A Dive Into Dark Pools

Earlier this week the luncheon topic for the NIRI Houston chapter was “Dark Pools”. This is a subject that has received much press lately, most of it with ominous overtones to accompany the rather sinister name, so I went with much anticipation, much like you’d go to a scary movie. I have to confess that I knew very little about all of this before I went, and when the luncheon was done, I was more confused than ever. So on the premise that I can’t be the only one who is confused, I decided to do a little more research and, at the expense of stretching a metaphor, try and shed some light on Dark Pools.

First, what are these things? As I understand it, a Dark Pool is an electronic crossing network that allows buyers and sellers of stock to place liquidity (an offer to buy or sell) into a pool anonomously and wait for execution while disclosing little, if any, information. Only when an order is executed is the information on the trade made public. To use a phrase from Bruce Springsteen, these market participants are “Dancing in the Dark”. This is in contrast to normal markets where public order flow allows market participants to judge supply and demand for a stock and adjust accordingly.

Second, are these things inherently good or bad? The ostensible purpose of Dark Pools is to allow holders of large blocks of stock to execute their buy or sell orders without indicating to the markets what they intend to do. Therefore Sellers can sell without driving the price down and buyers can buy without driving the price up. The pricing is done within the Best Bid or Offer context of the National Market System, so price discovery is occurring using normal market systems. This seems like a good thing if you are a large institution looking to move large blocks of stock. Additionally, if you are looking to buy or sell a relatively illiquid stock, dark pools can help you do so with a minimum of price disruption. If you are a company, it would seem that this balances itself out, especially when you consider that institutional investors trade approximately 80% of the stock volume in the U.S.

Third, why the big deal about all of this? Follow the money. The Exchanges – NYSE and NASDAQ, hate these things because they pull significant amounts of orders off the exchanges, which means less order flow and less earnings for them. Traders and specialists hate them because they obscure market information and eliminate trades that they would otherwise execute by putting it all into a machine. This eliminates both the lifeblood of traders – information – and jobs. So much volume has come off the floor of the NYSE that there are significantly fewer traders these days and they have been forced to close trading rooms.

Finally, are there things that should be of concern? If too much volume comes off of the visible Bid/Ask market system, the bids and offers shown on the publicly displayed market quotation system might not accurately reflect true supply and demand. This is why we are seeing rumblings by the SEC to regulate areas of dark pools if too much volume is traded in them. (The nature of regulators is to regulate.) While dark pools are good for large institutional investors moving large blocks of stocks and companies that trade using sophisticated algorithms, it is considerably less clear that they offer any benefit for anyone else.

I think what is happening here is that technology is opening up new channels for trading and moving things away from the old duopoly of the NYSE – NASDAQ. As they are the ones with the most to lose, they are also the ones that will yell loudest. At the end of it all, the lesson is that not all investors are equally suited to all markets. With the emergence of several new ways to trade stocks we are moving away from a “two markets fits all” approach to customized execution based upon the needs of the investor. Many permutations on order execution are bound to follow. The exchanges better figure out how they fit into all of this or they will be left behind.

More On Social Media and Investor Relations

My goodness gracious, but social media seems to bring out divergent opinions among investor relations professionals. My post last week elicited more responses, both in the form of comments on this blog and in emails, than anything I’ve written over the past two years. Interestingly, the opinions voiced were pretty evenly split; half of the people were proponents of the use of social media in investor relations and half didn’t see the point. Even more interestingly, the half that supported the use of social media were generally those that posted a comment on the blog, while the half that admitted that they, like me, didn’t get it, sent me a one-on-one email.

I thought it might be useful to distill down some of the things I’ve learned over the past week as I have dipped my toe into the waters of social media. In no particular order, here are some of the things I’ve found:

1. Sign up for things and people will start finding you.

In doing research on this topic, I set up accounts on facebook and twitter and worked on updating my linkedin profile. One thing I discovered is that all of a sudden, people started to ask to be my friend on facebook. I don’t know how they knew I was out there, but they found me. The same thing, to a lesser degree, happens on linkedin, but there I can at least see how it happens, as the site shows you how people are linked.

