If at first you don’t succeed, try, try again. So it goes at the Nasdaq.

Last autumn the exchange proposed to charge small-cap companies fees of up to $100,000 to incentivize market-makers to trade small-cap ETFs, arguing to the SEC that it would infuse thinly traded securities with liquidity. The rule would have required the SEC, FINRA and the exchange itself to reverse longstanding prohibitions on paying market makers to trade securities. For certain exceptions only (of course, exchanges pay billions of dollars in rebates to “liquidity providers” each year).

The SEC promptly rejected the rule-filing. Now it’s back. See it here.

IR folks, do you know the adage about being wise as serpents but meek as doves? Question what you hear from exchanges that rely on data and transactions – not issuers – for revenue and profits. Take nothing at face value. Examine the facts.

First, why liquidity? Berkshire Hathaway Class A shares need no liquidity to achieve a low beta and high institutional retention. So is trading activity in liquid names investment – or something else, such as statistical arbitrage?

Second, understand how ETFs work. To meet fluctuating supply and demand, ETF sponsors create and redeem units daily through authorized participants (APs) consisting of broker-dealers and large institutional investors like Vanguard and Fidelity.

Setting aside that unfair advantage (and stat arb opportunity) for APs, can you create and redeem your shares daily? No. What does incentivizing trading in small-cap ETFs create, then? Arbitrage. Statistical calculations of fluctuation in a set of securities. That’s not investment, it’s noise. Worst, the Nasdaq wants you small-caps to pay for it in your stocks – so it can generate more data and transactional revenue.

Lesson: Exceptions to rules always foster arbitrage. Apply it to any scenario, from taxes, to trading, to regulations.

So express yourselves. If or when this proposal reaches the SEC, go here, find the rule filing, and comment. One public company can change outcomes.

Here’s proof. The letter from ModernIR is referenced in the SEC’s decision to extend discussions about extraordinary market volatility. We were just one voice (none from public companies!) – but every voice counts.

We’ve opined again on market-volatility rules. Please read it. In two pages, we summarize how market rules are depriving public companies of what they want most in trading markets: Differentiation.

Your company should comment, too. So be heard, be seen, and be counted.

And with good reason. The lovely KQ and I winged southward with fellow wayfarers for time over the keel on the cayes and reefs of Belize. At Queens Cayes east off Placencia past the wildlife preserve at Laughing Bird Caye, we found what one friend called “your own Corona commercial.” As the sun faded toward dusk there, we caught this grand view of our boats on Dec 11. Our companions below the surface included this delightful fellow, a spotted eagle ray. The Eagle Ray Club is a good name for a rock band.

Inland on the far side of our trip we trekked the jungle and climbed this spectacular Mayan temple at Lamanai in the Orange Walk district. Lamanai, with some 32,000 structures hidden by the jungle, once was home to 60,000 Mayans. If the world ends next December (this comic strip offers an alternative view), we’ve redeemed the time between the best we could.

Speaking of speaking, the SEC in latter December told the Nasdaq no-way on its Market Quality Program proposal that would have authorized the exchange to charge small-cap stocks an additional $50,000-$100,000 annually to incentivize broker dealers to make markets. Read the proposal here (we say “read” loosely, as it’s composed in “marketstructureeze,” intelligible if you have a decryption tool akin to what the Allies in World War II used to debunk the German cipher machines called Enigmas).

The Nasdaq, NYSE, BATS and Direct Edge (as well as other exchange operators) file many rule-making proposals each year. These rules affect how your stock trades and often incentivize the very things making markets loathsome to real investors: statistical arbitrage and high-frequency trading. Why? These behaviors are essential to exchange profits. Thus, in 2011 alone, the Nasdaq, curator of the most codicil constipation, filed at least 171 rule proposals. The NYSE made 73 proposals, and BATS and Direct Edge 51 and 42, respectively.

