Shawn Flynn  01:58

What’s the history of Nasdaq? How did it come to be what it is today?

Jeff Thomas  02:03

So Nasdaq was started in 1971. It was always around bringing technology to have more efficiency in the capital markets. So at the time, the New York Stock Exchange was the dominant player in the US equities market. They literally created stocks, using pieces of paper, passed around by people on the floor of the exchange. And Nasdaq brought this revolutionary idea that you could automate that process with computers. Fast forward to today, one in 10 securities transactions around the world runs through Nasdaq technology. So we’ve been on this journey since 1971, always as the kind of incumbent challenger in the space, looking for opportunities to bring technology that can help bring efficiencies to the capital markets.

Shawn Flynn  02:46

So I’ve heard of the national market system, how has that impacted trading and traders?

Jeff Thomas  02:52

Sure, so if you go back and this gets a little bit into the history of the exchanges, again, Nasdaq was the first electronic exchange. We felt like that made markets more efficient. It made price discovery more efficient. Well, the New York Stock Exchange had these folks called specialists who were on the floor of the exchange, who got this privileged position in the marketplace to create liquidity. We thought that having, you know, computers to do the matching of buyers and sellers would be more efficient, in the long run. There were a number of startup electronic crossing networks or EC ends that came to pass. Nasdaq, of course, identified that as a big trend. We acquired one, New York *inaudible one, and more and more the volume was moving off floor to the electronic crossing networks.

Jeff Thomas  03:37

And so the SEC was obviously watching this and they said, “Well, wouldn’t it make more sense if all markets were interconnected? And if no matter where you put your order in, it got routed to the market with the best price at the best time.” And so that was what they rolled out through Reg NMS in 2006. And it mandated that all exchanges basically go electronic, that when an investor puts in their order through whatever broker dealer, the broker dealer then puts that into the market. That order then has to get routed to this central order book, where then wherever the venue with the best price, the best time is, that’s where your order will get executed. And that could be a lit exchange. So it could be one of the national exchanges that boost the bids and the offers between buyers and sellers. Or it could be a dark pool, or an internalized where a bank or other you know, financial firm is looking to cross their own line orders.

Jeff Thomas  04:37

So what the lead exchanges do is they basically bring together buyers and sellers, and then they post what’s known as the national best bid and offer. So if a bank is going to internalize an order, they have to cross it at that national best bid or offer, NBBO, or they have to route it to a lit exchange. And so what the exchanges are doing, they’re creating the price discovery mechanism and what that does is that tightens the overall spreads in the market and helps to ensure investors are getting efficient execution.

Jeff Thomas  05:04

The benefit of the dark pools is that then the banks, or the internalizers, can cross those orders without having to post their clients interests publicly. Now that trade does have to get printed through the Nasdaq trade reporting facility. So that the fact that a trade happened to that price is known publicly. But that discovery of the price is not happening in the public domain. So that’s one of the reasons we think it’s really important to try to encourage more flow to go to lit live venues because we think that that provides better price discovery and better investor outcomes. But there’s always been that kind of tension since the SEC rolled out Reg NMS, you know, for 10 years ago now.

Shawn Flynn  05:42

Walk me through… That whole process is a little overwhelming, to be honest. Say, I place a trade, Charles Schwab or Robinhood or one of these online platforms, what is the step by step that’s actually taking place?

Jeff Thomas  05:56

Sure. So you’re going to put in an order. It’s either going to be a market order, where you’re saying, “Hey, I want to buy or sell shares at the prevailing market price.” Or a limit order where  you say, “I want to buy or sell at this price.” In the case of retail brokerage firms, they have the opportunity to send that order to an exchange, where it can get executed through the whole Reg NMS structure. Or there’s this whole other option where they can sell their order flow to what’s known as wholesalers, which are groups that will aggregate retail orders, and then execute those orders either through their own internal matching engines or through the lit exchanges. 

But in either case, it’s always going to have to be done at that best prevailing price that we talked about, the NBBO. So it literally can go through multiple steps before your order actually gets executed. And then of course, once your order gets executed, it’s going to take what’s known as T-plus two or two days to settle before your trade is actually executed in the cash ends up in your bank.

Shawn Flynn  06:53

And then when a company goes public, what’s the process for that?