2. You may already be on Twitter.

After I signed up for twitter, I discovered that you can sign up to follow a link called IRbloggers. Lo and behold, when I went there, my latest blog post was listed with a link back to the blog site. Who knew? A close analysis of some of the statistics from my blog shows that for the last month, twitter is actually the fourth most frequent means by which people get to my blog. This is a recent phenomenon, as the same analysis over the past year shows twitter well down the rankings as a referral site.

3. Twitter can get your message out fast.

Perhaps the most common reason cited for the use of twitter is its ability to let people know quickly that more information is available elsewhere, with a link back to the full information set.

4. Twitter can let you know what’s going on in the virtual universe.

Assuming you subscribe to the right feeds, or follow the right people, twitter can give you fast insight into what people are thinking in the webosphere.

5. You can waste a lot of time on this stuff.

Following all the links and feeds takes time, which for most of us is a precious commodity. Robin Tooms, of Savage Design and a social media maven, during Q & A at her Social Media Boot Camp at this year’s NIRI Southwest Conference estimated that she spends an hour to an hour and one-half per day on social media. Personally, I don’t have that kind of extra time in my day and if I did have the extra time, I would want to be somewhere other than in front of my computer.

6. A lot of the stuff is irrelevant or garbage.

Even on a twitter follow site as targeted as IRbloggers, 90% – 95% of what comes across has no relevance to me. Do I really need another distraction in my day wading through the dross to find one or two relevant pieces of information?

7. The digital tsunami is descending on us and we might as well learn how and when to swim.

Where all this comes out no one really knows. The proper etiquette has yet to be figured out. There are certain to be fits and starts into how it comes out in the end, with plenty of unintended consequences along the way. Just because you can be connected 24/7 doesn’t mean that you should be. I’m always amazed when I see analysts who have flown thousands of miles to attend a meeting with management ignore the person in front of them, assume the “Blackberry crouch” and start dealing with emails and other items on the web. Not only is this incredibly rude, but it also makes you less effective for both tasks that you are undertaking. Maybe they’re trying to find the extra hour or two to deal with all the additional information they are being deluged with. In a counter reaction to this type of behavior, this year, for the first time, at the Jones Graduate School of Business, we have to include a statement in our course syllabus banning the use of laptops and cell phones during class because the preponderance of students were not using their laptops for note taking.

I could write more, but I have to go now and update my facebook wall…

Investor Relations and Social Media

Every generation has a point in the development of technology where they hit the wall. For my grandparents’ generation it was color TVs. My grandparents could never seem to be able to tune in their color TVs so that people looked normal – they always had a reddish or green tinge to their skins. For my parents’ generation, the people who were able to survive the Great Depression and World War II, cell phones have stopped them cold. Today’s seniors just don’t seem to be able to grasp what all those cool features on the phone are for – and why would you want a camera on your phone anyway? While I don’t claim to speak for my entire generation, for me, my technological Waterloo has been social media.

I don’t think of myself as a Luddite. After all, I write a blog, my business has a web site, I have an iPhone and I work on a computer most days. I’ve even learned how to send text messages on my phone, as it is the fastest way to get a response from my three college age children. But I confess that twitter and facebook have me stymied. I just don’t get it. Twitter because I’m incapable of saying anything in 140 characters or less and facebook because why would you want to put all that information out there in the public domain? And because I don’t get the social application of these services, I certainly don’t understand their application to investor relations.

First, let’s start with our friends at the Securities and Exchange Commission. The SEC has been very clear that all of the rules that apply to disclosure of information in other contexts also apply to social media. So I guess that means that if you inadvertently twitter a piece of material, non-public information, you must issue a press release as soon as possible thereafter. Of course, if you’ve taken the time to type out the information, I would question how “inadvertent” the disclosure was, which means that the press release should have been issued either before or simultaneously with the twitter. And how do you write a “Safe Harbor” disclaimer in less than 140 characters? These are the sorts of things that will drive your securities law lawyer to distraction, so they are quite possibly inclined to say that you would be better off not twittering about investor relations topics in the first place.

