Speech by SEC Commissioner:
After-hours Trading: Are Retail Investors Ready for Prime Time?
Laura S. Unger
Commissioner, U.S. Securities & Exchange Commission
At the 1999 Arthur Page Society Spring Seminar
New York Stock Exchange
April 7, 1999
The views expressed herein are those of Commissioner Unger and do not necessarily represent
those of the Commission, other Commissioners or the staff.
Thank you for the kind introduction, Bob. I'm honored to have the opportunity to give the keynote address for the 1999 Arthur Page Society Spring Seminar. The theme of this year's Seminar is "24/7: New Demands in a New Environment," which couldn't be more timely.
In the last decade, technology has truly reworked the business environment. It has made the global, round-the-clock company a reality. For better or worse, we've all become tethered to it electronically on a 24/7 basis -- by digital phone; pager; e-mail; and the Internet.
In its wake, this new environment has created a host of new demands on corporate communications officials -- which this Seminar is designed to meet. The distinguished panelists and speakers you'll hear during the course of the Seminar should help prepare you to better deal with the fast-breaking news impacting your companies that is part and parcel of this new 24/7 business environment.
The Society couldn't have picked a more appropriate venue for this spring's Seminar than the NYSE.
U.S. securities exchanges always have operated in a highly competitive environment. Of late, however, technology is tearing down international barriers and is bringing exchange competition to a global level.
The Exchange has moved to respond to the demands of this new environment. Last fall, the NYSE, the DeutscheBorse, and 16 other markets around the world listed the shares of DaimlerChrysler, creating the first truly global equity security. More recently, the Exchange announced plans to open a new trading room next year dedicated to trading securities of the almost 400 foreign issuers listed on the Exchange. In addition, the NYSE plans to expand its trading hours to better compete with foreign markets in Europe and Asia by remaining open during their primary trading sessions.
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Turning back to the U.S. markets, I'd like to use this opportunity to talk about another 24/7 issue -- how changes in technology and investor behavior have laid the groundwork for widespread after-hours trading by individual investors -- and briefly mention some issues it raises both for investors and the Commission.
Institutions and professional traders make up the majority of today's after-hours market. After-hours trading takes place mainly on electronic alternative trading systems such as Instinet. These systems have imposed high creditworthiness criteria on participants, effectively barring direct individual participation in the after-hours markets.
The distinguishing characteristic of the after-hours market is its lack of liquidity. This illiquidity keeps investors from effecting transactions in size at or near the security's closing price on its primary exchange. Large transactions and executions significantly away from the closing price are the norm in the after-hours markets. In addition, after-hours trading volume generally concentrates in periods immediately following significant late-day news announcements and shortly before the next day's regular market opening.
However, sweeping changes in investor behavior, technological advances, and market participants looking to take advantage of the new environment have combined to create the underpinnings of an after-hours market for individual investors.
As a nation, we've moved from relying on Social Security or a pension to provide for retirement to managing our own retirement planning through self-directed plans. Using this experience, individuals generally take a more active role in managing the rest of their investments. The Internet and online brokerage empower self-directed investors to manage their investments. Initially, the Internet and online brokerage were but a catalyst in the shift to self-directed investing. Lately they have become a driving force in transforming not only investor behavior, but the markets themselves.
The Internet has given individuals great flexibility. Online trading takes this flexibility into the world of investing. As a result, today, untold thousands of investors get home from work, sign on to the web, and connect to their online brokerage accounts. They look over their portfolios, review the latest news and research reports, check the closing price and enter orders. These "after-hours investors" transmit their orders to their online brokers' internal systems, where they are queued for routing to market centers for execution the next morning.
As online investing continues to gain momentum, it may be impossible to ignore the need for extended trading periods. Otherwise, significant numbers of orders entered by online investors will continue to pile up during the evening, making the opening of trading even more difficult to manage. By some estimates, up to 40% of online investors' orders are entered after the primary markets close. These orders make up the critical mass that cause new and established market participants to salivate and could make after-hours retail trading a viable proposition.
Already, there are online brokerage firms and at least three trading systems planning to get into the after-hours retail business later this year.
The primary markets are also exploring the possibility of expanding their trading hours. While the NYSE's extended trading hours plans are focused on competing with foreign markets in foreign issuers' securities, Exchange officials have mentioned the possibility that sufficient demand could cause the NYSE to add some U.S. issuers' securities to its after-hours session. Last week, Nasdaq announced it is considering whether to extend its trading hours as well. Of course, we don't know whether NYSE and Nasdaq members would make these after-hours sessions available to their retail clients.
After-hours retail trading raises a wide variety of issues that touch upon the Commission's primary missions of protecting investors and promoting fair and efficient markets.
To my knowledge, the Commission has never taken an official position on the advisability of opening after-hours trading to individual investors. We've only dealt with this issue tangentially in the context of extending regional exchanges' trading hours until 4:30 p.m.
I'd like to share some preliminary thoughts on what issues I believe this development raises for the Commission.
Disclosure of Material News Developments
As you all know from reading your NYSE Listed Company Manuals, your company is "expected to release quickly to the public any news or information which might reasonably be expected to materially affect the market for its securities" and "act promptly to dispel unfounded rumors which result in unusual market activity or price variations."
Companies should notify the Exchange prior to the release of news announcements or statements concerning rumors made shortly before or during market hours so the Exchange can determine whether a trading halt is necessary.
Will an expansion of after-hours trading impact current corporate practices to release material news or information after the close? I would assume that the NYSE and Nasdaq would extend their existing policies to any extended trading sessions they may develop in the future.