 Jeff Thomas  06:57

Well, so just like if you are sitting there on your Robinhood account, you submit a buy order, right? You’re going to go out and try to buy that stock or say you want to sell stock, you’d go and execute a seller of shares that you own. With an IPO, it’s really no different. The company is saying, “Hey, we want to go sell shares into the market.” So they’ll hire what’s known as an underwriter, which is a broker dealer, and they’ll hire that underwriter to go and market those shares for them. So the net effect is really it’s the same process. The company would sell those new shares to the underwriter, underwrite the offering by buying those shares. And then the underwriter goes out and places those shares or sells those shares on to their end clients, which would be the investors of those shares.

Jeff Thomas  07:34

Typically, as part of that process, the underwriter will take a company out on a two week roadshow. They’ll do an analyst teaching day, where the company educates the analysts about their financial model, so that those analysts can then write good research coverage on those stocks. And all of that will culminate at the end of the roadshow where they decide on the pricing. So the company and the banks have been on a two week process to talk to all the investors, try to generate demand. You’ll often hear about the book being oversubscribed by X amount, then 20x, 30x. So people know they’re not going to get as many shares as they want. So they’re saying, “I want, you know, a million shares,” when they know they’re probably going to get cut back 200,000 shares. So they go through that process, they have all this demand on their books. And then they have to decide who they’re going to allocate those shares to. So they’ll go through, they’ll allocate those shares, and the bank will sell those shares on to those investors at a certain price.

 Jeff Thomas  08:25

The next day, everybody wakes up, they come to Nasdaq. And that’s when we execute what’s known as the opening cross. So all the investors that bought stock the night before from the underwriters now have the opportunity to sell those shares into the market. Equally, they come or the investors that didn’t get shares or as many shares that they wanted the night before, have the opportunity to put buy orders into the market and we go through this price discovery process at Nasdaq where we’re gathering up all the buy and sell orders. It usually takes, you know, from 30 minutes to sometimes three hours to build that book and the lead underwriter is often the stabilization agent for that process.

 Jeff Thomas  09:01

And so the stabilization agent’s role is to organize that opening cross. They get something that’s known as the green shoe, or the underwriters over allotment option. Green shoe just sounds cooler. And that’s 15% of the number of shares that were sold the night before, where the stabilization agent can actually put their own balance sheet to work to buy those shares, and then either buy or sell those shares in that opening cross to help stabilize the stock on day one.

Jeff Thomas  09:28

So we go through this whole process. Everybody’s at Nasdaq. They’re looking over our IPO execution officer’s shoulder. There we have the software called the Book Viewer where we can actually see all the buy and sell orders coming in. The stabilization agent gets the full view of the book through that. 

Everybody on the street gets the Nasdaq opening cross indicators so they can see where their shares, their clients’ buy and sell orders are coming in, if they’re going to get executed or not, and what the price is indicating at. At some point in the morning, the stabilization will say “Okay, I like where the books at. You know, we’ve got a decent number of the shares that we sold last night.” It will get executed in the opening cross, usually around 15-20% of the shares that they sold the night before they want to see go off in the opening cross. They also look for the levels below the price at which they’re going to open the stock. So they want to make sure they have good supply and demand there to keep the stock trading smoothly throughout the day. Again, that can be client orders, it can be their orders using the green shoe. And once they say, “Okay, we’re ready to open the stock.” We confirm back, we push the button, it runs the auction, and then the stock opens for regular way trading.

Jeff Thomas  10:28

Once it goes into regular way trading, obviously the stock can go down. All the broker dealers in the street are again executing their client orders on that stock. All those trades are then going through the whole Reg NMS, or the national market structure system, where the stocks are then trading on all venues. So that opening cross is one of the few times where a stock is going to trade on a single venue where we can aggregate all the buy and the sell orders. The other times that happen is that the opening and the closing every day. So the opening cross and the closing cross every day is executed on a company’s listed venue. All the trading from 9:30 to 4, throughout the day, that all happens across the entire market. So it’s this really interesting point when you can kind of aggregate all those buy and sell orders.

