Underwriters & Market Makers

Underwriters & Market Makers By William Cate Brokerage firms are in business to make money. They are not in the business of building viable companies. Nor, are they in the business of making their clients rich. Stockbrokers are salespeople. They are not investment advisors. Anyone who ignores this axiom will lose their money in the Market. Market Makers The textbook definition of market maker is a thing of the past. The broker isn't making a market in any stock trading on the Over-the-Counter, Over-the-Counter Bulletin Board or Nasdaq Small Cap markets. You can't expect your market makers to support your share price. In the past, a market maker would attempt to keep a neat market by trying to balance the bids and asks. They would trade the stock on their own account to maintain a stable share price during times when there was not a match of sellers to buyers. This practice would greatly enhance the liquidity of the market and diminish volatility. Today, most of the brokerage houses trade stocks short for brokerage houses profits. It's the second most important source of income for most brokerage firms. The ease of selling short is why so many hyped stocks have so many market makers. Under NASD (National Association of Securities Dealers) Rules every stock trade represents two commissions. There is the commission paid by the brokerage firm client. Computerized trading allows wire houses to charge a few dollars to the client for the trade. Computer trading has reduced client commission income to levels that require the brokerage firm to increase the other NASD allowed commission. This commission is called "the spread." Marker makers make money by paying the buyer and seller less money than the trade would cost them, without the market maker. The worst spreads occur in the OTC Market. 50% commissions on very low priced shares are fairly common. The OTC shows the Market Makers Bid/Ask and not that of the buyers or sellers. The market makers don't want the investing public to know the true bids and asks that are available. The market makers license to steal would evaporate. Unless your equity finance consultant knows how to limit the spread problem, your shareholders have paid too much for your stock. Potential investors will pay too dearly for their shares. As a public investor or public company, your job shouldn't be to make the market maker rich. The spread allows the market makers to make money at the expense of the public and traded companies. In fact, the SEC and NASD should limit the spread to 3.5%. However, that doesn't appear likely in the foreseeable future. Historically, there has always been a tendency in NASD Markets to sell short the NASD traded companies. Market makers sell nonexistent shares and thus expand the float. The Stockgate Scandal reflects a real and deep-seated type of fraud in the NASD Market. The SEC appears to be working very hard trying to ignore the Stockgate issue. Unless the company's advisors can devise a poison pill defense against nonexistent shares, most market makers are short sellers of the company's shares they trade. Short selling guarantees the eventual collapse of the company's share price and in almost all cases, the company's fall into bankruptcy. Market makers defend their excessive spreads and sale of nonexistent stock by pointing out that most public companies are scams. They see themselves as garnering the scraps left behind by the swindlers and crooks. Their argument being that if the investing public is dumb enough to buy shares in a company with no hope of success, what difference should it make to the public who steals their money. Underwriters The Big Rock Candy Mountain for most CFOs of private companies is to find an underwriter offering to do a "firm commitment" underwriting. More often than not, the candy is made of cyanide. Here are a few of the reasons why doing an Initial Public Offering (IPO) is usually a mistake for a private company. 1. There is no such thing as a "firm commitment" underwriting. Read the fine print in the agreement and you'll find that your underwriter can withdraw from the agreement, without penalty, at any time. 2. The average cost of doing a SB2 Registration with the U.S. Securities and Exchange Commission (SEC) now exceeds US$3 million. Your odds of getting a SEC "Effective Letter" in over a year are about even. Doing an IPO is betting against the odds and usually with borrowed money that the company can't repay. 3. The NASD (National Association of Securities Dealers) allows the underwriter to charge the company 18% of the money raised. This is a 10% discount on the share price, a 5% payment of accountable expenses and a 3% payment of non-accountable costs. The 3% payment is due with the signing of the "firm commitment" underwriting agreement. It isn't refundable. 4. If you have a hot IPO, like Google or Ebay, you will pay far less than 18% of the funds raised to do your IPO. If you have a typical IPO, you will pay more than the 18%. Requiring the company to supply a percentage of the IPO buyers to the underwriter does this. In almost all cases, a public company is better served doing a Private Placement (PIPE financing) rather than an IPO or a secondary offering. CFOs that fail to seek outside equity finance advice are certain to become victims of the hundreds of pitfalls that await the unwary in the public marketplace. They are very unlikely to find the money their company needs. Speculative investors who think the public market is their Big Rock Candy Mountain are certain losers. They should join a venture capital club or subscribe to a newsletter with a better Market plan than getting rich quick now. For the average investor, the odds of winning their State's lottery are better than their odds of making a major killing in speculative stocks.