Let's talk about shareholder activism. After all, activism has reached dizzying heights this summer and it's likely to stay there for a long while. That will eventually affect all operations of a business, including its regulatory compliance and audit programs.
Oh, you thought I meant those Occupy Wall Street protesters? No. Those protesters are people; I'm here to talk about shareholders—who, by and large, are no longer human beings.
Shareholders these days are automated computer trading programs, buying and selling shares of your company all day long. These programs trade based on algorithms, and many of them exist solely to exploit weaknesses they perceive in other trading programs' algorithms. They own your shares for perhaps a few milliseconds at most, which means they don't give a damn about your profits, revenues, corporate culture or financial integrity. The only thing that matters is share price.
How much of the churn that we see on Wall Street can be attributed to high-frequency trading? Nobody knows precisely. But estimates are that “HFT” accounts for 2 of every 3 trades on U.S. markets, and 70 percent of the total dollar value of trades on any given day. By any measure, HFT has come to dominate Wall Street trading. All the wild volatility we've seen lately is not the collective wisdom of human traders predicting where the economy will go; it's just automated trading, looking to exploit a mathematical edge 1,000 times a second—on a slow day.
This has several implications for compliance departments. First is the regulatory wave gathering energy against HFT. The Securities and Exchange Commission adopted new reporting rules in July for HFT traders that are the first step in creating a consolidated audit trail, so the SEC can better investigate phenomena like the flash crash of May 6, 2010. The rules apply to anyone who trades above a certain number of shares (2 million in a day, or 20 million in a month), or above a certain cash value ($20 million in a day, or $200 million in a month). Large traders must now submit a Form 13H to identify themselves to the SEC, and obey numerous rules for monitoring the trades they and their customers transact. Those rules went into effect last week.
Across the Atlantic, meanwhile, the European Union has proposed a 0.1 percent tax on financial transactions. The logic is simple: the more an activity is taxed, the less people do it—so if you tax high-frequency trading, you'll see less of it. Yes, the result will be fewer trades, but those trades (at least in theory) will be more deliberate and focused on long-term investment.
The governments of European nations aren't thrilled with the tax; Treasury Secretary Timothy Geithner has said he doesn't like the idea either. And of course, at the best of times EU regulation moves more slowly than molasses on a cold morning. But the transaction tax is a step in the right direction.
Critics will say that by imposing HFT taxes in one place, you'll simply drive high-frequency trading to other exchanges. That's theoretically true, but to my thinking it actually underscores the broader point that in a globalized financial environment, we need globally standard financial rules and should be imposing the same HFT taxes around the world.
They'll also say that high-frequency traders add to overall market liquidity (When was the last time you couldn't sell a stock?), which drives down the costs ordinary investors pay for trading. I've never bought that argument. If an investor is going to hold 100 shares of Apple stock for 10 years, why would he care that a broker charges him $9.99 or $19.99 to place that trade? That $10 difference is a rounding error over the long course of investing, which allegedly is the timeframe investors should consider. Likewise, if you're dumping a loser for tax purposes, the extra $10 cost isn't going to change your mind.
That idea of slower, more deliberate markets is the second implication compliance officers should consider; in fact, you should strive for it. High-frequency trading divorces share price from business fundamentals—and as soon as that happens, senior leaders in the corporation are pressured to focus more on the former at the expense of the latter. We still compensate huge numbers of employees based on share price, and if high-frequency trading causes all sorts of share price gyrations, employees focus on how to keep the price moving in the right direction. Strategic decisions can't be made properly. Good conduct gets pressured. Once you start fumbling those fundamentals, then real human beings—corporate raiders, Justice Department investigators, the media, Wall Street protesters—do start showing up.
And that's a level of activism no compliance officer wants to see.