SEC regulations require comment periods for each proposal. We weigh in when a rule strikes us as unhelpful to public companies. We cannot recall ever reading a single comment letter from a public company on any rule filing. Why? Good question. Public companies should be a key voice in the markets where their shares trade. Instead, listed companies have seemingly handed the hen house to the coyotes.

How about a New Year’s Resolution, IR pros? Resolve this year (this week?) to involve your General Counsel in watching the rule filings from your listing exchange.

Heck, do it yourself. Fast-trading is a by-product of exchange trading incentives. Nobody drives these more than statistical arbitragers and high-frequency traders from both sellside and buyside. As in any loyalty program, exchanges give their best customers the most attractive trading rates. But their best customers are often your worst enemies – in terms of setting real, natural prices.

It continues because thou protesteth too little. Read and comment on rule proposals from the NYSE, Nasdaq and BATS at the links below. You can view other comment letters to see the best way to opine, but it’s straightforward. Write a letter explaining your objection, emphasizing your standing as a publicly traded company listed by the exchange:

http://www.sec.gov/rules/sro/nasdaq.shtml

http://www.sec.gov/rules/sro/nyse.shtml

Exchanges’ sites:

http://www.nyse.com/nysenotices/nyse/rule-filings/list?year=2011

http://nasdaq.cchwallstreet.com/filings/

Let’s make 2012 The Year That Public Companies Spoke Up.

This is how Pipeline Trading describes its predictive analytics for helping buyside customers identify large-block trading opportunities.

For those of you who missed the news that rocked The Street this week, Pipeline, a dark pool, was fined $1 million by the SEC for misleading clients about the nature of its liquidity.

Were you harmed? Check to see if your shares trade at Pipeli—

Oh. You can’t. It’s a dark pool. You don’t know if your shares trade there unless Pipeline’s orders route to your listing exchange.

Of Pipeline, SEC Enforcement Director Robert Khuzami said in a statement: “Investors are entitled to accurate information as to how their trades are executed.”

Pipeline offers a platform where institutional customers like mutual funds can find “natural liquidity,” or real orders from other buysiders. What’s more, Pipeline provides execution algorithms that mimic how high-frequency traders try to project price and volume in order to place profitable trades ahead of moves. If the buyside can beat HFT at its own game, then instead of being victimized, it can also generate alpha – market-beating returns on trades.

In a dark pool, you’ll recall, there are no displayed prices. You don’t walk in looking to see what lettuce sells for here. You come because you want to keep secret your interest in a truckload of lettuce. Maybe Pipeline with its predictive algorithms and natural lettuce liquidity can fill your truck at a price midway between Safeway’s and Kroger’s, whose prices will still set yours but without your walking into either store and creating a run on lettuce.

Turns out, Pipeline was filling nearly 80% of orders with its proprietary trading subsidiary, Milstream Strategy Group. Which was also using Pipeline OODA analytics to front-run orders at other markets.

Yup. That’s bad. By the way, Pipeline matches about seven million shares of about seven billion daily at present across all US equity venues. Drop in the bucket. But it earned a big fine.

Because accurate information matters.

Two takeaways for the IR chair. First, the line between what Pipeline did and what the big listing exchanges do is fine and gray, frankly.

Exchanges sell circuits and colocation services that give good customers fractionally better information, the same as predictive analytics. See our piece some weeks back about Burstream.

Further, exchanges present themselves to their public-company customers as impartial venues with displayed prices. But they pay around fifteen cents per hundred shares for DARK liquidity. Exchanges, which vilify dark pools for distorting price-discovery, incentivize dark orders with rebates and encourage it with order types.

In fact, liquidity often advertised to you as proof that your listing exchange is doing you service is paid to be there. Well, isn’t that what Pipeline was in form and function doing? Those brokers the Nasdaq lists as liquidity providers? Lots of that is incentivized order flow that earned thirty cents per hundred shares. Incentivized volume is not investment; it’s fleeting, artificial. It’s hoping to profit from the act of intermediation.

And why do exchanges pay for that? Because the act of intermediation generates data, the revenues from which are shared by exchanges under the SEC’s quote and tape plans. What drives data? High-speed trading. Who consumes data? High-speed traders. What is the majority of your volume? Do the math.

