The TSX Venture Exchange: Fire in the Hole!
There’s a great deal of talk these days about corruption in the marketplace. Let me say that, for the most part, I believe there is a strong need for such discussion. While it’s true that people losing money in the stock market would much rather blame corruption than their own investment choices, I do believe that there is a significant measure of under-the-table dealing going on.
My own frustration is founded on the prospect that I can work hard and work smart on developing and applying all the due diligence tools imaginable, and still fail because of nefarious behind-the-scenes activity.
The only question to ask, of course, is: What can be done about it? I applaud the many varied efforts just now gathering steam, such as those of Jim Sinclair, Jim Puplava, and the new Stockhouse discussion group, working to shine a light on suspected evil-doers. Finding and following the paper trail is both a logical and formidable pursuit. Where there’s a will, there should be a way. Note that I’m not 100% convinced that there IS a way on this one. This is because the fox runs the chicken coop.
Until and unless an independent, objective, and gnashing-teeth regulatory body is created, some of those chickens will inevitably go missing. For this reason, one must turn, in this particular pursuit of regulation, to government intervention. Remembering the axiom, however: If you want something done slowly and poorly, assign it to the government, one must be ready to wait and wait and wait, never sure that the sought-after prize will be at the end of the line when you get there.
I’ve had a number of recent conversations on this topic. In my own naïve, simple way, my thinking is always to back up several steps, asking: If we were to create this business again today from scratch, how would we go about the task? In my view, this is how great new businesses are launched. Failure to clear the desk and consider the entire landscape freshly on a regular business is why some businesses… and entire industries… fall by the wayside. Witness Theodore Levitt’s classic Harvard Business Review article, “Marketing Myopia”, penned in 1960. This one article captured and articulated the premise upon which all great successes in marketing have been based since that time. If you haven’t read this piece, please be encouraged to do so.
In essence, Levitt made a study of the question: What business are we in? Using the railways in the early 1900s as his illustrative example, he showed how they brought about their own demise by declaring that they were in the ‘train’ business. In fact, they were not. They were in the business of moving people and things from place to place. When air travel and trucking came along, the ‘train’ businesses failed to see the threat to their own existence because the paradigm of their marketplace was too short-sighted, or ‘myopic’. The entire industry went into a steady decline.
Of note, one player in that sector eventually saw the opportunity to exploit new developments in technology, and embraced these developments in a wide sweeping phase of diversification. Canadian Pacific Railway (CPR) was one of the two major rail companies instrumental in connecting what would eventually become a united Canada (the other was Canadian National Railway – CNR). Without these two companies, it is very likely that the Canadian West would now be a part of the United States. Even now, many in the West feel a greater affinity to their southerly neighbours than to their compatriots in the East. This is especially so in Alberta, where the oil and gas industry ties them more naturally in a north-south band. In any event, this company morphed into a conglomerate of varied businesses, all tasked with moving people and things, including information, from place to place. CP Rail; CP Trucks; CP Air; CP Shipping; CP Hotels; CNCP Telecommunications. For many years, this diversification sustained the business.
My point? To survive, you need first to understand what business you’re in. Moreover, you need constantly to revisit a cleared landscape, asking how new developments might affect the very model on which your business is based. To do otherwise could easily find you holding a rather large inventory of buggy whips. The pace of modern advances in technology accentuates the need to be on the lookout for new opportunities and new threats. Any paradigms that fail to take this dramatic pace of change into account are worth no more than twenty cents (pair o’ dimes… sorry).
Let’s now move this over into consideration of the stock market business. Lots of talk these days about misguided motivators on the part of stock brokers and investment bankers. What business are they in? Purportedly, they exist to help others match money with good investments. It’s been argued that many of these folk have confused their own need to make money with the need to provide a service to others. In the end, those businesses who become more enamoured with profit than with satisfying a market need will do neither. Implosion is the only possible outcome.
There are many topics and sub-topics to this conversation. I will focus here on only one. Short-selling, legal and otherwise, works against the basis for a service-based business on the part of the players in this market. Why would anyone in their right mind allow something they’ve bought and paid for to be used explicitly against their interest? If you’re my client retail investor, and I’m holding shares you’ve bought in hopes of gaining in share price appreciation, how am I serving you when I lend those shares to someone else so they can sell them in hopes of share price going down? I am not serving you. I am serving myself. The basis for our business relationship is entirely undermined. You have every reason to dismiss me.
Of course, there’s always the topic of naked shorts, when people sell shares that don’t even exist. You can take possession of your certificates. You can give explicit instructions to your broker not to lend your shares. You can even have your broker agree in writing not to lend your shares. Nothing prevents your broker from selling phantom shares, shares that don’t even exist. Not even the law, when it has no teeth, can protect you. So what can you do?
