The objectives of securities market regulation are articulated in a variety of ways, for example efficiency, honesty, fairness, public confidence, market integrity, and investor protection. In general, we agree that securities market regulation should aim, among other things:
- to facilitate informed decision making by investors;
- to minimise investors' risk of loss arising from fraud, mis-management, malpractice, and misleading and deceptive trading practices;
- to promote stable, orderly trading; and
- to promote cost-effective procedures for enforcing duties and rights under securities contracts.
In addition, we think that securities market regulation should aim to improve competition.
Provided these objectives are met, the above represent the benefits of a securities market regulation. A regulated market will normally be more competitive and efficient.
However, regulation is also a costly exercise. There are direct costs which take the form of costs of intervention which from the regulator's point of view are costs of developing, reviewing and updating regulation, monitoring compliance, and enforcement, and, from the market participant's point of view, the cost of complying with regulation. On the other hand, the indirect costs are numerous. Investors may adopt a passive attitude and this maybe detrimental in the sense that they may incur losses and thereby lose confidence in the market. Also, potential new entrants to a market may be deterred from participating because of high entry requirements (eg, minimum capital requirements or licensing standards) or because of the significant compliance costs of operating in a heavily regulated market. Less competition may stifle innovation, reduce product choice, increase costs to investors, and produce economic rents (that is, excess profits for providers of financial products and services).
The ultimate decision in favour of a regulation will only be when the benefits will exceed the costs. A balance can be sought in order to gain from regulation while maintaining a certain level of competition. However, this is not a simple exercise because the costs and benefits of various forms of regulations are difficult if not impossible to quantify.
1.4 Over-the-counter or unregulated securities markets
The name used for these markets varies internationally, being sometimes called ‘second board,’ or ‘third board’ or ‘parallel markets’ and ‘unlisted securities markets.’ Unlike the organized exchanges, the over-the-counter markets (OTC) have no central location where securities are traded. Being traded over-the-counter implies that the trade takes place by telephone or electronic device and that dealers stand ready to buy or sell specific securities for their own accounts. The NASDAQ system is an example of an OTC securities market in US.
OTC markets exist for stocks, corporate bonds, mutual funds, federal government securities, state and local bonds, commercial paper, negotiable certificates of deposits and various other securities. Altogether these securities make the OTC the largest of all markets in the US in dollar terms.
2. US SECURITIES MARKET: EVALUATIING THE UNREGULATED MARKETS
2.1 NASDAQ (National Association of Securities Dealers Automated Quotations)
2.1.1 The NASDAQ in history
The NASDAQ is an American stock exchange. Founded in 1971 by the National Association of Securities (NASD), it is the largest electronic screen-based equity securities trading market in the United States of America. With around 3200 companies, it has more trading volume per day than any other stock exchange in the world. The NASDAQ is owned and operated by the NASDAQ OMX Group, the stock of which was listed on its own stock exchange in 2002 and is monitored by the Securities and Exchange Commission (SEC).
NASDAQ OMX controls and operates the NASDAQ stock exchange in New York City, the second largest exchange in the United States. It also operates eight stock exchanges in Europe and holds one-third of the Dubai Stock Exchange. It has a double-listing agreement with OMX, and will compete with NYSE-Euronext group in attracting new listings.
When the NASDAQ stock exchange began trading on February 5, 1971, the NASDAQ was the world's first electronic stock market. At first, it was simply a computer bulletin board system and did not actually connect buyers and sellers. The NASDAQ helped lower the spread (the difference between the bid price and the ask price of the stock) but somewhat paradoxically was unpopular among brokerages because they made much of their money on the spread.
The NASDAQ was the successor to the over-the-counter (OTC) and the "Curb Exchange" systems of trading. As late as 1987, the NASDAQ exchange was still commonly referred to as the OTC in media and also in the monthly Stock Guides issued by Standard & Poor's Corporation.
Over the years, NASDAQ became more of a stock market by adding trade and volume reporting and automated trading systems. NASDAQ was also the first stock market in the United States to advertise to the general public, highlighting NASDAQ-traded companies (usually in technology) and closing with the declaration that NASDAQ is "the stock market for the next hundred years." Its main index is the NASDAQ Composite, which has been published since its initiation. However, its exchange-traded fund tracks the large-cap NASDAQ 100 index, which was introduced in 1985 alongside the NASDAQ 100 Financial Index.