Do they tell you? You’re a customer entitled to accurate information about how your shares trade. I don’t mean to criticize our friends at the exchanges. But has the exchange ever explained to you precisely how they match trades in your shares?

Which brings us to Key IR Takeaway Number Two: If investors deserve accurate information about how trades are executed, on pain of fines, what about public companies?

In the past ten years, all the exchanges have become for-profit entities. Regulators have instituted a vast host of rules fragmenting markets and fundamentally restructuring how trades are intermediated, matched, monetized and compensated.

Do you know what changes have been made to data for public companies during that time? Exactly NONE.

This is why you know less about your trading activity than any generation of IROs. Permit me to be blunt: Regulators have not considered public companies worth the time to modernize data rules to reflect the market structure they fostered.

A year ago we thought it would take an act of Congress to redress this inequity. We now know that FINRA can fix it with a rule-filing.

All it takes is some of your CEOs asking FINRA: Why are investors entitled to accurate information, but public companies are not?

Editorial Note: Don’t miss the IR Magazine Think Tank next week in NYC.  Hope to see you there!

Speaking of thunderous roar, I attended the jam-packed NIRI Rocky Mountain Chapter’s kickoff session today. Nasdaq chief economist Frank Hatheway offered a thoughtful and statistical look at the market. He joked that when he first prepared slides two weeks ago, the trends were improving but he’d had to change his comments to reflect reality.

Dr. Hatheway launched his talk by comparing stock indices with VIX volatility, Treasury yields, oil prices and gold. He observed that investor-relations professionals today need to develop a level of understanding of these “macro factors” – benchmarks of group behavior across asset classes (clients, we include a Macro Factors segment on page two of your Market Structure Report).

It was a chunky nugget I wanted to share. Get to know macro factors. Use these events to shape tactical outreach. If a macro factor like VIX volatility is deteriorating ahead of VIX futures expirations, it’s going to affect both risk hedges for major institutional holders and speculative trading by those chasing mathematical calculations of divergence. Call your deep-value holders ahead of time. If you’re on their minds, maybe they buy the dip.

Plus, the IR chair is in some ways today like the chief economist for each company. You’ve got to have your hands on data, trends. Why? It’s how markets work. If you want to know the outlook for your economy – the market for your shares – you need to understand what behaviors and trends drive it. As Dr. Hatheway noted, discounted cash flows still form the basis for asset value. But macro factors create the discount rate, in a sense, which can change quite dramatically how your shares are assessed in diversified portfolios or as liquidity in speculative models. Both are legitimate activities in your economy – your equity market. But you should know what role they play.

Often, rational money is out of step with market realities too. Today I reviewed data for a large real estate company and noted how rational money bought ahead of options expirations in August, just as trend traders and risk managers cashed out and shifted to derivatives. If IR professionals can avoid being caught flat-footed like that poor investment manager, well, you look smarter, cooler and better in the IR chair.

And that’s good job security in an economy that Dr. Hatheway thinks will grow about 1% next year.

Two quick reminders: Options expire, including VIX futures, Sept 14-16. And we’re sponsoring IR Magazine’s Think Tank session Nov 3 on tracking trading in the IR chair. Join us!

Orlando sweltered like you’d expect a swamp in central Florida in June might. We heard 1,300 were on hand, up triple digits from last year. There were new faces in the crowd and new vendor names, though big ones were absent too because exhibit costs go up while things like annual reports and total public companies decline.

We were tethered to the booth mostly but I sat in on the session about how equity markets work. Rich Barry from the NYSE, John Adam of Liquidnet, and Brian King at BATS paneled, and well. Our client Moriah Shilton at Tessera moderated like a pro.

The room was packed to standing-room-only. In the two years since I sat in Moriah’s seat on the stage, how markets work and what to do about them continues to populate the thoughts of IR folks, clearly. They streamed to the mics throughout with queries.

