So far this year, there has been a great deal of media attention surrounding the private company marketplace (PCM) or what is commonly called, the secondary marketplace due to the nature of shares it currently trades. While there are some who feel that this marketplace is nothing more than a thorn in the SEC’s side or a means for dead grandmothers to acquire shares of hot social media companies, many, like myself, believe that we are witnessing the embryonic period of the next big stock market.
To substantiate this theory, I spent the last few months delving into stock market history. I discovered that once upon a time, not long after my old college friend, Jill, used her first protractor, there was a little-known marketplace about to blossom into one of the world’s most recognizable brands. If I would have stated back then that this marketplace, once branded a “moribund backwater of the security industry”,[i] would go on to exceed the New York Stock Exchange in global dominance and even make an offer to purchase it outright, you would have presumed I was I dipping into Charlie Sheen’s premium stash. But, as history has revealed, the marketplace we all know as NASDAQ, had emerged from relative obscurity and became the most powerful stock market in the world.
Unbeknownst to most, NASDAQ’s road to iconic status is strikingly similar to the one presently being paved by today’s private company marketplace. Its ancestry dates back to the earlier part of the last century when regulators searched for a way to oversee over-the-counter (OTC) trading of smaller companies whose shares were not welcomed on the New York Stock Exchange (NYSE). Analogous to today’s nascent marketplace for private company stock, the marketplace for OTC stocks was, for much of its existence, a fragmented one residing in a completely alternative regulatory universe. In the pre-NASDAQ years, when listing requirements and real-time quotes were essentially non-existent, most firms that made markets in OTC stocks did so without the knowledge of an issuer’s financial condition or even an accurate bid-ask spread.
In fact, according to The SEC’s Special Study of the Securities Markets in 1963, 25% of OTC issuers did not furnish any financial information whatsoever, and that the data supplied by the remaining 75% was appallingly deficient. Without privy to even the most basic fundamentals, share prices were quoted purely in response to order flow. The 1964 Securities Acts Amendments, following the Special Study, unexpectedly led to a boost in share prices of OTC securities as a heightened level of integrity and investor confidence penetrated the marketplace. Most notably, though, this legislation unwittingly laid the groundwork for NASDAQ to emerge and forever revolutionize the way securities are traded and capital is created across the globe.
NASDAQ was officially born on February 8, 1971. By 1982, it had grown to encompass 25 percent of all market trading. From 1983 to 1993 NASDAQ grew from $153 billion in annual trading volume to $1.3 trillion, and in 1994 it had surpassed the trading volume of the NYSE. By mid-1995 the market capitalization of listed NASDAQ companies exceeded $1 trillion. Today NASDAQ lists 3,600 companies from 46 countries worth $5.4 trillion in market capitalization and has more trading volume than any other electronic stock market in the world.
While the regulators may have furnished the fuel, it was technology that ignited the NASDAQ rocket. Computers made it possible for a diffused network of dealers to obtain price and volume data on a real-time basis; setting the stage for NASDAQ to transform the OTC marketplace into the first fully automated stock exchange operating without a trading floor. Interestingly, the same technological ingenuity that made it possible to build NASDAQ’s trading platform is ingrained in the companies that went on to embody its composite. And just like the NASDAQ itself, its listed companies came to epitomize both innovation and growth.
It was NASDAQ, not the long established NYSE, that unveiled behemoth’s like Microsoft, Intel, Dell, Adobe, Cisco and Amazon. More importantly, NASDAQ introduced us to these darlings of Wall Street, not when they were billions of dollars in market capitalization, but when they were promising young companies about to make their mark on the world. Fortunes were made because NASDAQ presented investors with the opportunity to invest in a company prior to its greatest growth spurt – not after it had already passed. While the brick-and-mortar exchanges traditionally barred these smaller companies from listing, thereby obstructing their access to capital, NASDAQ would enthusiastically seek them out. Embracing our most innovational during their most crucial expansionary phase not only distinguished NASDAQ from the other exchanges, but enabled it to become the greatest wealth producing engine the world had ever seen. As a result, it did not take long for that “moribund backwater of the securities industry” to morph into, “the crown jewel of American capitalism”. [ii]
In the beginning, the issuers listing on NASDAQ viewed it as a stepping stone to the conventional exchanges. Then, as time went on and the multi-market-maker approach proved to be a more favorable liquidity system, most of the higher profile companies such as Apple, Intel and Microsoft chose to remain with NASDAQ, despite strong persuasion from NYSE. As NASDAQ aged, it became evident that pandering to larger caps, even at the expense of America’s smaller cap, was its new mantra. With more stringent listing requirements, NASDAQ started looking less like NASDAQ and more like the traditional exchanges. Not surprisingly, its role evolved from an intermediary platform to a more competitive one. The marketplace that once incubated young companies to large cap stardom, today, idly awaits their maturation alongside the other major exchanges. By deserting small caps, NASDAQ left the financial markets with a gaping void in capital formation.
With NASDAQ’s motor at a grinding halt, the birth of a new capital creation machine was not only inevitable but critical to the entire capital markets ecosystem. Today, NASDAQ’s most important function, grooming young innovational companies, is being replaced by cutting-edge private company platforms such as Gate Technologies, SecondMarket, Sharespost and Xpert Financial. The same principles and innovation that once propelled NASDAQ to unforeseen heights is now energizing the private company marketplace as an aggressive new generation of technology companies, able to create value far faster than was ever possible before, remain private longer.
As we embark upon this next evolution of our capital markets, it is worthy to note a few significant distinctions. Because there is no way of shorting or margining private company shares, the PCM, unlike NASDAQ, is not conducive to leverage, derivatives or manipulation. Instead, it is a marketplace that encourages shareholders not traders; growth not speculation. Whereas the public markets breed volatility, the private marketplace upholds stability. Although what NASDAQ accomplished during the last technological revolution was unarguably momentous, it was not without its flaws. This next iteration of the OTC markets is not only given a clean slate, but the gift of hindsight. By preserving NASDAQ’s greatest attributes and improving upon its shortcomings, we have an unprecedented opportunity to unleash the most superior wealth generator the world has ever encountered. Imagine the economic impact of an untarnished, less volatile, pro-small-cap marketplace, rising today, during the most remarkable era of technological achievement. With this alignment, the possibilities are limitless.