Secondly, who has the time? We all live days that are filled with lots of information flow, meetings, phone calls and other demands on our time. Do you really need another distraction, particularly one as unfiltered as social media tends to be? In a business context? I remember in the early days of email having a colleague extol the virtues of email because it bypassed all the filtering layers of a corporation, allowing anyone to communicate directly with you. These days I look at the constant stream of email that flows through my computer and sincerely wish for better filtering devices. And I don’t even work in a corporation, with its constant stream of emails from Human Resources, Security, IT, meeting and calendar reminders and notices of the annual golf outing, charity events and other odds and ends.

Finally, let’s not forget the primary mission of investor relations, which is relating to investors – making sure they understand your company and its prospects so that they can accurately value the company and its stock. Call me old fashioned, but I believe that this means that you actually have to talk to investors, listen to their questions and give them thoughtful responses. For that, the best, most efficient piece of technology that you have was invented in 1876. It’s called the telephone.

I suppose that over time social media will create a niche for itself in business, but for the present, to me, it seems over-hyped. I believe that truly sophisticated technology simplifies you life rather than adding more complications. And I don’t see how social media makes your life simpler.

More on Activist Investor Situations

As I wrote last week, the highlight of the NIRI Southwest Regional Conference this year was a case study on how activist investors swoop in on a company that is experiencing operational and governance problems. That is not to say that the case study was the only thing we learned from. Damien Park, who runs a firm devoted to helping companies who find themselves in these types of situations called Hedge Fund Solutions, opened the conference with some interesting facts about activist investors. Here are some of his observations, mingled with my views on the situation.

Activist investors will have studied your company for an extended period of time – often a year or longer. This means that they are not acting on impulse but rather have thought through exactly what they want to do. The company, in the meantime, is often caught unawares, much like a deer in the headlights of an onrushing truck.

To this I would add that companies compound the time crunch by the committee structure to how they react in these situations. The CEO, COO and CFO get together and discuss the problem. Then they bring in their advisors – the general counsel, the investor relations officer, the corporate communications people and others and have another meeting. Then the Board of Directors schedules a meeting. All of this takes up that precious commodity, time.

As Damien pointed out, while the company is doing this, the activist has issued a press release and probably started giving interviews to the press. He probably is also saying that the company has not responded to his overtures. He may have already started to talk with other investors about how he thinks things can be improved at the target company. “Me too” hedge funds have started to buy up the company’s stock in anticipation of making a quick buck. Everything is designed to ratchet up the pressure on the company and the Board of Directors to force them to accede to the activist’s demands quickly.

The company, after an internal meeting or two (or three, or four) will come to the realization that they do not have the expertise in-house to deal on even terms with the activist and will start casting around for experts they can hire. This is one of the critical junctures of the process. Choose wisely and you may emerge unscathed; choose poorly and you may have a couple of directors on your board from the activist firm. Companies, especially the smaller capitalization companies that tend to be the focus of many of these types of attacks, generally don’t know the right people to call.

From what I can see, there are a limited number of firms that specialize in these types of situations and if you are a company under the gun, you want one of them. You don’t want your local outside counsel. You don’t want your normal public relations firm. This is like brain surgery – you want firms that have done this many times before and know exactly what the options are and are capable of acting quickly. Yes, they will probably be from New York and cost a lot of money, but now is not the time to be cheap.

One way to help prepare your company is to start to get to know the right firms before things go downhill. At a minimum you should have in your rolodex/contact list the following types of firms that work on activist shareholder defense situations: a law firm that specializes in this area, a proxy solicitation firm, a firm that is expert in the defense against activist investors, a public relations firm that has experience in proxy contests and shareholder activism and investment bankers that have M & A experience. There are a limited number of firms that have extensive experience in this area, so talking to all of them, selecting the ones that fit your company and you are comfortable with and maintaining a dialog is not that time intensive. And more crucially, when the time come that you need this type of advice, you will know the right people to call and save precious time.

Think of it as the Boy Scout defense: “Be prepared”.

IR and Activist Investors

Last week I had the pleasure of attending the National Investor Relations Institute (NIRI) Southwest Regional Conference in San Antonio. I’m on record as having said this before, but I think it bears repeating: I believe that the Southwest Regional Conference is a better learning experience for investor relations professionals than the National Conference. I say this because the Southwest Regional Conference is shorter – a day and one-half as opposed to two and one-half days and thus more focused and, with a smaller number of people in attendance, you actually feel as if you have a chance to get around and talk to everybody.