Karen and I nudged each other and shook our heads at this one: “How can we understand where our shares trade and for what reason?”

Answers were given but ones that rambled and muddled because, in the main, there are no good answers besides ours – behavioral ones (and our effort to get better data on where trades occur and by which firms). I’m not demeaning the superlative work of the panelists either, who are bright and terrific fellows with vast knowledge.

It’s just a fact that if you don’t look at the market behaviorally – like we do – you won’t know what’s going on. We’re about the central question of the panel: Where your shares trade and for what reason.

One giant reason things are nuts out there is rules. Ever heard of the rule of Best Execution? When the SEC adopted it on January 30, 2001, it was called Rule 11ac1-5; now it’s called Rule 605. It created standards and measures of how brokers execute trades so customers could compare results and see if they were getting proper execution quality.

Of course, these are your traded shares we’re talking about. The SEC was concerned in 2001, when the Nasdaq had about 75% of its market and the NYSE over 83% in NYSE securities, that market fragmentation was depriving folks buying and selling shares of the best deal. It was because market makers were handling lots of volume, and the average public company had 13 market makers.

Stop for a moment. I just tallied the brokers, platforms, and exchanges for a mid-cap stock ($14 billion) with daily volume of 4 million shares. There were 70 different firms printing trades on June 17 at the Nasdaq. But 70% of the volume occurred at exchanges and market centers that don’t disclose the executing brokers. Doing the math, we might estimate that 230 participants were behind trades.

Realize that we’ve gone from 13 to 230 because regulators thought markets were too fragmented. Also, that it was their responsibility to do what buyers and sellers should: determine if they’re getting a good deal, just as you do every day when you buy gas, food, or toiletries (answer: you are getting hosed because the Fed keeps debasing that dollar in your pocket, so it buys less).

Rule 605 requires brokers to stay within standard deviation on trade executions – size, speed, fill rate, proximity to the best bid or offer, and other defined characteristics. These reports must be published monthly. Brokers may be fined for aberrance.

I like analogies. How did executive compensation spiral up to the heavens? Uniform behavior. Everyone complains about CEO pay, but no board wants to be out of step with the market, so pay goes up and up as do the statistics used by those who craft the pay. By contrast, Les Schwab, founder of the eponymous tire stores, earned pay of $32,000 in 2000 at a firm with $1 billion in sales then. Some store managers participating in the firm’s profit-sharing made over $200,000. It’s a private company.

The point is, the more uniform the rules, the more uniform and disconnected from reality becomes the behavior. If all trading activity must behave the same way, what happens to it? It becomes the same. We see it.

Liquidnet, the dark pool (and great friend to IR and the rational buyside) estimates in a June 14, 2011 release with trading statistics that “natural” liquidity in the markets is about 1.9 billion shares. It’s including statistics for microcaps, so if we use microcap volumes and national market volumes of about 15 billion daily shares combined, rational investment is less than 13% of the US market – about where we see it.

A big reason why is that rational money doesn’t want to follow the crowd in most cases. But try to execute trades outside the crowd, and it’s darned difficult and may even earn a fine. Liquidnet has a fraction of the market – about 1%. But a huge part of the block market – sometimes 60-70%.

See the problem? Rules force behaviors into sameness, which diminishes the participation of the money you spend all your time trying to reach.

This problem is reversible. If hundreds of CEOs or CFOs wrote letters to the SEC, say on its still pending dark-pool proposal, that read: “The markets need fewer rules and more freedom so individual thought can distinguish one stock from another,” maybe things would change.

If you’re interested in doing so, drop me a note.

Sentences like that are why alcoholism remains widespread. It’s also the reason IR folks don’t want to know how markets work. Too complicated.

Yet if we’re brutally honest, we know we should understand more. I mean, you can’t claim to be a great Yankees fan and not know the rules of baseball.

The sentence above from Nasdaq Reg NMS FAQs says: If I’ve chosen to fill my order up to the designated number of shares at a set price without leaving the Nasdaq to check for better prices elsewhere, suppose the time to complete the order is something besides “immediately or forget it.” Will that order be accepted at the Nasdaq?

