M&A Activity in the Investment Industry Bodes Poorly for the Retail Investor

December 11th, 2006

December 11, 2006 - I read a statistic the other day that the ten largest investment firms in the world, on any given day, control anywhere from 50% to 70% of the market volume on the New York Stock Exchange, with the top five largest firms each controlling about 7%-8% of the total share volume. That is an astounding testimony to how much control large companies have seized over market behavior, considering that last week, 70% of listed volume on the NYSE equated to almost 2 billion shares with a market worth of about $54 billion. And these figures do not even account for the huge volumes of trades that these firms execute on their own internal systems.

Take this into account, and these firms control even higher percentages of all daily stock market trading volumes. In fact, many clients prefer that firms use dark pools (private, internal systems), where prices remain secret, to move huge blocks of stocks for them. Whenever I buy or sell stocks, I always use systems that show all bids and offers for the stock in question that exist on various trading platforms. This assures me that I can place limit orders that will get me better prices on buys and sells than I could without seeing all the bids and offers that exist at the time.

However, many large firms take this another step further for their best clients, using mathematical algorithms to search these “dark pools” to find the best prices for their clients. Though the vast majority of Americans that trade stocks don’t know this, there are about 20 different platforms, not just one, that you can use in order to execute a purchase or sale of a NYSE listed stock. And there are multiple platforms in other parts of the world as well. Computers and technology have vastly changed the strategies to identify the best opportunities in the world today as you’ll discover inside our SmartKnowledgeU™ online campus. It has also vastly changed how trades are executed today at large investment firms. Last week, the NYSE raised the trading transaction fees for brokerage firms and also lifted a previous monthly USD $750,000 cap on commissions. As a result of these policy changes, the transaction fees for firms that engage in massive volumes of trades, such as Goldman Sachs, will reportedly leap by more than 100%, from about $9 million a year to $20 million a year.

However, don’t think that the largest global firms will take these fee increases kindly. To challenge such fees, they are responding by building huge trading platforms through joint ventures. In Europe, Citigroup, Goldman, Deutsche Bank AG, Merrill, UBS, Morgan Stanley and Credit Suisse are forming a continent-wide equity-trading platform to challenge the London Stock Exchange Group Plc and Euronext NV. But the exchanges are counterpunching with a flurry of M&A activity designed to consolidate their power as well. The New York Stock Exchange is attempting to buy the Paris-based Euronext, NASDAQ has purchased a 25% stake in the London Stock Exchange after a failed bid to buy the whole thing, and there is speculation that the NYSE may also try to purchase the LSE in addition to NASDAQ.

Today, the largest firms in the United States, execute about 12% of their entire daily trading volume in these “dark pools” executed on their own internal systems. An estimated 5 billion shares trade every day on all U.S. stock exchanges, so 12%, though it may not sound like much, still equates to a massive 600 million shares. Due to the increase in fees of various exchanges, in all likelihood, the volume of shares traded in dark, secretive pools is bound to increase over the next several years. If it does, this may very well signal the end of fair share prices for the individual investor unless some new regulations are quickly implemented. Today, the SEC (the Securities Exchange Commission) mandates that all firms must execute trades on behalf of clients at the best electronic price available.

It seems that technology has created all kinds of transparency problems that the SEC has not yet caught up with in the area of risk regulation to protect the consumer. Theoretically, a firm could trade all day long within these dark pools at one price and provide another price of execution to their client, and pocket the difference.

A second danger presented by this concentration of power in the investment industry created by M&A activity is the ability of the largest firms to literally move markets. In fact, collusion to drive the price of certain stocks higher and lower would be fairly simple for the world’s largest firms but fairly difficult to prove. This is precisely the reason why options trading is becoming more difficult these days. Sometimes, perfectly formed bearish rising wedges that indicate an immediate break to the downside may continue to trade higher for days on end because institutional purchases of huge blocks create abnormal breaks from strong trading patterns.

In fact, I would love to see statistics regarding the largest blocks of stocks for both purchases and sales executed by the five largest global investment firms reported on a daily log. This information would be infinitely more useful than any of the reports most financial publications currently produce.

In 1984, a U.S. Justice Department anti-trust suit against AT&T (then, a massive telecommunications company) mandated the break up of what had effectively become a monopoly into 7 separate regional companies called “baby Bells”. These same actions should be taken against the largest global investment firms as well and tighter regulations should be implemented regarding how much share and dollar volume large global investment firms can control on a daily basis to prevent abnormal market behavior from occurring and to protect the individual consumer.

But will this ever happen in the future?

I highly doubt it. The people that control the finance and money world are a billion times more powerful than those that control the telecommunication industry, and any dissolution of their power is highly unlikely. For now, the best way to fight the colossal powers of the global investment giants is to leverage technology to utilize information more efficiently than these firms to give yourself a leg up in finding the best investment opportunities in the world. That’s what we’ve done at SmartKnowledgeU™ and that’s what you should do as well.

On tap for later this week: The Most Significant Technology Opportunity of the Decade, and The Reported Demise of Microsoft is Premature

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J.S. Kim is the founder and Managing Director of SmartKnowledgeU™, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.

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