Thinking in analogies, as always, recall the John Travolta movie, “Phenomenon”. In one set of scenes, he was troubled by a rabbit that kept getting into and raiding his garden. Building a higher fence didn’t help. Burying the fence deeper into the ground didn’t work either. Eventually, he figured out that the rabbit lived ‘inside’ the garden. There was no barrier to entry. Sound familiar? He figured this out by adopting a new paradigm.
Again, only from a simple mind, I ask: What can we do? How can we stop the rabbit from raiding our garden? Perhaps more to the point, how can we stop the rats from raiding our pantry? Setting traps is one way, to be sure. Following the path of destruction is another. Instead, I say: Let’s burn down the pantry and build a new one altogether. That pantry, of course, would be the TSX Venture Exchange.
Huh?
Let me ask you this. If I’ve got $10,000 in my bank account and I’m sitting around the table with five friends, why can’t I give them each a cheque for $3,000? Simple. The banking system knows that I haven’t got $15,000. The slowest two among my friends will be out of luck, and so will I when they catch up with me.
This simple checkpoint (cheque point?) protects the integrity of the entire banking system as we know it. As is readily apparent, I’m fond of asking stupid questions. Here’s another. If we can keep track of every dollar and cent in the banking system, across branches, and across completely separate businesses, why can’t we similarly track shares in the stock market? Why not? Why not, indeed!
When I ask this of friends close to the business, the regular answer is that the ‘business’ wouldn’t let me do it. The brokers and the bankers would never go for it. There’s just too much money to be made from the current leaky system. My answer: Who cares what they think? Do the job, and it's yours. Don't do it, and we'll give it to someone else. Just as bank tellers have gone the way of the dodo in favour of ATMs. Just as bookkeepers have lost out to Quickbooks. Just as the post office has given way to Fedex. Investment brokers and bankers may ultimately lose out to a system that bypasses them entirely, in favour of the direct link between investors and listed companies. Again, why not?
Imagine a new exchange where there are no investment bankers and no brokers, no middle men at all. The exchange allows the electronic connection between buyers and sellers of stock, along with the funding of companies on a direct basis, with no need for private placements, warrants, and mandatory holding periods. Funding takes place in a fluid format, with no need for major event-related stress being placed on the market or on the company. If a company has a good story, and tells it well, money will flow to support its operations. This is called the efficient market theory. The number of outstanding shares is automatically updated, so everyone knows the level of dilution. Every share is tracked: I’m sorry, sir. You cannot sell that share, because you don’t own it. Short selling, of course, is not permitted.
To my way of thinking, not only could the investment bankers and brokers not stop such an exchange, if the marketplace had the will to create it. In my view, the investment bankers and brokers (or at least some of them), by completely forgetting the people they’re in business to serve, have created the opportunity for such a new model to exist. They’ve been just too successful in serving themselves. Success, after all, is one of the best predictors of failure. Perhaps we’re on the cusp of witnessing just such a collapse.
To the extent that retail investors feel that their interest is subordinated to that of their broker… to the extent that listed companies feel that their interest is subordinated to that of their investment banker… so opportunity presents itself for a new market model to emerge.
When a business makes money for its clients, they are happy to share their winnings. When a business makes money at the expense of its clients, they will search out alternatives. When a business becomes bankrupt, either financially or morally, its raison d’être disappears, and it’s time to walk away.
It is my firm belief that the model of the modern stock exchange, as we know it, has outlived its usefulness. Its general lack of transparency, coupled with the self-dealing practices of some of those in control of the market have rendered it on the edge of obsolescence. As a result, there is no efficient market at work.
There appears to be a total lack of (legitimate) method for making money in this market. In turn, money is frightened away from this market, and will not be placed here until these problems are addressed. There are so many mainstream investors who must surely look at the Venture Exchange as worse than a roulette wheel in Las Vegas… and often rightly so. In the absence of method, money will eventually dry up altogether. At that point, those who have made money will take their winnings and find/create/destroy another playground. The rest of us will be left holding an empty bag.
On the other hand, with a mobilized grassroots movement, this need not be the case. Whether or not a new exchange will be created to solve this problem is not for me to say. Whether or not new efforts by various factions of retail investors can bring enough sway to effectively regulate the current marketplace is not for me to say. Maybe the threat of dissolution will be enough to even the playing field. I suspect not. What I can say without hesitation is that all markets, like all forces, tend toward a point of equilibrium. Goodness knows we’re a long way from equilibrium now.
Here’s hoping…
Kevin Graham