This is how markets work. If you want homework, Google “Rule 611 Reg NMS.”

Buyers today are entitled by law to get the lowest price for a stock. In the 1970s, Congress got together and brooded at length about how to improve competition. As this forum of politicians deemed itself superior to thousands of years of unfettered human commercial interaction, it determined that forcing people to trade at the best price was an improvement over people figuring it out for themselves.

Before the rule was even in effect, exemptions flurried. Because obviously getting the best price begs a giant question: For What Quantity?

To address vast variances, the SEC decided on Rule 611, called the Order Protection Rule.

Remember (if you’re old enough) playing tag and getting to yell “Olly, Olly Oxen Free”?

ISOs are olly-olly-oxen-free orders. If you’ve got an ISO for 1,000 shares at the NYSE, it may only find 10 shares at the confluence of your specified price and the lowest one available. If the order is immediate or cancel (IOC), then it returns with 990 shares unfilled. If the Time in Force (TIF) is “Day,” then throughout the day the order is going to loiter at the exchange where it’s been routed, filling the rest if and when its price is hit.

But it doesn’t have to leave the NYSE for the better price at a “protected quote” elsewhere. Like other situations in which prophylactics offer a measure of security, a protected quote is one that, shall we say, comes with confidence. A protected quote is by definition immediately and automatically accessible. Therefore, no manual quote – somebody entering a trade – is protected.

Protected from what, you say? Somebody skirting it, like an ISO can. So if you want your price to be guaranteed to display, then it must be an automated order.

Do you see the problem? To comply with Reg NMS, machines and markets must automate orders. It’s the only way that they get protection. That means machines have been given an edge over humans.

At the same time, regulators have granted a bunch of exceptions to exchanges that let institutions work around those prices. What then do you suppose the displayed prices reflect?

Compliance.

Not the best value, or even the best price. Perhaps not even real intent. What happens when compliance requires that you do one thing and believe another? Deception, sleight of hand, arbitrage.

On the cattle ranch of my youth, when we brought cattle to market the auctioneer didn’t rattle off a bunch of prices to a set of shill bidders batting worthless and hollow trades back and forth while the real pricing was occurring somewhere else unknown to us and anyone else in the room.

The only thing required for a fair market is that buyers and sellers are satisfied that nobody is gaming the price they’re getting.

The equity markets today are the grand archetype of gamed prices. And that means, IR folks, that you need to do more to know the REAL price of your shares, and who’s setting price, be it investors, trend followers or arbitragers.

Further, the IR chair should be leading the campaign for issuer involvement in market rules. We’re doing our part to help with the IDI (and we’ll have an update soon – we are talking with folks at the very highest decision-making levels. But I guarantee that change will only happen if the household names trading on the Nasdaq and the NYSE demand it – so demand it!).

Oh, and the answer is: Yes. The ISO with a TIF of something other than IOC is accepted at the Nasdaq. You probably have thousands of those bouncing around in your volume, arbitraging spreads between protected quotes and undisplayed prices.

The NBBO stems from legislation passed in 1975 by Congress to create a national market system. If you’re already snoozing, you’ll miss the good stuff. You cannot make up stories like this.

Back in the 1900s, several cases involving the NYSE and other exchanges and their proprietary data reached the Supreme Court. In each, the Court held that exchanges possessed an undeniable right to their proprietary quotations.

In other words, where we take for granted now that quotes for stocks are as basic a right as breathing, it used to be that keeping those quotes secret was as basic a right as breathing. (Since our markets flourished then and gasp now, we’d be idiots not to wonder which approach was correct.)

When the SEC asked for comments on new rules to establish a national market system and a true, national best price for stocks, it was unsure of its legal standing to do so. In an SEC press release from 2000 is this, from what humorist Dave Barry would call the “I Swear I’m Not Making This Up” category:

“We believe it is questionable whether the SEC has proceeded properly in proposing these Rules and we have attached, as Appendix A, a legal opinion which discusses this matter. It is long-standing and clearly established legally that the Exchange has a proprietary right in its transaction data and quotation information.”