Will extended primary market trading hours push the dissemination of material news or information later into the evening, or to the next morning? Or, will after-hours sessions merely have to deal with a higher proportion of trading halts than primary sessions? That is something that companies and the markets will have to work out amongst themselves over time.
The widespread availability of technology to instantaneously transmit orders across the globe underscores a global company's need to promptly disseminate information using major U.S. and foreign media outlets with worldwide reach. Take the example of a U.S. multinational whose Asian subsidiary determines that it will have materially lower revenues for the next quarter. If the subsidiary puts out a press release in that country, with the belief that the information eventually will be picked up by U.S. media outlets and flow into the U.S., foreign investors could have an informational advantage over U.S. investors in the interim.
The availability of after-hours trading in U.S. securities could enable foreign investors to capitalize on this advantage, to the detriment of U.S. investors using such systems. Of course, this is also true in the case where foreign investors use information disseminated after the foreign market closes to trade on a U.S. market during its primary trading session.
Issuer Discussions with Analysts and Insider Trading/Selective Disclosure Concerns
I'd like to digress for a moment to touch upon a selective disclosure issue more pertinent to this audience, but separate from after-hours trading: sharing information with analysts and the Commission's views on insider trading. Going back to your NYSE Listed Company Manual, while it is recommended that your company observe "open door" policies with analysts, your company should not reveal material information it hasn't given to the press for publication. If substantive disclosure is made during a discussion with analysts, your company should simultaneously release the information to the public.
Last year, on more than one occasion, Chairman Levitt expressed his concerns with unusual price movements occurring after analyst conference calls that companies arrange prior to the issuance of a press release on material information.
As I've said elsewhere, issuers are probably talking more, not less, these days during analyst calls as a result of private securities litigation reform legislation passed in 1995 and 1998. This legislation allows issuers to disclose earnings projections or "forward-looking" statements during analyst calls without the threat of private securities litigation.
The law currently requires some benefit to flow back to issuers for insider trading liability to attach to them for providing material, non-public information to analysts. The benefit need not be monetary, however, it can be reputational. Therefore, issuers should not feel immune from liability. We will put these situations under the microscope, and if the right facts present themselves, consider bringing an enforcement action. I would also mention that our Office of General Counsel is considering rulemaking to address a number of insider trading-related topics, including selective disclosure by issuers to analysts.
Returning to after-hours trading issues, should we pay closer attention to the information-gathering disparity between institutions and individual investors that works to disadvantage individual investors who participate in the after-hours markets?
Has the availability of real-time news through online brokers sufficiently bridged the information gap between institutions and individuals -- or are individual investors at an informational disadvantage?
Even if the information gap has narrowed sufficiently as to news developments, what about the market information gap? Institutions and professional traders have access to a wealth of market data -- the closing price; prices and sizes of transactions that have taken place during the after-hours session; prices and sizes of bids and offers on the trading system's book; and transactions occurring on other after-hours systems or foreign markets trading U.S. securities.
What information will be available to individual investors in the after-hours market? I would not for a moment underestimate the sophistication of online investors. However, even if online brokers or alternative trading systems give individual investors information comparable to that received by institutions, will those individual investors be sufficiently savvy to sort out and interpret such information correctly?
The relative lack of liquidity in the after-hours market compared to the regular trading session raises the most significant after-hours trading issues. Even for securities trading after-hours without any material news developments, a lack of liquidity could cause investors' orders to be executed well outside the closing price for the security.
A lack of liquidity in the after-hours market also could exaggerate the market impact of after-hours corporate news developments, causing a greater price movement than if the news was released during the primary trading session. Moreover, in an online investor-driven after-hours session, the lack of liquidity could make prices much more susceptible to movement based on non-traditional media, such as postings on investor chat rooms and bulletin boards.
In addition, the reduced liquidity in the after-hours market may magnify the potential for market manipulation. The price of a security would be susceptible to moving on much less volume than during the regular trading session. Dissemination of false or misleading information through chat rooms or bulletin boards could quickly impact a security's price.
Finally, the presence of individual investors coupled with the lack of liquidity in the after-hours markets will almost certainly increase the amount of volatility during after-hours trading sessions, making price discovery even more difficult than it already has become recently during normal market hours.
Of course, the lack of liquidity during after-hours sessions could reduce the quality of executions for less sophisticated individual investors. The Commission will have to ensure that broker-dealers take their fiduciary duties seriously and evaluate closely whether executing customers orders in an after-hours session comports with their best execution obligations.
At a minimum, should online investors be able to choose whether or not their orders may participate in an after-hours trading session?
Should there be an opt-in requirement (i.e., orders will be eligible for an after-hours session only if investors affirmatively opt-in)?
Should online brokers be required to affirmatively disclose the risks of after-hours trading to their customers before they can participate?
What market data should be made available to individual investors? Closing price, last sale price, best bid and offer information, transactions on other after-hours or foreign markets?
Given the illiquidity and increased volatility after-hours, should online brokers only permit individual investors to enter limit orders in an after-hours trading session?
What, if any, linkages should be in place among after-hours markets trading the same security?
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In closing, I can envision a 24/7 (or at least 24/5) global trading environment developing within the next few years, with liquid, interconnected markets throughout the day. However, for the foreseeable future, which nowadays is limited to about six months or so, it seems fairly evident that after-hours trading in U.S. securities, even after it is opened up to individual investors, will remain a less liquid environment, posing unique risks to individual investors and challenges to the Commission.
Thank you for your attention, and I'd be happy to take a few questions.