Cutting Middlemen From Trades on Internet Is a Mixed Blessing
“Cut out the middleman” has long been the battle cry of manufacturers and consumers. Thus, it comes as no surprise that this concept is now being applied in the securities business via the Internet.
Is this a positive development? In some respects, yes. In others, definitely not. Actually, there’s not just one but two groups of middlemen who can be bypassed through the Internet. One consists of the people who set the price of a stock and process trades in it. On the stock exchanges, these are the specialists and floor brokers; on Nasdaq and the over-the-counter market, they are the market-makers.
Last month, the Securities and Exchange Commission, facing the inevitable, for the first time formally approved a company’s request to trade its stock on the Internet. Soon, anyone who owns or wants to buy stock in Real Goods Trading Corp. of Ukiah, Calif., for example, can post a notice to that effect on the World Wide Web. When a buyer and a seller agree on a price, they’ll clear the trade outside the Internet through a transfer agent.
Through this process, buyers and sellers will realize savings because there will be no “spread”--the difference between the price market-makers are willing to pay for a stock vs. the price at which they are willing to sell the stock.
As for the companies running markets for their stocks on the Internet, they will benefit from the increased liquidity gained in this process.
So far, so good. But eventually--probably sooner than later--scam artists will figure out ways to manipulate stocks traded on the Internet. This naturally increases the regulatory burden on the SEC, because it now relies heavily on the stock markets and the National Assn. of Securities Dealers to do the policing.
What effect will stock trading on the Internet have on the exchanges and Nasdaq? That’s impossible to predict at this point.
Thirty years ago, few would have believed that a computer-based stock market to be known as Nasdaq would emerge and ultimately outgrow the New York Stock Exchange. It’s unlikely that we will see an early demise of the exchanges and Nasdaq because of the Internet. But there’s no question that trading of stocks on the Internet is an idea whose time has arrived, and its long-term benefits would seem to outweigh any potential short-term negatives.
Other middlemen in the securities industry who can be bypassed through the Internet are the investment bankers. Offerings of securities directly by companies to the public without an underwriter’s involvement are perfectly legal, but they account for only a minuscule portion of all offerings.
Still, such sales are on the upswing. According to one survey, the number of direct offerings rose from 28 in 1994 to 40 last year. No companies have yet gone public through the Internet but it’s a good bet that deals will begin to be done via this medium.
Obviously, this trend bodes well for the issuers of securities. But what will it mean to investors? To a considerable extent, that depends on whether the issuing company is already publicly owned or whether it is offering its shares to the public for the first time.
A company that is already public is subject to regulation by the SEC and by either a stock exchange or Nasdaq. It has to comply with disclosure rules and compliance requirements. The stock offerings of most public companies were underwritten by investment banking firms who checked them out thoroughly as part of the due diligence process.
Companies that are already public have to register additional shares with the SEC, regardless of the distribution channel they plan to use in selling the stock. Offering shares through the Internet would practically be the electronic equivalent of a shelf registration, under which a seasoned company is permitted to sell stock whenever it chooses after getting the SEC’s approval.
But shelf registrations are limited to blue-chip companies that scrupulously meet all reporting and compliance requirements. There’s little likelihood that the SEC would authorize a shelf registration for a public company that has been showing consistent losses or has been fined for compliance violations. Nor are shelf registration privileges accorded to companies making initial public offerings or who have been public only for a short time.
Nonetheless, IPOs may be done by nonpublic companies simply by meeting the SEC’s filing rules. If a company feels it can go it alone in selling its stock, it is not subjected to the due diligence process that is part of any underwritten offering. Thus, it’s not only possible, but quite likely, that there will be some offerings made through the Internet that will turn out to be disastrous for investors.
What it comes down to is that technology has once again outrun regulation. Government could hardly have been expected to anticipate what has become possible in the securities field via the Internet. Now all it can do is catch up as quickly and effectively as possible.
Until it does, those who buy from those who deal in securities on the Internet must take the caveat-emptor approach. If they don’t beware, they may be burned.
