A case of lobbysts vs. small cap investors

By Lise Buyer
July 3, 2013

It’s tick season again: the time of year when those small, seemingly unimportant beasts emerge and attack the unsuspecting or unaware. This year, they seem to be everywhere and have a particularly robust group of carriers. The problem with ticks is that, while they seem benign, they can cause significant harm to those who are not vigilant.

But this is not about those annoying little creatures that hang out in the tall grass and spread Lyme disease. We’re talking about the kind on Wall Street, transported not by deer, but by a loud army of lobbyists.

Representative David Schweikert (R-Ariz.) and this army of lobbyists, a loose-knit association of exchanges, traders and others who stand to gain financially, are asking the Securities and Exchange Commission and Congress to consider legislation that will increase the cost of trading the stocks of smaller companies — those with market capitalizations of less than $500 million. Those stocks are often less-liquid stocks than those of large-cap businesses.

The logic is that if the brokers can capture more profit on every share they trade, they will put more effort into making those trades (makes sense) and so will increase the liquidity of these particular securities (possibly). This increased liquidity will, they believe, then cause more investors to want to own these stocks, make these better investments and thus will spark a return to the “glory days” of initial public offerings, the late 1990s. Huh?

Let’s start with where the proponents of larger tick sizes are spot on. Making it more profitable for brokers to trade small stocks will, in all likelihood, increase the trading of those stocks. If it is more profitable for a salesperson to sell a specific product, odds are good he or she will do just that. In retail, it’s called a spiff — and it happens all the time.

The problem is that those spiffs, or in this case, the increased profits on each trade, do absolutely nothing to increase the value or desirability of the item being pushed — whether it’s a ginzu knife or a share of stock. While caveat emptor applies, the ramifications of encouraging brokers to push some stocks over others, not based on the underlying fundamentals but rather on the profitability of the trade, may not be such a good idea for Mrs. and Mr. America who tend — perhaps foolishly — to expect unbiased advice from their brokers.

The next question is whether or not increasing the profit on each trade actually increases liquidity. While it encourages trading, it also creates a strong incentive to churn stocks — or trade the same shares repeatedly — adding no real liquidity but generating juicy commissions. This is the antithesis of convincing brokers to help clients make studied, longer-term investment decisions.

While each investor should buy, sell or hold based on his or her own logic, new public companies, many of which will fall into this sub-$500-million market cap pool, generally seek investors who are long-term shareholders. Increasing the profitability of every trade would press brokers to seek exactly the opposite kind.

Let’s cut to the chase: The current move is an effort to tax investors in small stocks. Period.

Proponents of the tax argue that the receipts can be used to fund research on small cap companies, increasing their desirability. Nonsense.

Unless the government is going to step in and mandate how private companies internally allocate their investment dollars between departments, and how they should determine the derivation of each dollar of trading profit, their theory shows little understanding of how investment banks actually work.

It is clear who will win and who, once again, will lose from this proposed new tick-tax. While larger investment funds can easily pass along the extra costs to clients in the form of increased fees, the small investor has no such option.

Higher fees on fund investments and higher costs on trades will enrich the brokerage industry and compatriots, placing the costs squarely on the wallets of retail investors, with no associated tangible benefits.

So , let’s hope that the SEC withstands the industry lobbying pressure and doesn’t let the tick carriers bite.

 

PHOTO (Top): A street sign for Wall Street hangs in front of the New York Stock Exchange, May 8, 2013. REUTERS/Lucas Jackson

PHOTO (Insert): The headquarters of the Securities and Exchange Commission in Washington, July 6, 2009. REUTERS/Jim Bourg

 

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/