Ecosystems are made up of many different moving parts—whether we’re talking a biological ecosystem, or a financial one, each part has a role—and just as surely as those roles ensure longevity, they also evolve. The financial tech sector has evolved many times over, from technology growth to legal policies, innovation drives business.
As trading and liquidity principles and practices progress, financial experts continue to find solutions to a variety of problems—like the lack of access for small-cap trading. Even though clearing brokers won’t hold private securities and the traditional public-markets settlement infrastructure doesn’t work for these transactions, Prime Trust and other technology-driven custodians are creating systems to allow smaller businesses and entrepreneurs to succeed.
- Why is it important for businesses to be able to go or stay public? How does this specifically hurt entrepreneurs and/or small businesses?
Regulations, including but certainly not limited to Sarbanes-Oxley and Dodd-Frank, make it practically impossible for businesses and real estate funds to go (or remain) public. Additionally, regulations surrounding decimalization, research, and suitability have made it impractical for brokers to sell or make markets for small-cap stocks. Thus the public markets are effectively closed to all but the very largest businesses (to raise capital) and their shareholders (for liquidity).
Imagine taking delivery of the physical certificate for the Apple stock you own and then trying to sell it on NASDAQ. You couldn’t. Traditional clearing brokers can’t (or won’t) custody private securities. Their settlement systems aren’t built for these, the volumes aren’t high enough to interest them, and the regulatory and litigation risks are far too high given their required compliance with 15c3-1, 15c3-3, and other regulations. Small business and small-cap stocks can’t succeed in this system.
- How do Alternative Trading Systems (ATS) solve problems of liquidity and access?
Alternative Trading Systems provide subscribers the ability to match buy and sell orders on a smaller scale. They are not regulated as an exchange like the DOW or NASDAQ, but matches buy and sell orders with its subscribers. Because ATS don’t set regulations or discipline practices like most national exchanges, they provide a needed alternative for liquidity for small-cap stocks and smaller investors. Most ATS deals are registered as broker-dealers, not as an exchange. By finding counterparties for these matches, it’s not just large businesses and institutions that have access to liquid capital. As of 2015, ATS accounted for 18% of all stock exchanges since 2013.
- What are the big tradability problems that have been created by previous regulations and now with current ATS regulations?
Regulations hamstring small-cap public stocks by effectively depriving them of research, market-makers, and selling brokers. Private securities are effectively more tradable thanks to new regulations issued pursuant to the JOBS Act but, thanks to regulations which focus on public securities but are nonetheless applied to clearing brokers, there just isn’t the clearing and settlement infrastructure to support the ATS’ in their quest to enable liquid markets for non-DTC eligible interests in small businesses and real estate projects.
Regulation D securities generally need to be held for a year before they can be traded, and kept to less than 2,000 shareholders of record (and less than 500 non-accredited shareholders) unless they register pursuant SEC Rule 12g. Also, interests in Special Purpose Vehicle’s created pursuant to ’40 Act exemptions need to be kept to less than 100 beneficial owners. These alternative exchanges also need to build in the databases to include original offering documents, histories of payments (if any interest, royalties or other payments are part of the security), company financial disclosures (usually unaudited), and third-party research, if any, so investors have at least some data. An ATS will need to get their arms around all of these issues moving forward.
- Where does Prime Trust come in?
Fortunately, the FinTech ecosystem is starting to evolve. Even though clearing brokers generally won’t hold private securities and even though the traditional public-markets settlement infrastructure doesn’t work for these transactions, Prime Trust and other technology-driven custodians are creating systems to accomplish these things. This solves the issues of custody, settlement, good-delivery and 12g regulations. And it’s working, as evidenced by something that didn’t exist a year ago: our settlement platform “PrimeX.” PrimeX executed 600,000 counterparty transactions in Q1 of this year, which even though mostly cash and cryptocurrency, the platform is asset-agnostic and so will settle transactions of private business and real estate interests securely and in a frictionless way. With the SEC and FINRA becoming more comfortable with trust and custody solutions (noncustodial broker-dealer models) for private securities, trust companies like Prime Trust will play a pivotal role in the growth of ATS and creation of efficient and orderly secondary markets.
- What are the biggest opportunities right now for businesses and executives to get into this system for this future state? What’s on the horizon?
This movement and evolution are largely formative at the moment. The ATS applications are still in process, the SEC is still getting their arms around how this world will take shape, and the brokers, issuers, trust companies, transfer agents, and other market participants are still defining how this system will come together. The opportunity right now is to be one of the first-movers and help define the next generation of capital markets. It will be a long and expansive effort that requires time, patience, and capital. Over the next couple of years, we will see a slow growth in liquidity and trading of private securities of businesses and real estate. Eventually it will catch on, the buy-side will emerge and things will accelerate.
About Scott Purcell
Scott Purcell is the CEO and Chief Trust Officer of Prime Trust, an innovative API-enabled B2B open-banking financial solutions provider. His firm provides custody, trustee, escrow, AML, KYC, payment processing, accounting, and compliance for numerous OTC desks, exchanges, stable coins, platforms, broker-dealers, investment advisers, portals and others who are building businesses that are changing the world. Before forming Prime Trust, Mr. Purcell founded FundAmerica, a financial technology firm providing software and back-office services to banks, trust companies, broker-dealers, investment advisers, securities exchanges, SEC-registered transfer agents, and large issuers (primarily real estate companies). He is a founding Board member of the Crowdfunding Intermediary Regulatory Association (CFIRA), the “Industry Best Practices for Funding Portals” and “BD and Registered Portal Regulatory Mechanics.” He also started a fixed income trading firm, a clearing broker for institutional investors and published the book “The Guide to Fixed Income Investing.”
In 1994 he founded Epoch Networks, one of the world’s first internet service providers and, as a Board member of the Commercial Internet eXchange, often represented the nascent industry before Congress and the FCC. In 1999 he founded OnAir Networks and built the first music storage and streaming services for Sony and Universal. During this time, the Recording Industry Association of America retained him to advise them on internet technology issues and copyright matters and to represent the recording industry before Congress as their technical advocate for intellectual property rights.
Disclaimer: This content does not necessarily represent the views of IWB.