Until 1987, most trading occurred via the telephone, but during the October 1987 stock market crash, market makers often didn't answer their phones. To counteract this, the Small Order Execution System (SOES) was established, which provides an electronic method for dealers to enter their trades. NASDAQ requires market makers to honour trades over SOES.
In 1992, it joined with the London Stock Exchange to form the first intercontinental linkage of securities markets. NASDAQ's 1998 merger with the American Stock Exchange formed the NASDAQ-Amex Market Group, and by the beginning of the 21st century it had become the largest electronic stock market (in terms of both dollar value and share volume) in the United States. NASD spun off NASDAQ in 2000 to form a publicly traded company, the NASDAQ Stock Market, Inc.
On November 8, 2007, NASDAQ bought the Philadelphia Stock Exchange (PHLX) for US$652 million. PHLX is the oldest stock exchange in America, having been in operation since 1790.
NASDAQ lists around 3,200 securities, of which 335 are non-U.S. companies from 35 countries representing all industry sectors. To qualify for listing on the exchange, a company must be registered with the SEC, have at least three market makers (financial firms that act as brokers or dealers for specific securities), and meet minimum requirements for assets, capital, public shares, and shareholders. NASDAQ OMX now has a dual listing agreement with the Tel Aviv Stock Exchange.
2.1.2 Dealing with NASDAQ
The NASDAQ allows multiple market participants to trade through its Electronic Communication Networks (ECNs) structure, thus increasing competition. The Small Order Execution System (SOES) is another NASDAQ feature, introduced in 1987, to ensure that in 'turbulent' market conditions small market orders are not forgotten but are automatically processed. With approximately 3,200 companies, it lists more companies and, on average, its systems trade more shares per day than any other stock exchange in the world.
2.2 Other examples of unregulated markets:
2.2.1 Over-The-Counter Bulletin Board – OTCBB
It is a regulated electronic trading service offered by the National Association of Securities Dealers (NASD) that shows real-time quotes, last-sale prices and volume information for over-the-counter (OTC) equity securities and have no listing requirements but Companies listed on this exchange are required to file current financial statements with the SEC or a banking or insurance regulator. Companies listed on the OTCBB are not a part of the Nasdaq.
2.2.2 PINK OTC MARKET
Pink OTC Markets provides a centralized quotation service that collects and publishes market maker quotes for OTC securities in real time. Pink OTC Markets is neither a Securities and Exchange Commission (SEC) Registered Stock Exchange nor a Broker-Dealer. Pink OTC Markets operates the third largest U.S. equity trading place which includes both the elite OTCQX market tiers for strong OTC-traded companies that can satisfy financial and disclosure listing standards and Pink Sheets for all other OTC quoted securities. Pink OTC markets got their name from pink sheets which are daily publications compiled by the National Quotation Bureau with bid and ask prices of over-the-counter (OTC) stocks, including the market makers who trade them and these sheets were actually printed on pink paper. Unlike companies on a stock exchange, companies quoted on the pink sheets system do not need to meet minimum requirements or file with the SEC.
An example of a pink OTC market is Pink OTC Markets Inc. it provides the leading inter-dealer electronic quotation and trading system in the over-the-counter (OTC) securities market. It creates innovative technology and data solutions to efficiently connect market participants, improve price discovery, increase issuer disclosure, and better inform investors. Over 230 financial services firms, including the ten largest U.S. investment banks, actively make markets in OTCQX and Pink Sheets securities. In 2007, these firms traded over $160 billion of OTCQX and Pink Sheets securities. Pink OTC Markets offers widespread access to all U.S. broker-dealers, enabling investors to seamlessly trade these securities through their institutional, online, or full service brokers.
