Changes in the Stock Markets Threaten Small Business Growth; New NASD Listing Requirements, Regulatory Initiatives Fail to Consider Small Issuers.

Business Editors

CHARLESTON, S.C.--(BUSINESS WIRE)--Aug. 3, 2000

Will Investments by Angel, Venture Capital

Investors Come Grinding to a Halt?

Amidst the euphoria of a bull market and proliferation of electronic trading systems, Wall Street's largest brokerage firms and investment banks have lobbied successfully for sweeping changes in the capital markets. In the process, one important constituency has been largely ignored, the small issuer marketplace.

Positioned at the lower end of the market, the small issuer market is a breeding ground for new business, enabling entrepreneurs to raise capital and providing a reliable secondary market for investors. But new market listing requirements and regulatory initiatives fail to consider the issues unique to the smallest companies, focusing instead on companies like Microsoft, Dell and Intel. This disparity could dramatically reduce the liquidity and capital flowing into the lower end of the market, and ultimately cripple this vital contributor to economic expansion.

The Market Changes Over-the-Counter

"The culprit is the stock market itself," said investment banker Kenneth Kamen, co-founder of Princeton, New Jersey-based Princeton Securities Corp. and Chairman of the Regional Investment Bankers Association (RIBA), a national trade group consisting of investment bankers who focus on initial public offerings of $20 million or less. "The Over-the-Counter markets are evolving and changing in ways which are tremendous for large companies and institutional investors, but disastrous if you are a small company looking for capital."

Divided into several tiers, the Over-the-Counter Stock Market consists of the Nasdaq National Market, the Nasdaq SmallCap Market, the OTC Bulletin Board and lastly the Pink Sheet market. The Nasdaq National Market and the Nasdaq SmallCap Market offer wide distribution of quotes, news, and company information. In addition, they offer traders and institutional investors efficient electronic access to companies. The OTC Bulletin Board and Pink Sheets are often considered second tier venues with many investors avoiding the companies that trade there.

Investor Interest in Small Deals on the Decline

Securities professionals, like Kamen, along with venture capitalists and entrepreneurs who typically support the small issuer fear that neglect of the lower tier markets will severely cripple the growth of small business. He added, "As the markets are regulated to emphasize large companies over small ones, we see the appetite for initial public offerings for smaller (IPOs) drying up. We are also seeing that angel investors in particular, as well as institutional venture capital investors, are reducing the number and dollar amounts of investments they make in promising small businesses. Our fear is that the volume of venture capital will tumble from 1999's volume of some $40 billion to $3 billion, which was more typical at the beginning of the decade. Where will that leave the small business in need of growth capital?"

While there has been a robust increase in the overall IPO market over the past decade, RIBA has seen the number of the small deals done by its members fall off dramatically as the markets have focused on larger companies (see Graphs A and B). For instance, RIBA member firms completed 38 offerings for $228 million last year, as compared to 190 offerings for $2.3 billion in 1994. While the numbers provided by RIBA are not exhaustive, they offer a proxy for overall market activity: the stock markets are less receptive to small business. Says Kamen, "It's not the investment bankers who are suffering from this decline, but the companies looking for capital."

Chart A
Total Initial Public Offering Proceeds
                               1991                   16836.5
                               1992                   24142.1
                               1993                   41320.9
                               1994                   28406.5
                               1995                   30046.3
                               1996                   49878.0
                               1997                   43312.9
                               1998                   36554.9
                               1999                   68890.8
2000(a)                                               94675.8

Source: Securities Data Company
(a)Figures for 2000 are annualized

Chart B
Small Cap Initial Public Offering Trend
         1993            1,180
         1994            2,336
         1995              884
         1996              896
         1997              640
         1998              364
         1999              221
2000(a)                    148

Source: Regional Investment Bankers Association Underwriting Survey
(a)Figures for 2000 are annualized

The problems are not confined to the small issuer IPO market. "The viability of public ownership for small business, and hence access to public equity, is being called into question because investor and market support for microcap equities is literally evaporating," Kamen added.

Kamen says that thousands of public companies with growing sales and earnings and bright prospects for the future cannot access growth capital because their publicly held stock does not trade at a level which feasibly permits the sale of additional equity. "If your stock does not trade regularly, and when it does, the trades occur at prices which are well below any standard benchmark of value such as book value or cash per share, then your company is not a viable public entity, putting into question most of the reasons for being public in the first place." Kamen says that the inefficiencies in the market, notwithstanding natural inflation, which cause this dysfunction can be exacerbated by new market regulations and changes which make it difficult for investors and brokerage firms to support these small companies.