Jump forward to today. All market centers in the National Market System are required by rule to display what used to be their proprietary property: their prices. (If you tack onto this the legal implication now that using valuable information may be criminal, it’s a wonder our markets consist of more than two parties anymore.)

This dubious path culminates in the following excerpt from a ruling filing with the SEC on May 6, 2011, from the Nasdaq. Be warned: Reading it without first consulting a physician may be hazardous to your health:

“In order to provide enhanced functionality, NASDAQ proposes to adopt an additional order type known as the Midpoint Peg Post-Only Order. Like a regular Midpoint Peg Order, a Midpoint Peg Post-Only Order is a non-displayed order that is priced at the midpoint between the national best bid and best offer (“NBBO”) (as determined using the consolidated tape). However, like a Post-Only Order, the Midpoint Peg Post-Only Order does not remove liquidity from the System upon entry if it would lock a non-displayed order…”

This goes on for pages! If you want to know more, Google “post only orders.” It’s a reaction from exchanges to the movement of trading off displayed markets. And what is the SEC response? To allow exchanges to hide orders too, and to price that non-displayed liquidity at points other than the NBBO.

You must think we’re daft. Hey, we’re just relaying the facts. Grasp one thing, IR pros, about how this stuff affects trading in your stock. All through the markets, in dark pools, on trading systems, at exchanges, there is a mad, desperate effort to avoid the NBBO. Which the investing public thinks is the best price.

Decades of rule-making and legislation and scores of billions of dollars from exchanges and brokers and traders have gone into this National Market System that is, it would appear, a colossal failure. The NBBO doesn’t work. Forcing price controls and behaviors on sentient beings fosters black markets. Elementary, Watson.

How do we undo this mess? Do what Stephen King told would-be writers – kill your babies. No matter how much you love something, if it doesn’t advance the story, slash it.

What if we just…scrapped the NBBO? If the CEO of every public company wrote to congresspersons a letter that said: “Dear Sir or Madam. Please ixnay the NBBO. Thank You. The CEO,” it would happen.

Or we can live with the stock prices you see every day moving all over the place that result from a maze of stultified rules so complex that only the most advanced machines can matriculate them. Barely. Thus all the trading halts, now averaging over 100 per day.

Choices, choices.

Only corporate IROs may answer. Apologies to the rest, but you’ll see why. Corporate IR pros, look up and write down your trading volume on March 4. First question: Where did your shares trade?

Second question: Which brokers executed the trades that, when added up, equaled that volume you wrote down for March 4?

Yesterday, Dow Jones reporter Jacob Bunge wrote about our drive to organize companies to petition Congress and regulators for more transparent data about their share-trading.

There’s a landing page on our website for the letter we’ve drafted. Our goal is to list 100 companies as supporters when we deliver this letter. It should be 5,500. I’ll tell you why in a moment.

Please read the letter, copy the talking points, set a meeting with your CEO, CFO and General Counsel, and explain why your company must support the initiative – which is free and requires no more work than adding your name to the list.

Why should you and 5,499 other companies support it? Permit me to be blunt. Many investor-relations professionals don’t know what they don’t know. If you knew which brokers traded your shares on what markets, you’d generally understand your share movements.

It need not be real-time. IR folks aren’t traders or investors. But 24 hours after the trading day, you should know where your shares traded and which brokers executed trades. If, for instance, the same group handles a bunch of volume during options expirations, well, that’s probably what they do.

Ten years ago, you could see a lot more. On the floor of the NYSE, specialists had 85% of the book for a given NYSE issuer. At the Nasdaq, almost all the volume could be tracked, save smatterings at ECNs. I was an IRO and downloaded my data every day.

Today, about half your volume flows invisibly into a consolidated tape. Another chunk executes or reports at other exchanges like BATS and Direct Edge. That means you see a third or so. We can apply mathematics and rules and track behaviors with stark accuracy because it’s a rules-driven marketplace. But you – there in the IR chair – are entitled to complete information. You are a member of the capital-markets community, not a side show.

