Shooting Up, Coming Down.

Day traders, who may buy and sell shares without even knowing what a company does, can cause huge fluctuations in stock price. Proxicom's CFO takes a hands-on approach to managing this volatility.

If it had been a fairy tale, Proxicom's story could have ended nicely with the company's IPO in April 1999. Five million shares offered at $13 were trading at $55 only six months later. Clearly, the market loved this stock.

So did the day traders, though. And that's where the happy ending got complicated.

Founded in 1991 to market Next Computers - the marvel machines that kept Steve Jobs occupied during his temporary exile from Apple - Proxicom had shifted its focus to the Internet by 1994 and rode to glory on the e-commerce wave, winning awards and big name clients. What's more, though Internet companies generally print their annual reports with more red ink than the Communist Manifesto, Proxicom which provides e-commerce solutions to large, multinational companies - has achieved the rare distinction of consistent profitability.

The evolution of e-commerce has been so rapid, even experts can't be 100-percent sure where it's going. So Ken Tarpey, Proxicom's CFO, ranks shareholder relations and investor information among his top priorities. He considers them so important, he'll personally field calls from individual investors.

Most such calls come from people who've already done a fair amount of research on Proxicom and want to clarify a point or two. But day traders aren't like other investors.

"One day trader called and said, 'Hello, I just bought your stock and by the way, what do you do?'" Tarpey recalls. "Another said, 'I just bought your stock, do you have any significant press releases coming out today?'"

Comical, until you consider that at times the day traders were the main driver behind Proxicom's stock price moves. Buying and selling into momentum, they can accelerate moves in either direction as they pile on to catch the wave. From an economic perspective, this makes for a more efficient market (see box on page 22). But from a managerial perspective, it's a challenge. "Erratic jumps up and down do cause distractions, to say the least, for employees," says Tarpey. "Shooting up is euphoric. But coming down is distressing."

Welcome to the brave, new, disintermediated world of the electronic marketplace. It's a world CFOs will have to become better acquainted with, and not just for their personal financial-management decisions. Technology is changing the whole structure of the stock market, bringing vast quantities of financial information and instant access to the desktop screen of anyone willing to open the right window. At the vanguard of change: day traders, the shock troops of a new order that lets individuals trade alongside the biggest names in investment banking.

After the IPO

When Proxicom went public, Tarpey expected institutions to take about 90 percent of the stock. In fact, individual investors snapped up a quarter of the issue. Day traders were among the company's biggest fans, with greater effect than their numbers might suggest. "They buy and sell more frequently than other investors. For a smaller company like ours without a large float in the market, it can have quite an impact day to day," Tarpey says.

Until recently, day traders were found only in futures pits, where they made a perilous living scalping eighth and quarter-point profits, buying and selling to the rhythm of the roaring crowd. But in the late 1980s, savvy players took the game to town. When they first used the electronic Small Order Execution System (SOES) to exploit pricing inefficiencies in the Nasdaq market, irate Wall Street firms dubbed the upstarts "SOES bandits" and tried to stamp them out. But these Zorro-like brigands developed even more powerful technology than SOES, and turned the tables by helping regulators uncover evidence of widespread collusion by Nasdaq market makers. So, instead of eradicating the outsiders, regulators forced Wall Street to accept their electronic communications networks (ECNs) as a permanent part of the market landscape.

Day traders play the market for minute to minute, or sometimes second to second, ups and downs. Specialized software helps them identify stocks on the move and they jump aboard, trying to buy on the dips and sell on the upticks. Says Tarpey, "In our case, just 10 day traders selling lots of 100 shares or so can push the stock down. But we've also had price swings up of 10 percent to 15 percent on news we wouldn't consider important enough to have much impact. We've had days when an announcement comes out, an analyst changes his opinion positively and it has some impact initially because of institutional trading, but we've been advised by our banks that the day traders came in at the end and took the price up by five or six dollars."

Tarpey is no Luddite. "We deal with the Internet; we believe in its possibilities, its openness," he says. He grew up in Brooklyn listening to his father's stories of World War II. "He used to talk about why the Allies were successful. One thing he always said was that we had the will of God and resolve, but we also had technology, an amazing amount of technology, and that's why we overcame the Axis," Tarpey recalls.

Those long talks with dad helped convince Tarpey to take an undergraduate degree in history, and to look for a technology-related job on graduation. He started his career with Price Waterhouse, where he audited high-tech firms along Boston's famed Route 128 corridor. "I was so bitten, I joined one, a minicomputer company, in 1985," he says, and he took the industry's standard path, moving from company to company as opportunities arose. He joined Proxicom as CFO in 1997, when the then-privately held firm had unimpressive annual revenues of about $8 million. Two years later, revenues were about $70 million.

"I think we are at a moment in time similar to that in which settlers in Conestoga wagons lined up in St. Louis and looked west," Tarpey says. One thing is certain the new frontier will include electronic stock trading. Despite Proxicom's harrowing experience with labile day traders, Tarpey sounds like a booster when he talks about how individual investors can use the Internet to make their own investment decisions. "This is democracy in action! You can try to put artificial barriers around the financial marketplace but fundamentally, it's supply and demand, and you need freedom in markets to express that interest in buying or selling," he says.

Proxicom now hopes to mitigate the bungee-jumping price action in its stock with a second offering that will increase its float by about 3 million shares. According to Tarpey, the company's relatively thin, 5-million share float made the stock particularly susceptible to the slings and arrows of day trading. But in a bow to the contemporary facts of corporate financial life, the investment banking group underwriting the new offering will include - in addition to more traditional Wall Street names - E*Offering, a subsidiary of Internet brokerage E*Trade that specializes in online offerings. Tarpey trusts the new issue will blunt the day-trader impact, and hopes to keep more traditional, buy-and-hold investors in the company fold by ensuring they have all the information they want, when they want it. Even if that means talking to the CFO directly.

RELATED ARTICLE: The Impact of IT (Information Technology) on IT (Insider Trading)

In a major address in September. SEC Chairman Arthur Levitt called for big changes in the way Wall Street does business. Among the biggest - a central order book that would give all investors information about all orders for any stock. At the University of Connecticut, where he runs the Treibeck Electronic Commerce Initiative, Prof. James Marsden cheered Levitt's message.

Why? In one interesting experiment. researchers at the university had looked at the impact of information technology on insider trading. They simulated a market by giving different groups of test subjects unequal amounts of information. People with valuable inside information were told they could trade on it. And, as in the real world, insiders were able to turn their information into market profits.

Then the researchers tweaked the market structure a bit. Though Some traders still had privileged access to inside information, the researchers made data about the order patterns for any stock equally available to all - so even those who didn't have the inside skinny could see when buy or sell orders began to come in for a particular stock.

The result? "People who didn't have the inside information were able to identify patterns of stock trading, so the actual market actions of the insiders revealed the nature of the information," says Marsden, Outsiders generally got on board so quickly that insider advantages were practically eliminated.

Economists define an "efficient" market as one in which prices rapidly reflect all available data. This experiment suggests a simplified structure with wide access to current information will held make the market more efficient. "If you think insider trading is bad and want to avoid gains to insiders, this is one way to do it," Marsden concludes.

G.M.