Environmental and Regulatory Issues Impacting Small Issuers

According to Kamen, some of the more fundamental shifts that have worked against small business include the following:

The emergence of ECNs. Electronic Communcations Networks (ECNs) represent a new, more efficient way for institutional investors to access and trade in the market. Groups like Instinet, Island, and Archipelago, among others, have captured a substantial portion of the trading that used to be conducted through brokerage firms. The problem with this trend according to Kamen, is that this form of trading has not fully reached the lower tier of the market, namely the OTC Bulletin Board. "The great technological advancements have not been fully implemented in the lower tier markets. Therefore, when the only way traders and investors can access these companies is through technology that is antiquated, they will likely cease to support and invest in these small companies."

Tightening of listing standards. The Nasdaq National Market and the Nasdaq SmallCap Market each have their own set of financial requirements that a company must meet to list its securities. On August 22, 1997, the SEC approved revised standards and financial requirements that all listed companies are required to meet to be listed and remain on the Nasdaq National Market and the Nasdaq SmallCap Market. Kamen says that the tightening of initial and continued listing standards which was implemented in 1998 for the Nasdaq SmallCap market has undermined the cause of small issuers.

"Increased listing standards for the Nasdaq SmallCap Market had two unfortunate side effects. First, it meant that many companies could no longer go public because they would not be large enough to meet the new listing requirements. Second, many companies that were once trading on the SmallCap market got delisted for failing to meet the new standards." There are informed investors willing to accept the risks associated with these stocks, but this latter event, says Kamen, "was a tragic event for many companies because they were thrown onto a marketplace, the OTC Bulletin Board, that reduced their access to brokers and institutional investors, and ultimately punished the shareholders of these companies for arbitrary reasons."

The emergence of for-profit stock markets. On April 14, 2000, the members of the National Association of Securities Dealers (NASD), which owns Nasdaq voted to spin off the stock market as a for-profit entity. "The idea of a for profit stock market is a good one," says Kamen. "However, without a stock market, how will the NASD fund its own regulation? Will the new cost of regulation be so high that it drives the brokerage firms which support and fund small companies out of business?" In addition, Kamen says that the prospectus, which details the spinoff of the stock market makes the future of the Bulletin Board unclear. "There was only one paragraph that even referred to the Bulletin Board, which does not bode well for the businesses that are trading there."

After-hours trading. Brokerage firms that trade and make markets in Microsoft or Intel, can do it profitably 24 hours a day because the average volume is in excess of 30 million shares a day. But for firms that concentrate on smaller issues that trade perhaps just 50,000 to 100,000 or fewer shares a day, a longer trading day means just one thing; a shift to longer trading hours will force firms that handle small issues to stay open for very little activity. These firms will subsequently go out of business or move to another type of specialty. Either way, small issuers will suffer without adequate sponsorship. Says Kamen, "The effect of across the board longer trading hours will cause the firms which have traditionally supported small business to focus on larger companies, further exacerbating the large company focus in the marketplace.'

Efforts to narrow trading spreads. A trading spread is the difference between the bid price of a stock - what buyers are willing to pay - and the ask, or what sellers want for their stock. Large spreads are to the detriment of investors because they result in higher prices. Kamen says the securities regulators such as the NASD and the Securities and Exchange Commission (SEC) have worked to narrow these spreads through the adoption of new order handling rules in 1996, and more lately with the approval of trading in decimals rather than fractions. "Narrowing spreads is a completely noble motive by securities regulators to protect investors and to make the markets more attractive to capital," says Kamen. "But the trend towards a `one-size-fits-all' market is a critical error. A company like Oracle with a market capitalization (total shares times price) of $240 billion, has significantly different trading characteristics than a stock with a market cap of just $35 million." Specifically Kamen says that if spreads are tightened too much, the risks to support and maintain markets will far outweigh the rewards. "If you can't make any money trading or underwriting small companies," says Kamen, "Why work with them at all?' has been the attitude adopted by many securities firms."

A Small Issuer Task Force

Recognizing the link between what happens on Wall Street and the importance of small cap participation in the capital markets, it is essential to examine all sides of the proposed changes and how the integrity and efficiency of the total OTC marketplace would be affected.

"Individually, regulatory initiatives like narrower trading spreads and tighter listing standards were developed for a positive reasons," says Kamen. "But ironically, the collective result of these changes they may actually result in greater price volatility and less liquidity for retail investors. A closer examination is needed to bring to light how some of these issues are negatively impacting the small public companies that have been largely ignored thus far."

RIBA is spearheading the establishment of a Small Issuer Capital Market Task Force whose purpose will be to "champion the cause" of the small issuer, and draw attention to the impact of changes in the capital markets on the small issuer marketplace.

For more information contact Kenneth Kamen, Chairman of the Regional Investment Bankers Association at [phone] or Jeffery Adduci, President, 843-577-2000.