It’s not the fault of listing exchanges or alternative markets. It’s how the rules work. Everybody forgot that public companies need data too, and rules left them standing by the roadside in 2001.

If companies want better data, they must ask for it. Comprehensive trading data is a baseline necessity for making informed decisions about your currency – your listed shares. It’s a fiduciary corporate responsibility to know where your shares are trading, just as the head of sales has got to know the distribution channels.

I’ll paraphrase our vice president and say it’s a big…deal. The door is wide open for public companies to enter the 21st century in our capital markets. You’ve got to walk through it.

So take my challenge. Try to figure out where our shares are trading. Then, ask your CEO and CFO to back this initiative so you all can have answers rather than questions.

Last Friday I was in Dallas (seventy-five degrees warm) for a trading panel discussion at the NIRI Dallas-Fort Worth chapter. Also Friday, the Market Structure Map from last week on artificial liquidity ran courtesy of Joe Saluzzi at the Themis Trading blog, and at Welling@Weeden, Kate Welling’s respected letter at Weeden & Co. (many thanks to both generous hosts). Today against a rocking backdrop of geopolitical unrest, rising global inflation, commodity uncertainty and cold winter weather, US equities are rolling.

Talk about wild temperature swings. Higher prices are nice. We loved them in home values too five years ago. There is no better way to be cool in the IR chair than riding a hot stock. And most times, your executives think your share price is undervalued.

But don’t you wonder, just a teensy bit, how come the prospect of the Suez Canal disappearing into a dark pool isn’t mildly sobering? We had four clients up 5-7% today, five down a little, and the vast bulk up equal or better than the market. Really?

The old adage was “for every buyer there must be a seller.” On the floor of the NYSE, the old specialists ran a book and monitored the crowd and committed capital now and then to smooth temporary imbalances. By the way NYSE companies, you lost another source of trading information last week when identification was removed from order flow hitting floor booths. It’s just liquidity now, a commodity.

“Artificial liquidity” is trading volume that does not exist of its own accord. It’s paid to be there. Mercenary shares. Traders and market makers can get them from anywhere, so long as the need for them does not move outside defined parameters (this is partly why exchanges and regulators want to control the movement of every security with circuit breakers). You can get 100 shares of anything, anytime, anyplace. Why do you think the average trade size today is close to 100 shares? In some massively machine-traded stocks, you can always get 500 shares because there are always five trading systems with 100 shares available.

Where does this mysterious equity ether come from? Over there. Literally. For instance, the Nasdaq’s “rebate,” or payment for order flow, (all approved by the SEC, as is every rebate, so we can’t just blame the exchanges) encourages selling at the Nasdaq and buying at the Boston Stock Exchange, another Nasdaq property. A trader goes over there and buys and offers the shares here. If shares move back and forth, it generates transactions and data for the exchange, which drive revenue, and it supports the ebbing and flowing demand on algorithms.

That seems good. But in essence, markets about 80% of the time now only need either a buyer or a seller, not both. How? If I buy 100 shares at the Boston Exchange, I’ll take them from somebody’s standing order. If I buy 200 now, I will alter all the behaviors, and machines will begin plucking shares from various points and pockets and places, and offering them in front of my order. And those shares could pass through eight machines that are not buyers or sellers at all, but intermediaries. So for eight of ten trades there was only one purpose – moving the shares.

Multiply the effect. What you see are liquid markets with low volatility. What you get are markets in which prices have been manufactured by machines. And this is what we’re getting right now. Part of it is because there is a vast sea of dollars, and dollar-denominated markets are best right now, so machines manufacture liquidity ahead of demand.

This works so long as nothing sloshes mercenary shares outside defined parameters, causing them to quit. But it also means that most times prices aren’t set by real buyers or sellers.

As humorist Dave Barry would say, “We are not making this up.”