This year, under the leadership of Lee Ahlstrom, President of the Houston NIRI chapter, the Conference took an interesting departure from the usual lineup of speakers. The first morning saw everyone engaged in a case study examining the actions of an activist investor confronting a company with operational and governance issues. The case required everyone to participate, assuming the role of members of the Board of Directors, while members of management, the activist investor, and an institutional investor presented their side of the situation. The case drove home the incredibly fast pace of events in these types of situations, as members of the Board found themselves with large amounts of data, conflicting agendas and not much time to make a decision.

As someone who uses case studies to teach investor relations, I was very interested to see how things would turn out. After all, the audience was mostly corporate IR practitioners, who would normally be expected to side with management. I had worked on the case with Lee and a number of other professionals in the field and thought that the case was even-handed, presenting issues on both sides of the situation, but with case studies you never know quite how the participants will react. To my surprise, the overwhelming number of participants voted in favor of negotiating with the activist shareholder, recognizing the difficult realities of activist investor situations.

I would be the first to admit that a single case study result does not a trend make. But Directors face enormous pressure to do something in these situations beyond the Nancy Reagan defense (“Just say no”). Add to that the additional pressure Board members face when you consider Director’s liability and potential lawsuits, and you start to understand the leverage activist investors have.

As investor relations professionals we are often the early warning system for these troubles. If you are consistently getting questions about underperforming units or assets, you should let your management know. Hedge funds often talk to one another about investment ideas and when the same question keeps popping up it can serve as a warning sign. Similarly, if your corporate governance scores are low or your compensation practices out of line with your peers, you should be tactfully suggesting that the Board address these issues. Better that the Board act on its own than be forced to by an activist investor.

Finally, set up a program to talk to your major institutional investors to discuss items other than the latest quarterly results. Solicit input on governance issues, compensation and equity plans, with senior management present. You can do this either as a separate call or ask that you spend 5 – 10 minutes on the topics during your next non-deal roadshow. Those are the institutional votes you will need next time there is a potential proxy fight and you would be well served to have a history of listening to your investors on these issues rather than waiting until you are under the gun.

Corporate Communications and Ethics

What do you do when you no longer believe in the position or information your employer wants you to tell the public? If you hang around the business of disseminating information for companies long enough, this is an issue you may very well face.

Such was the position Wendell Potter, former Vice President of Corporate Communications at CIGNA, the health care insurer, found himself in a while back. His experience in seeing the human side of lack of health care coverage ran smack into his company’s opposition to health care reform and its practices of canceling health care coverage in order to write only the most profitable policies. Potter underwent a change of heart and wound up leaving his executive position at CIGNA in order to work for the opposite side of the argument. You can discover more about his actions and see his interview with Bill Moyers at www.pbs.org/moyers/journal.

The interview set me to thinking about the right way to handle such situations, either in an investor relations context or a broader communications context. What are the ethics of the situation? Does your duty lie to your employer or your sense of what’s right? When do you reach the point of walking away? What about your family that relies on you for support? You can’t predict how or in what circumstances these situations will confront you. Not all of us have a moment such as St. Paul on the road to Damascus, but if you have thought through some of the things you may face beforehand it helps clarify the issues when it becomes your turn in the penalty box.

First, there are the simple cases. At the egregious end of the scale, if your employer tells you to communicate something that is wrong or clearly misleading, and it’s material, you are obligated to say no. For public companies, disseminating false or misleading material information is a violation of federal securities laws and no employer can make you break the law. If your choice is between going to jail or being unemployed, better to be free and poor than employed but awaiting sentencing.

At the other end of the scale, there are the things your company does which you may not personally like but which you have to defend. Corporations are profit-maximizing entities that sometimes close divisions or plants at great human cost. You may not like the particular actions in question, but they are for the long-term health of the corporation and its shareholders, so you swallow hard and stick to the company talking points. Welcome to the real world. As long as you can get up in the morning and look yourself in the mirror, you should be OK.

