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Saturday, September 28, 2013

Be A Little Angel

Starting this week, small investors for the first time can put money up to invest in the preferred shares of young companies.

Small investors gain access to a new asset class this week.

As a result of the JOBS Act of 2012, retail buyers can put money into the preferred stock of young companies that haven’t gone public yet. This portion of the legislation—more formally known as Jumpstart Our Business Startups—goes into effect on Sept. 23, and numerous Websites stand ready to help you become what is, in essence, an angel investor.

Companies raising funds on sites such as CircleUp, Crowdfunder, and AlumniFunder are allowed to advertise these offerings to what the Securities and Exchange Commission calls “accredited investors,” who must meet certain income and net-worth requirements. Once the new measure goes into effect this week, the promotions also can be made to nonaccredited investors with far fewer assets. However, the companies do have new registration requirements with the SEC to avoid fraudulent fund raising.

This is the same provision of the JOBS Act that will allow hedge funds to advertise to retail investors for the first time, but the returns possible from angel investing are more intriguing. According to the Angel Performance Project, published by Robert E. Wiltbank of Willamette University for the Kauffman Foundation, the average return for early-stage investments is 2.6 times the initial investment in 3.5 years. That’s much better than many investment classes, including hedge funds. However, there were wide variations in returns, suggesting risk, as well.

We took a close look at San Francisco’s CircleUp (, which focuses on businesses with revenue of at least $1 million per year that produce consumer goods. CircleUp members recently funded SmartyPants, a maker of gummy vitamins for kids and adults, as well as 18 Rabbits, which makes granola and snack bars. Rory Eakin, CircleUp’s co-founder and CEO, says his site has narrowed its investment selection for three reasons.

“We believe that the average retail investor is better at assessing consumer products than high-tech offerings such as cloud computing,” Eakin says. He also thinks the consumer-products industry is underfunded relative to other sectors, and that there’s a tremendous growth opportunity in this sector. “If we did tech, we’d be competing against venture firms and other institutional investors,” Eakin notes. Venture firms, he says, don’t have much experience doing due diligence on consumer firms, since so much of the industry concentrates on high tech.

Signing up is relatively quick and easy, though it takes a day or two to verify your identity and financial accreditation. Under the soon-to-expire rules, a household net worth of $1 million or more, not including your primary residence, or annual income of $200,000 for an individual, or $300,000 for a couple, puts you in the accredited-investor ranks. Once accepted as a member, you can browse available companies by location and industry, and converse with officers of individual firms.

THESE CONVERSATIONS, which take place on each company’s Forum page, can be extremely detailed. The answers from company reps are quite straightforward. In many cases, the companies are already producing goods, so you can go to a local store and check them out before deciding whether to provide financing.

The minimum investment varies by offering; some are as low as $1,000. CircleUp narrows the choices for members. It looks for innovative companies that already are generating pretty substantial revenue. The site has its own professional consumer-focused investors who evaluate each opportunity, handpicking those that go onto CircleUp. Members can suggest new additions to the site.

A key component of venture funding is an exit strategy. Eakin says that CircleUp hasn’t yet seen a company through to exit, as it was just opened in 2012 and the average holding period is 4½ years. Generally, this occurs through an acquisition, buyout, or initial public offering. CircleUp tries to focus on companies that could appeal to a larger brand or a private-equity firm down the road.

Is this an asset class you should consider? If you are willing to wait for a payout and do your homework, this could be extremely exciting. It’s a high-risk, illiquid asset class, but the upside is huge.

Published in Barron’s, September 23, 2013. 

Posted by twcarey on 09/28 at 12:07 PM
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Saturday, September 14, 2013

Toughen Up SEC Rules

The government should mandate higher standards and tighter compliance for the exchanges’ technology. Last week’s brief shutdown was just the latest snafu.

Would a proposed Securities and Exchange Commission rule have prevented the three-hour outage at Nasdaq in late August or the six-minute version that occurred last week? Probably.

The SEC is readying Reg SCI (Systems Compliance and Integrity) to replace and expand portions of the commission’s Automation Review Policy (ARP), which covers trading technology and systems. With their 60-day comment period finished, the Reg SCI rules—designed to get a better handle on Wall Street’s technology infrastructure and create more trading stability—are in a revision period with the implementation date still unclear. SEC Chairman Mary Jo White is a strong advocate. In many cases, the rules make mandatory what has been voluntary, and the industry has opposed them, mostly based on the cost of implementation.

Reg SCI would impose new standards on “key market participants,” such as exchanges and certain alternate-trading systems, clearing agencies, and automated systems that directly support trading, clearance and settlement, order routing, market data, regulation, and surveillance. Also covered would be the self-regulatory organizations: the Financial Industry Regulatory Authority (Finra) and the Municipal Securities Review Board. The SEC has said 10 dark pools, or private trading platforms, are large enough to be regulated, based on their 2012 volumes.

AFFECTED MARKET PARTICIPANTS would be required to establish, maintain, and enforce policies and procedures to ensure that their systems can operate and promote fair and orderly markets, and that they comply with all laws and regulations. They are also required to correct any system disruptions or compliance issues and to notify the SEC of system changes. Disaster-recovery plans would have to be tested at least annually, with a report on compliance to authorities.

Frankly, it’s surprising to me that such policies and procedures are still voluntary, given recent history. Nasdaq OMX Group (ticker: NDAQ), which is slated to brief the SEC this week about the Aug. 22 breakdown, has said that problem occurred because of a massive number of data requests from a rival exchange, NYSE Arca, that came in above tested limits. Nasdaq’s securities-information processor failed to handle the extreme message traffic. The messages included requests for price quotes.