Jeff Thomas  11:11

And what’s really unique about opening an IPO is that we get to hold the stock. So it doesn’t open regularly at 9:30, right? But we go through this process, we can actually watch the stock come to life, right? And so we talk a little bit with our issuer clients. You know, when you go public, it’s kind of like a wedding, being public is the marriage. Well, I always refer to these opening crosses like the birth of your first child, because this is when the stock literally comes to life. You get to watch it kind of the price form. And again, all the people who are selling into that opening cross are people you just sold the stock to the night before, and all the people that are buying it are the people that didn’t get shares the night before, right? So it’s this really interesting process where the companies have been out on the roadshow for two weeks talking to all these different investors. There’s always more demand than there is supply for the IPO shares and so that’s one of the reasons why you’ll often see the price of an IPO go up on the first day, right? Because there’s a limited supply. And often one of the tougher things that first opening cross, especially on an IPO, is getting sellers to come into the market. So if you just bought the shares the night before at $20, and the stocks are indicated at 30, okay, you can book a 50% game, but who knows how much higher it’s going to go up? And so that’s what the stabilization is doing, going out talking to all those clients who, you know, again, they just place the shares to last night and trying to either get them to come in as buyers or sellers into the market.

Shawn Flynn  12:32

And is there a certain range on that first day that’s considered a big win? Or what is a win for everyone involved in this process?

Jeff Thomas  12:40

That really depends one, on what seat you’re sitting in, and then two  what’s your time horizon? So, from the company’s perspective, an IPO is a financing event. You’re going out and you’re selling shares to the underwriter and then they’re placing them out to their clients. And the price at which they sell to their client. Net of their fees is the amount of proceeds that the company gets so they obviously want the highest price possible, that’s going to reduce the dilution for their existing shareholders. And it’s going to allow them to raise capital in the most cost effective way.

Jeff Thomas  13:09

If you’re one of those investors who’s buying the shares, again, you’re buying stock that’s never traded on an exchange before. You maybe have been tracking the company for a while, but there’s definitely no history in terms of their stock performance. You’re taking a big bet on that stock. And you’re saying, “Okay, I believe in this company, I want to get in at the beginning of their life as a public company.” But there’s risk there, right? And so what they want is to be compensated for that risk, where they don’t expect, you know, buy the stock and have it go down on the first day. So they want to see some appreciation. So those are kind of the two things that are in balance on day one.

Jeff Thomas  13:44

But then as you kind of look at the time horizon, right, put yourself in the CFO shoes of the company. You’re going out and educating investors, not just about what the stocks is worth today, but what you think it’s gonna be worth in 3, 6, 12, 18 months, right? And you’re saying, “Here’s what we think we can do over that timeframe.” The analysts are building their models, according to that. And they’re kind of implicitly then talking about what they think they can do to hit that performance. So the higher you price the stock for the IPO, the higher those expectations are 3, 6, 12, 18 months out. So that’s going to make the company’s job that much harder if the stock is priced higher to achieve those expectations.

Jeff Thomas  14:27

There’s also this concept when you’re talking about Wall Street models, right? You want to beat and raise. So the analysts will have kind of consensus estimates. They’ll say we think the company is going to make $1 per share this quarter. As a company, you want to come out and have $1 and five cents per share. And then you want to be able to raise how the analysts raise their guidance the next quarter. They’ll say, “Okay.” But as you can see if that keeps happening, keeps ratcheting it up, better to start on a low number if you want to beat and raise in consecutive quarters then if you start at a high number, which you know if you price the stock at a high point of the IPO, you’re kind of implicitly saying, “Hey, we’re going to hit a much higher earnings per share faster than if we hit a low number.”

Jeff Thomas  15:07

The other amazing thing about the US capital markets is a lot of companies are not making any profit, right? And so as an investor, the long term value of a company is really a discount on their future cash flows. So if the company is not even cash flow positive yet, you’re making a bet that this company is going to grow fast enough and grow their revenue faster than their expenses, where at some point, they’re going to cross over. And they’re going to start generating profit and cash flow. And so what you’re doing is you’re pre-paying today for the expectation of future cash flows tomorrow. And it may be years before a company hits that. So you’re building a multi-year model as an investor saying, “Here’s what I think this company is going to achieve profitability. And here’s what I think that’s worth today.”

Jeff Thomas  15:52

So in both cases, whether you’re the CFO of the company or the investor, you have to have this multi-year time horizon when you’re trying to figure out what the price is that you’re willing to sell or buy the shares at the IPO. So that you make sure that you know, on the company side, you’re able to hit those promises, or on the investor side, that you believe that the company can meet those promises. So a lot of people get caught up on, “Okay, day one, they price the stock at 20  and it popped up to 40. It is 100% gain on day one.” That doesn’t really change that contract between the company and the investor. If they sold stock at $20 a share… They’re worried about where the stock is going to be trading a year from now, not 24 hours from now. Companies oftentimes are only going to sell 10 to 15% of their outstanding shares in an IPO. So it’s a small percentage of the company that’s trading on day one. 

