By Alexander Osipovich | The Wall Street Journal | April 23, 2018
A proposal backed by the Trump administration to make the U.S. stock market more attractive for smaller companies came under criticism on Monday, as rivals called it a giveaway to Nasdaq Inc. and the New York Stock Exchange.
The proposal would allow small-cap firms to restrict trading in their shares to the exchange where they are listed, instead of the 12 exchanges currently in operation. Proponents say it would boost liquidity for small-cap stocks by funneling activity in their shares to one exchange.
That would also benefit Nasdaq and the NYSE, which dominate the market for U.S. corporate listings and could gain market share at the expense of competitors. Nasdaq floated the idea last year, and the Treasury Department endorsed it in a report in October.
Securities and Exchange Commission Chairman Jay Clayton, a Trump appointee, has vowed to make the U.S. stock market work better for smaller companies. In a speech last week, he questioned whether small-caps were well-served by a highly fragmented U.S. stock market.
Brad Katsuyama, chief executive of upstart stock exchange IEX Group Inc., blasted the Nasdaq plan in a meeting at the SEC on Monday.
“It’s anti-competitive, in a way the commission has historically rejected,” he said. IEX is seeking to start its own corporate-listings business.
Virtu Financial Inc., a high-speed trading firm, voiced doubt that tinkering with the plumbing of the U.S. stock market would stimulate trading in small-caps.
“Liquidity in these names is actually pretty good,” Stephen Cavoli, a senior vice president at Virtu, said at the SEC meeting.
The main factor driving trading activity in small-caps is investor interest, not the structure of the U.S. stock market, Mr. Cavoli added.
Virtu runs a massive off-exchange trading business that executes many of the orders entered by customers of Charles Schwab Corp., TD Ameritrade Holding Corp. and other retail brokers. Such “internalizers” have long jockeyed with exchanges, since they handle orders that otherwise might get executed at exchanges like the NYSE and Nasdaq. Internalizers could lose business if regulators push more trading onto exchanges.
Currently, around a dozen exchanges and more than 30 off-exchange “dark pools” compete for trades in U.S. equities. Much of that fragmentation resulted from past SEC efforts to break the dominance of the NYSE and Nasdaq and bring more competition to the trading space.
Nasdaq says that brokers who specialize in small-cap trades have a tough time navigating the complexity of U.S. markets. For such brokers, “having to trade potentially in 13 places is a challenge,” Nasdaq chief economist Frank Hatheway said on Monday.
Advocates for small-caps say that thin liquidity hurts the sector.
Light trading volumes in a company’s shares can make it harder for the company to raise capital or even to entice top talent with stock-option grants, said Adam Epstein, founder of Third Creek Advisors, which advises small-cap firms.
“It’s a pretty austere challenge for these companies,” he said at the SEC meeting.
Driehaus Capital Management, an $8.8 billion mutual-fund manager, often rules out investing in small-caps that aren’t liquid enough, said Jason Vedder, the firm’s director of global trading and operations. That is because it could be too costly to enter or exit a position in the small-cap company’s shares, he said at Monday’s meeting.
“It is a deterrent,” Mr. Vedder said. “If it’s not trading enough, we won’t invest in it… It may be really hard to get out of.”
This post was originally published in the Wall Street Journal.