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A LETTER TO SENATOR DURBIN
Published: 9/14/10

May 18, 2010

The Honorable Richard Durbin 309 Hart Senate Building Washington, DC 20510

Dear Senator Durbin,

It was almost a year ago that I wrote you a letter regarding our capital markets. The events of May 6th compel me to reiterate my concerns. Again, I am a registered investment advisor so I do make my living from investing and markets so my concern is professional as well as personal.

The fact that extreme market dislocations occur is very disconcerting and potentially very damaging. These actions cause the average investor to lose faith in the system and that can be catastrophic for US business. If listed businesses can no longer find financing from the savings of the US worker, the growth that we have enjoyed for hundreds of years will be in peril. The entrepreneurial spirit that makes this country the greatest growth engine in the world will be dampened and damaged.

Remember the purpose of stock is to allow businesses to finance their growth and allow the average citizen to share in the profits of that business. The exchanges and OTC markets were established to facilitate a secondary market that permits the purchase and sale of these securities. That way every buyer knows that she has the ability and means to enter or exit a position easily.

Now market makers are an entirely different actor in this environment. They, at their best, provide liquidity to the market and order to the process. If their primary motive is profit, that is fine. That is the same motive for all the players and can be mutually beneficial. The problem occurs when their actions do not support this process. If their presence becomes a detriment instead of a benefit, their presence must be examined.

Many of the liquidity arguments by these traders are disingenuous at best. Dark pools obscure information by design the exact opposite of the open, transparent market that equities need to flourish. In other words, they are anathema to the primary goal of the secondary markets. Also, the high frequency traders that dart in and out of markets subvert the system. They jump in front of resting orders that establish the market and maintain order. Usually, these traders provide fills to retail clients at a 1/100 of a penny better. This miniscule difference doesn’t assist my clients, but it certainly hurts the true market makers; the ones that show their orders on the various systems. The traders that truly provide liquidity.

What can we do to remedy this situation? First the SEC should hire more ex-traders that understand the machinations of these markets. There are plenty around Wall Street with decades of experience. A few more marketers and a few less attorneys would serve the SEC well.

Next, compel the various exchanges and players to acquire a better understanding of their own constituents. When I hear them at a Congressional hearing stating they do not know what happen, I am amazed. They should know what happened. It is their business to know what happened. Otherwise it certainly will reoccur.

Finally, allow all participants to invest or trade if they so desire. Just make all transactions open and transparent. There is no legitimate excuse for hiding trades, offers, bids, or any other transactions except to tilt the playing field in one direction. Also, all trades must be traceable to an individual or a company. There is no legal rationale for hiding ownership in any capital market.

Finally, as I previously averred, do not allow tax deductions for losses on positions held less than one week; even against short term gains. This will eliminate the type of trader that does not facilitate the market only gains from the manipulation of it.

All players in this arena should contribute to the system not just profit from it. The final investors provide capital for business; the primary purpose of stocks and bond markets. True traders that place orders and make markets provide liquidity. Both groups hope to gain wealth from their actions which is fine. All of the participants should fall into one these two categories and assist in the ultimate progression of building US business. Otherwise, they are merely parasitic entities that prey on the legitimate players that make US business what it is today.

Sincerely,

Martin Gallagher, CFA

Written by: Marty Gallagher

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