In May 2010 came the “Flash Crash” that caused nearly $1 trillion in temporary paper losses; and in 2012 a tech snafu at Knight Capital led to the firm’s losing millions of dollars and ultimately being sold. Another tech failure: Facebook’s (FB) disastrous initial public offering, which spurred Nasdaq to make good on up to $62 million in systems-related losses.

Most responses to the proposed regulations are, rather predictably, against the added burden of new rules and requirements. Finra says, in its comment letter of July 8, 2013, that while it supports the goals of the proposed regulation, it is “concerned that the scope of Regulation SCI may be overly broad and may potentially encompass a large number of systems, perhaps unintentionally, which could diminish the overall focus and effectiveness of the proposal.” Finra considers the proposal too rigid, and would like the entities involved to have more discretion and flexibility in adopting their own policies and procedures. Its 43-page response makes numerous requests for clarification, using the phrase, “unclear and potentially overly burdensome” dozens of times.

Others suggest the industry has adequate incentives to fix the problems.

Not everyone on Wall Street agrees. One trading executive, who spoke on the condition of anonymity, insists tougher regulation is needed. He believes that, given their size, importance, and risk, the exchanges should be treated like public utilities and regulated as such. “They have a critical public function to fulfill,” he says.

Dave Lauer, a market-structure and technology-architecture consultant, thinks the regulations should also apply to broker-dealers, and has said that, “anybody with direct market access should be covered by Regulation SCI and have stringent and robust technology standards imposed on their processes.” The emphasis on competition has overwhelmed the need for stability.

Clearly there is room for greater technological stability. We will continue to monitor the state of these regulations, and how they affect the retail trader. 

Published in Barron’s, September 9, 2013

Posted by twcarey on 09/14 at 01:14 AM
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Saturday, August 31, 2013

New Online Broker Bucks the Tide

Industry veteran Doug Engmann’s latest venture will provide accounting, risk-management and sophisticated portfolio margining techniques for professional traders.

Bucking the online brokerage business’s relentless consolidation, industry veteran Doug Engmann has just launched a new firm that will cater to mid-sized proprietary traders, professional trading groups, and hedge funds. “I like to get into a business when others are getting out,” says Engmann, who’s spent more than 35 years in various parts of the broker-dealer business.

Engmann’s company, Sage Brokerage Holdings, recently acquired a small San Francisco institutional dealer, VT Broker, which it has reconfigured as SageTrader ( Clients will be able to trade equities, options and futures immediately, and later on fixed income and swaps will be added. SageTrader provides all of the back-end services that heavy traders require, including accounting and risk-management tools.

The creator of Sage has run a number of brokers serving proprietary traders, who trade their firms’ own funds. Among them were Preferred Trade and Fimat. The latter became Newedge Trading. When Engmann retired briefly in 2007, Newedge was gradually wound down, and its clients migrated to retail-focused brokers such as Interactive Brokers and thinkorswim. His previous customers, he says, find today’s trading technology interesting, but miss the service they once enjoyed. So Engmann’s new firm will try to entice these traders with “hands-on service at more efficient and reasonable rates.”

Engmann was working on other projects but says, “This opportunity to acquire a firm and work with my old team was too good to pass up.”

A key attraction for SageTrader’s customers is the ability to utilize portfolio margining, thanks to the firm’s real-time risk management system. Engmann was one of the pioneers of portfolio margining while at Fimat/Newedge USA from 2005 to 2007. This technique can significantly lower the capital required to place a trade because it takes into account both equity and options positions. An offsetting option reduces the overall size of the position, thus cutting the amount of capital required. To offer portfolio margining requires real-time account updates and a sophisticated risk management.

SageTrader won’t offer its own front-end trading system. “It’s easier for clients to choose their own front end and interface with us,” Engmann says. Among the possibilities are RealTick, NeoVest, Sterling Trader, InstaQuote and Silexx. These are all downloadable software packages rather than Web-based trading applications, and typically incur a monthly fee for real-time data. These packages allow traders to develop their own algorithms, which is appealing to very frequent traders and hedge funds.

SageTrade clears securities transactions through Merrill Lynch and Wedbush, while futures are cleared through ED&F Man Capital Markets. One advantage of its back-end transaction management system is that SageTrade can provide customers with a consolidated statement even if they are clearing trades at multiple venues. “We’re finding that very attractive for traders who handle multiple asset classes,” he says.

For lower stakes players, Capital One ShareBuilder ( has made mini options available . Mini options went live in mid-March on five stocks and ETFs, including Amazon (ticker: AMZN), Apple (AAPL), Google (GOOG), SPDR Gold Trust (GLD) and the S&P 500 Index ETF (SPY). They allow investors to trade contracts that represent 10 shares rather than the standard 100 shares. ("Apple in Small Bites,” Barron’s, March 4.)

Dan Greenshields, president of Capital One ShareBuilder, says, “Mini options make this increasingly popular investment strategy more accessible to today’s Main Street investors who may not have the capital required to trade standard options, particularly for higher priced securities. We look forward to educating our customers on this new offering, and enabling them to be more successful investors for the long term.”

After reducing fees significantly for options trades during the second quarter of 2013, to $6.95 plus $0.75 per contract, ShareBuilder has seen a 30% increase in options transactions. ShareBuilder’s customers can place regular automatic trades in dollar amounts—for instance, $100 worth of Google stock every month—rather than buying by the share, which recently cost $873.

Published in Barron’s Online, August 24, 2013. 

Posted by twcarey on 08/31 at 01:47 AM
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