The DXY, the spot market for the US dollar, declined 7% in July. Stocks were up 7%. May was a good month for the DXY, which rose from 81 to 87, roughly. May crucified equities and gave us the Flash Crash on the heels of a surge in the value of the dollar.

Is it six of one, half a dozen of the other? The dollar in your pocket loses 7% of its purchasing power versus other currencies in July. Stocks appreciate 7%. Call me simple, but it seems that when a thing you buy is worth more because the thing you buy it with is worth less, that these sort of cancel each other out.

Which brings us to making and taking liquidity, the main method by which traded shares move today. In this “maker-taker” model, market centers pay participants to provide shares that attract customers, and charge customers to consume these offered shares. The spread is profit. At BATS Exchange the cost gap between consuming and providing shares is one penny per hundred shares. On the Nasdaq and the NYSE it’s about five or six cents, but narrows if you offer tens of millions of shares daily.

This is crucial to understand. If you conclude that your volume is buying and selling meeting up, that’s true only sometimes. Most of the time, buyers are consuming shares offered by other market participants whose principal job is to keep the liquidity flowing, for pay. This is why high-frequency trading exists, really. Technology and human ingenuity adapted to market structure built around incentives. So now, there are systems doing both the providing and consuming, and if the spread between the two prices is a penny, and your stock moves two pennies, why that’s riskless profit. Mind, that’s harder to do than it seems!

Where do shares come from that liquidity providers offer for sale? Somebody always has inventory. Sometimes it’s coming from major broker-dealers whose millions of retail and institutional account holders don’t realize that their positions are used to generate profits for market-making operations. This is the main reason why Citadel invested in E*Trade. In many other cases, shares simply move from place to place at high speed.

To do that, traders can arbitrage different structures. Most market centers now, like BATS, Nasdaq, Direct Edge, and so on, are “time-priority” models, where the first to show up at the best bid or offer gets to complete the trade. On the NYSE floor, it’s a “parity” model that gets apportioned to all parties priced at market. So if you’re fast enough, you can move shares from parity to time priority and back and forth. This constant replenishment generates revenues for the firms doing it and looks like massive volume. It’s often the same liquidity appearing again in different places.

What’s good about this? It keeps price spreads tight, and it ensures that vast numbers of securities, regardless of appeal, offer anyone wanting to transact in them an easy, ready market. If you’re asset allocation managers, these are great conditions. Think of it like swiping your credit card through a reader rather than needing the exact cash price each time you buy.

What’s bad about it? Number one, market centers are motivated to entice volume that isn’t real. They make money through transactions. More transactions, more data to monetize too. This is not the fault of exchanges. They are businesses producing returns for shareholders. But if parties matching your product with buyers and sellers are financially incented to attract middle men, in time your market is most appealing to intermediaries and least appealing to real buyers and sellers.

That’s what maker-taker models encourage. Transient intermediation. It’s the most reliable way to make money. If 80% of volume is moving from place to place, and you’re in the 20% buying and holding, what form of activity is more likely to produce a return on investment? Clearly, making and taking liquidity, not owning things.

But the biggest problem is the same one afflicting the US dollar. In stock markets now, the maker-taker model has removed the focus of market participants from the value of businesses to the supply or demand of shares. The study, manipulation, and maximization of liquidity movement have come dangerously near to disconnecting underlying business fundamentals from stock markets. Intermediaries trade stuff for spreads. They don’t own investments for their intrinsic value.

This is true of the dollar too. Its value bears no connection to underlying national productivity or assets. That’s the essence of “fiat” currencies, and we’re near now to having “fiat stocks” too. Movement of the dollar from place to place alters the value of all the goods and services denominated by it. In time, no one knows the value of either the goods and services or the currency in which these things are valued. Then, the data derived from transactions in it are incorrect or distorted, too.

Think about this: does the same thing happen in the global economy that we described with the DXY and stocks? What if it’s just yin and yang of currencies and goods and services, with no real change in economic output? That path would lead almost ineluctably to large national debts.

Oh. Hm.