2.2.3 OTCQX
It is a new market tier organized by Pink OTC Markets Inc. that sets apart a select group of issuers as worthy of consideration by U.S. investors. Qualified issuers use the efficient and robust OTCQX listing process to provide credibility and visibility of disclosure to investors. OTCQX is designed to meet the needs of small to medium sized, publicly-traded U.S. companies and non-U.S. companies listed on qualified international stock exchanges. The market consists of four types of OTC markets, each catering for various needs of customers namely:
2.2.3.1 International PremierQX
This type of OTC market is meant for companies that are able to meet the financial qualifications of the NYSE's Worldwide Listing Standards. International PremierQX provides a mechanism for companies to make their home country disclosure available in English to U.S. investors rather than via duplicative SEC reporting requirements
2.2.3.2 PremierQX
This type of OTC market is meant for U.S. companies that trade over-the-counter, identifies issuers that are able to meet the financial requirements of NASDAQ's Capital Market continued listing standards. PremierQX provides a credible disclosure process for companies that choose not to be SEC-reporting or, for SEC reporting companies, a more reputable platform for growth or a springboard to a NASDAQ listing
2.2.3.3 International Prime QX
This tier identifies those companies that are listed on an international exchange but are not of sufficient size to list on International PremierQX.
2.2.3.4 Prime QX
This tier identifies those companies that have that have ongoing business operations with audited financials and management review, but not of sufficient size to be on PremierQX
2.3 Grey markets
Some OTC securities are not quoted on either the Pink Quote system or the OTCBB; these securities are sometimes referred to as grey market or "Other-OTC" securities. Because Other-OTC securities are not quoted on any quotation service, bid and ask quotations for these securities are not available. There are no market makers in this security. It is not listed, traded or quoted on any stock exchange, the OTCBB or the Pink Sheets. Trades in grey market stocks are reported by broker-dealers to their Self Regulatory Organization (SRO) and the SRO distributes the trade data to market data vendors and financial websites so investors can track price and volume. Since grey market securities are not traded or quoted on an exchange or inter dealer quotation system, investor's bids and offers are not collected in a central spot so market transparency is diminished and Best Execution of orders is difficult
2.4 Advantages of unregulated stock markets
- Higher flexibility and fewer regulations
As per its designation, unregulated are markets that do have to abide to minimum or no regulations by authorities and are thus more flexible to operate and thus is able to attract a number of investors who are not capable or willing to follow strict rules to gain a listing on the stock market. Stock markets such as NYSE or AMEX have specific quantitative and qualitative listing and maintenance standards which are stringently monitored and enforced. For instance companies listed on such markets have to have a high turnover and market share, regularly publish accounts, abide by various security laws and also mandatory provisions such as Sarbanes Oxley acts on corporate governance. The Sarbanes-Oxley corporate governance rules in the US have imposed such an onerous burden on companies that they are taking their listings elsewhere, or they’re selling themselves to private equity firms who then de-list them. Unless companies abide by these rules, they are unable to gain a listing on the stock market and this renders capital financing a problem and there exist an on-going regulatory relationship between the market and its listed companies.
In terms of unregulated markets, there exist relatively limited or non-existent regulatory relationship between an OTC market and the issuers and thus companies do not have to meet strict rules nor abide to listing rules and laws. Thus, unregulated and OTC markets provide an alternative to companies that are unable to meet such stringent rules and facilitates the financing process. These alternative exchanges and markets provide easier and lower cost access to capital and thus help in the development and expansion of small and medium enterprises. OTC quotation services facilitate quotation of unlisted securities and thus allow companies to attract the public to buy shares to raise finance. Many OTC issuers are not subject to SEC registration requirements and therefore do not make regular filings of financial information and other corporate events with the SEC. these unregulated markets allow small and medium firms to have access to a wide range of finance and improves liquidity in the financial market. It also provides a cheaper alternative for buyers and sellers to meet and trade.
As compared to registered stock exchange such as NYSE and NASDAQ, these unregulated markets and OTC allow the listing of securities that have a low value commonly known as penny stocks and the OTCBB does not have a minimum price for listing a company and nor a starting bid. For instance, the NASDAQ only lists securities with a market price of above $5 and if the stock price falls for a certain amount of time below the threshold level, the stock can be de listed.