But what if things fall somewhere in the middle or you can no longer look yourself in the mirror? You become convinced your company is wrong, or headed down the wrong strategic path? They are not doing anything illegal, but they are doing things you don’t agree with. At what point do you get off the bandwagon? Are there things you can do to prevent what looks to be inevitable or are the only options quit or keep your mouth shut? I wish I had the answers for those questions, but they are often very dependant on the exact situation a person finds themselves in, and each of us must find our own ethics path, often without much help from anyone else. There are however, a couple of books that might be helpful to the process. Joseph L. Badaracco, Jr. a Professor of Business Ethics at Harvard Business School, has written two books, Defining Moments, When Managers Must Choose Between Right and Right and Leading Quietly, An Unorthodox Guide to Doing the Right Thing. These books suggest strategies for de-escalating situations where ethical conflict may arise. In addition, Professor Badaracco recognizes in Leading Quietly that sometimes the small things we do in the name of self-preservation are OK. All of us have mixed motives in the business world, including the desire to stay employed. Sometimes it may be necessary to pick your battles, saving your moral stands for the important issues.

I haven’t presumed to provide many answers here. When faced with these situations, each of us must do what we believe to be right. The press celebrates those like Wendell Potter who take a clear moral stand. Certainly there is justification for this, as they have clearly sacrificed much to make their stand. But as Professor Badaracco points out in his books, there are often things we can do to dial down the potential conflict before it comes to an all or nothing stand. These may not be perfect solutions, but it’s not a perfect world.

Getting Useful IR Data for Free

Occasionally, while doing research on the web for something I’m working on, I will run across something that I didn’t know about, pause, and think, “Huh, I wonder if I’m the only one who hasn’t known about this until now?” Such was the case recently when I was engaged in research about the change in ownership of a company.

There is a web site, www.whalewisdom.com that I have found to be very useful in tracking change in investor ownership. The improbable name comes from (I think) the fact that they attempt to follow the investments of some of the largest hedge funds, the whales, and derive some measure of wisdom from what they are doing. The site is set up to help investors track the holdings of hedge funds, but it is also very useful for tracking the change in investor ownership of companies as well. The site has compiled data from SEC filings about investor ownership in companies and put it into reasonably useful form.

As most investor relations officers in the U.S. know, the Investment Advisors Act of 1940 requires that all investment advisors with assets under management of over $100 million file a report of their holdings on a quarterly basis with the SEC. The quarterly reports are known as 13 F filings and are helpful in understanding your company’s shareholder base. There is an entire cottage industry of firms that provide this sort of information to investor relations officers. Generally, this information tends to be expensive and bundled with lots of other services. The advantage of the Whale Wisdom site is that it’s free – and you don’t even have to register to use it. In this day and age of constrained budgets, that’s a big advantage.

There are several useful things you can do on the web site. You can select a company, yours, your competition or some other company, and see who owns them. You can look at ownership changes over time, as the information on filings goes back to September 30, 2007. I find this particularly useful, as when you look at a whole year’s worth of data, trends become much clearer then if you are looking at a single quarter. Are good, solid, long-term holders trimming their positions? Are more hedge funds moving in? Are you losing growth investors and getting value investors in their place? (I’ve seen this with several companies I follow closely as they have hit the wall on organic growth. When you start seeing lots of value investors, you know the P/E ratio will be a long time recovering.) You can even download the information to an Excel spreadsheet if you want to manipulate the data further.

Often times the investors themselves won’t tell you what they’re doing – the larger funds are particularly sensitive to this – so it’s up to you to figure it out. If the type of investor you are getting doesn’t match your story, it’s time to sit down and reconsider reality.

Another nice thing the site does is allow you to type in the name of an investment firm and see their holdings. So if you’ve got a new investor you’ve never heard of before, you can go see what else they own and get a feel for their investment style. You can sort their holdings to see how important you are in their investment universe. You can even see if the firm has any 13D filings, indicating the possibility that they may be a more active (read hostile) type of shareholder.

Due to the schedule of 13F filings – 45 days following the close of each calendar quarter – the information is not up to the minute. You wouldn’t want to rely upon it if you were in the middle of a proxy contest. But if you are interested in looking at longer-term trends in your company’s stock, this site is helpful. And the price is right.

Personal Note: Investor Relations Musings is taking a vacation next week, as I join 8,000 of my closest friends biking across the great state of Iowa in the rolling party known as RAGBRAI. If you are a faithful reader, do not fear, the blog will return in two or three weeks, as soon as I’ve had a chance to recover from my vacation.