to discourage people from buying different companies.
TM: What’s the legislative outlook for the tax? Do you know?
Armstrong: I just have a hard time believing that, once the American public realizes that it’s them being taxed, that they’ll be in favor of it.
TM: The Volcker rule seems stalled or dead for now. What are STANY’s thoughts on the concept?
Armstrong: Well, I think we’ll see it resurface in a different light. In its first form, nothing was defined properly. We covered this topic extensively in last year’s conference. The proposal affected way too many different financial institutions. We’ll see it raise its head again, but it will be interesting to see what it will look like.
TM: You are right in the middle of this debate?
Armstrong: As an independent firm, we represent a number of different cash equity desks and program desks. They facilitate market making by putting capital to work, and their volume is substantial. As a small independent firm, we trade for these clients more than 200 million shares a month. 
TM: So, even though the debate over Volcker rule is now on hold, this issue of proprietary trading and how it will take place is a key issue for you.
Armstrong: It is important for financial institutions to make efficient markets for their customers.
TM: So what was wrong with the proposed Volcker rule?
Armstrong: It was just too far-reaching. Being able to put up firm capital, to facilitate a trade for a customer, is an extremely important tool and should not be restricted. That is the definition of market making. To inhibit that is ridiculous.
TM: So you’re saying that people have a right, should continue to have a right, to make bets?
Armstrong: Yes, it’s akin to the changes to the short-sale rule, when they would restrict short selling.
TM: Why?
Armstrong: I think short selling is essential to an efficient marketplace. And short sellers have to come back and buy that equity eventually, which is important liquidity to the marketplace.
TM: Let’s look at your career. Your whole adult life has been in trading?
Armstrong: Yes. I graduated from Columbia University in 1994 with a BA in premedical studies. I played football there and worked part time at a buyside firm. They offered me my first job, and I took it to pay off my student loans.
TM: So how did you start in the business?
Armstrong: I started on the buyside. I spent two years with Glickenhaus & Co., which just closed their doors at the end of last year.
TM: Doing what?
Armstrong: Originally I was a portfolio administrator, reconciling accounts and speaking to clients. From there I worked my way to the trading desk. I thought I’d make some money quick, but what I discovered I had a true passion for trading and I wanted to stay in it.
TM: You’ve also had some personal traumas?
Armstrong: In June 2009, I had my stomach removed as a preventive measure for gastric cancer. 
TM: How are you now?
Armstrong: Fine. My family has a very rare gene. Many members of my family have had their stomachs removed.
TM: And so your favorite charity is related to this kind of cancer.
Armstrong: Yes, the charity is the Degregorio Family Foundation, and I’m proud to say that STANY will be promoting my charity for the annual dinner and conference.
TM: You want more public comment, more than just the usual groups?
Armstrong: I think that’s so important. I want to see comment letters from mutual funds, from hedge funds and investment managers.
TM: Do you think buyside traders are getting a bit jaded about algos, that they think there is less and less innovation?
Armstrong: I actually will have that as a topic at our conference. I think there are always ways to innovate and the smart players will find a way to do so, but I think we are at a point of diminishing returns with algorithmic trading.
TM: Why?
Armstrong: You can’t just trade blindly with an algorithm. You need to trust the agent that you’re giving an order to in order to navigate the marketplace. You need to trust the people you’re working with. 
TM: On the issue of traditional markets, exchanges have lost a lot of business over the past few years, yet you are optimistic.
Armstrong: I believe the pendulum is going to swing back.
TM: Why?
Armstrong: I think that no one envisioned 70-plus different venues to go and trade stock. It is fundamentally unfair that people can price merchandise and print it in a trade-reporting facility based off an exchange’s quote that has an obligation to the marketplace.
TM: The rules aren’t fair to traditional exchanges?
Armstrong: I don’t think they are ,and I think people are starting to take a cold, hard look at that.
TM: But do you miss the old NYSE?
Armstrong: Of course I do, but I also realize that the marketplace has moved on. In periods of great distress we still add value on the floor. However, I also believe the NYSE community adds value from the relationships they have with their customers. Nobody understands the true role of “agency” better than a floor broker. I am privileged to work in a building where “our word is our bond” and there is an inherent trust between customer and broker. I believe in a centralized marketplace. I believe that leads to proper price discovery, and I think we have lost some of that in the last eight years.
TM: How did it happen, and how would you correct it?
Armstrong: Unfortunately, it isn’t any one thing. It is the combination of decimalization, maker-taker, NMS and other rules. But with this pilot program, we might have a tertiary stock that trades at a nickel spread, with an interested investor willing to buy it.