Despite the risks that unregulated markets are claimed to have, a number of unregulated markets are taking measures to increase confidence and investor protection. For instance despite that Pink OTC Markets Inc not governed by a securities regulatory authority, The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) regulate all Market Makers in Pink Sheets securities. FINRA's responsibilities include establishing rules governing the business conduct of its broker/dealer members; setting qualification standards for securities industry professionals; examining members for their financial and operational condition, as well as their compliance with appropriate rules and regulations; investigating alleged violations of securities laws and responding to inquiries and complaints from investors and members. Thus, despite these unregulated markets do not have direct controls, the individuals responsible to run the market, i.e. market makers are well regulated and this ensures that investor’s funds are well managed.
Moreover, in some OTC markets, it is unlawful for a broker or dealer to effect a transaction in any penny stock for or with the account of a customer unless he has the client approval or is able to do by law which is known to the client. In order to eradicate fraud that may occur on unregulated markets, Pink OTC Markets for example cooperates fully with securities regulators and those regulators are continually working to combat fraud.
OTC markets are able to tailor make products to meet customer needs as compared to organized markets which offer standardised products. For investors, OTC offer stocks on undervalued and up-and-coming companies and thus investors may have a chance to boost future returns by venturing into such markets compared to regulated markets who offer stocks for companies that are in the mature phase. Pink OTC Markets offers a variety of products and services designed to meet the specific needs of investors.
For instance as mentioned, the OTCQX market lists companies ranging from those that strive to be worthy of investor consideration to economically distressed companies to speculative shell companies. With its market categorized in four parts OTCQX, it is able to address these different needs for the benefit of both buyers and sellers. For example, on the International PremierQX, foreign issuers that are able to meet the financial qualifications of the NYSE's Worldwide Listing Standards can enter the US market and choose such markets instead of regulated markets for personal benefits like less administrative works and rules. It also allows investors to invest in international firms that may not be quoted on regulated markets. Likewise, the PremierQX allows US companies to have a reputable platform for growth or a means to NASDAQ listing given the reputation of such markets. In addition the two other categories under the PrimeQX, this market lists companies that are not big enough but meet standards of regulated markets. Thus, with its reputation and reliability OTCQX market enables growing firms to have access to a robust and efficient market where these qualified issuers are able to show credibility and visibility.
In addition for issuers, the pink quote system for instance makes no charge for a company to be quoted and is also introducing a range of premium products and services that can raise issuer's profiles with both professional and individual investors. For broker and dealers, Pink OTC Markets are continuously trying to improve and expand its trading products to help these traders enhance their trading in the market.
Moreover, as organized markets, unregulated markets offer market actors the possibility to have up to date listing over the internet and on their dedicated web sites offer various information on market makers activity, financial reports, market news etc.
- Cheaper source of finance and issue
As compared to regulated markets like NYSE who charge fees and maintenance fees to issuers offering stock through them, unregulated markets charge very low or no fees. This reduces the cost of finance to issuers and is convenient for small firms with limited resources. The cost of capital includes transaction costs, the expense of an initial and subsequent public offerings and other charges and these costs tend to be lower in u regulated markets which compared to regulated markets may range in thousands of dollars.
As compared to registered stock exchange such as NYSE and NASDAQ, these unregulated markets and OTC allow the listing of securities that have a low value commonly known as penny stocks and the OTCBB does not have a minimum price for listing a company and nor a starting bid. For instance, the NASDAQ only lists securities with a market price of above $5 and if the stock price falls for a certain amount of time below the threshold level, the stock can be de listed. OTC market also offer a shorter listing process time of around 3 days for the OTCBB compared to 6-8 weeks for regulated exchanges like NYSE. Moreover, in terms of cost of capital, with access to finance on unregulated markets small firms are able to substitute loans to equity finance and thus reduce their gearing and risk of bankruptcy.
2.4.2 BENEFITS OF NASDAQ MARKET
Closely linked to an OTC market, where it is the largest U.S. electronic stock market NASDAQ offers several benefits as compared to its main rival NYSE. NASDAQ's competitive electronic market structure is designed to provide a fair, fast, efficient and low-cost marketplace for companies and investors. As an electronic market, NASDAQ does not have a physical location as compared to NYSE and people trade on a sophisticated telecommunications network where companies are electronically connected to each other. With this system, buyers and sellers around the world can trade with each other and this eliminates physical barriers and allows the market to have more participants and the market becomes more liquid. Thus, due to its system of trading, this market trades about two-billion shares daily. It has around 3200 companies from 37 countries and due to its reliability and robustness, it is able to attract the most successful firms and provides a reliable source of investment and thus allows raising of capital easier. Stocks on the NASDAQ are considered to be more volatile and growth oriented and is suitable for risk takers.
In terms of services provided, NASDAQ stands to be a leader in the world and with the number of mergers and acquisitions, NASDAQ, now under NASDAQ OMX has become even more powerful and competitive. The NASDAQ Corporate Client Group is dedicated to providing NASDAQ-listed companies with unmatched customer service, visibility and market intelligence. NASDAQ-listed companies have access to innovative products and services through a robust group of wholly-owned subsidiaries, strategic alliances and a joint venture that make up NASDAQ Corporate Services. NASDAQ Data Products is committed to providing investors, portfolio managers, broker/dealers and registered representatives with the highest quality market data available. NASDAQ’s data products are powerful tools that enable unparalleled market transparency to help users make better-informed and more confident trading decisions.
Compared to other OTC, NASDAQ, being a recognized stock exchange, delivers the highest regulatory integrity and a robust body of high-value services for companies at all stages of public ownership. Thus, companies that are only meet certain listing rules are allowed to be listed and ensures a safe arena of investment for investors.
As a dealer market, NASDAQ is also able to trade in bigger volumes than other exchanges. Moreover, in this market, trading is conducted and controlled by market makers as compared to specialist in the NYSE market. As compared to specialist who only facilitate trading, a market maker "creates a market" for a security and thus raises the chances of financing firms efficiently.
In terms of costs, which affect a company’s decision on which exchange to list on, the maximum on the NASDAQ, is only $150,000 while that of NYSE is $250,000 and thus the NASDAQ is more affordable for firms with less initial capital. Moreover, despite both the NASDAQ and NYSE are public traded companies and have to abide to SEC requirements, the NASDAQ has less stringent rules compared to NYSE.
2.5 Disadvantages of OTC markets and the NASDAQ
- Over-the-counter markets in the US represent investment opportunities for clever and informed investors, but at the same time, bear a high degree of risk. This is related in particular with the fact that many issuers on these markets are small companies with a short history of operation or are in an economically awkward situation. Eventually, as a result, in comparison with shares quoted on an organized securities exchange, they bear a higher degree of risk. Therefore, also investing on legitimate OTC markets can lead to loss of an investment.
- Many shares today are only relatively liquid or not very tradable. Some shares today in the OTC markets are practically unsellable. The low liquidity of this part of the market causes high volatility in prices which can again mean loss for the investor.
- One inherent NASDAQ problem is the danger of collusion between market makers. Market makers make profits by buying and selling stocks with their own capital, taking in the spread between the bid price and the ask price and the spread is the main source of income for market dealers.
Market failures can prevent competitive markets from delivering efficient and socially beneficial outcomes. For example, information asymmetry and transaction costs impair the ability of investors to monitor the activities of issuers and to enforce their rights under securities transactions. This can result in fraud, malpractice and misleading or deceptive trading.
3. Conclusion
The world's capital markets have faced a traumatic event with the aftershocks of the US sub-prime market crisis which continue to reverberate around the global financial markets. This has caused a number of the world's economies to suffer or to plunge into a recession. Certainly the financial markets of the world face the most severe turbulence of recent times. Consequently, the US government wants to minimize market risk and protect investors’ interest in every possible way. A regulated market may surely be a solution but at the same time imposing a regulated market on small and medium enterprises may undermine their efficiency. Moreover, the existing changes in the securities laws are already affecting the non regulated markets and further amendments may eventually make them less competitive.
With increased regulation, the unregulated markets are finding it more and more difficult to survive. To ensure their success, these markets have to develop strong self regulations so as to attract investors and remain competitive.
References:
- http://www.seccom.govt.nz/speeches/pre-1998/jfs160497.shtm
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http://www.economywatch.com/stockexchanges/mauritius.html
- www.google.mu