The vast majority shares are subject to a lack of agreement for six months or 180 days. And so when you watch a stock trading in that first six month period, you’re only watching the shares that they sold in the IPO trade. So it’s a very small number of shares. There’s not a lot of what we call liquidity in the market yet. You know, there could be a high level of trading, but it’s not a small number of shares. And then once you get to the end of that six month period, that’s when the lockup is released. Employees can sell their stock, the venture capital, or private equity investors can either sell shares into the market, or potentially distribute the shares to their LPs. Founders and the management can then sell, although they have to disclose any sales through an 8-K, which oftentimes will have material impact on the stock.

 Jeff Thomas  17:25

If you see the CEO selling a bunch of stock, maybe you want to think twice about, you know, buying it. And so that’s when you start to see all of these new shares coming to market. And of course, everybody knows that. So leading up to that lock up release, you’ve got people that are saying, “kay, there’s going to be more supply coming to the market, I think that the stock price is going to go down.” And so you can of course, go to a place that bets in the market by being short of stock. You can look at their performance or the first couple of quarters and say, “Well, they’ve been beating their numbers, I think they’re going to keep beating their numbers. I think there’s gonna be a lot of demand for this stock.” So you can bet the stocks is going to go up after that. And I think a lot of people spent a lot of time thinking about what happens to stock performance around the expiration of the lock of provision.

And I think the one thing that’s true is, if a company is performing and hitting their numbers, their stock generally goes up, right? If investors believe that you are able to achieve what you said you can achieve, and you have a demonstrated track record of doing that, people are going to buy the stock. If companies come out of the gate and they miss on the first quarter earnings, or they have stumbled or they have some other, you know, headwind, a new competitor comes into the market, something like that, that usually has a lot more to do with the price that people are willing to pay for the stock than the number of shares that are out there. But when you have that kind of smaller number of shares, because it is a smaller pool, you can see a lot more volatility day to day on the stock.

Shawn Flynn  18:44

Do you think there’s more pressure or excitement on the IPO or when the lockup period ends?

Jeff Thomas  18:50

I think the IPO is just a uniquely… It’s this unique point in time, right? There’s a lot of media focus on the companies. There’s a lot of focus on where you’re going to price or where the underwriters are going to price those shares the night of the IPO. The IPO roadshow is a grueling process. It’s two weeks of non-stop back to back meetings. And so I think that is where there’s a lot more focus and pressure. I think the lack of exploration is maybe where there’s more anxiety, right? So you have a long time to wait for it, you know, it’s coming, you have all these other factors at play in terms of how you’re doing as a business. You know, you’ve been through your first earnings call, how are you doing as a business, how are investors responding to the story. So I think there’s more anxiety there, but I think there’s more pressure around the IPO.

 Shawn Flynn  19:32

Let’s go back to some of the anticipated ideas at 2019. Some of them didn’t perform as well as expected. What’s the investment community saying about these deals?

 Jeff Thomas  19:43

So there have been a number of kind of high profile deals that underperformed on day one where they went out and they priced their shares at a level that both the underwriters in the management thought there’s plenty of demand, and they came out the next day. And a lot of the folks that said they were going to be long term holders decided they wanted to be sellers, and a lot of the demand that they thought they had in the book building process didn’t materialize.

And so then, what happens when there’s more sellers and buyers, the stock trades down. Now, on average in 2019, IPOs were up 15%. On average, if you’re an investor and you bought every single IPO, you’re up 15% on the year. So that’s why we’ve continued to see a lot of momentum through the IPO market. I think when a handful of high profile deals trade down, that’s when people start to say, “Oh, the IPO market is broken, the window is closed.” And that can have a material impact on the psychology of investors because then the question is, are the next deals going to perform, do the bankers have a good handle on the demand for those shares, is management trying to stretch too far and get too much to reduce their dilution? But I think that on the whole, the markets,as a whole, performed very well in 2019. And so IPOs, given the risk, are still a decent investment. And as you kind of… then we look out into what’s coming up in 2020.

 Jeff Thomas  20:59

Some of the things that companies will look at when they’re thinking about when or how to go public. One, it’s obviously valuations, right? So what are their peers or their parable companies known as their comps, trading up. They’ll look at the revenue multiples for their peers, the earnings per share multiples of any profits for their peers. And then they’ll also look at the relative volatility of the market. There’s this one metric called the volatility index, known in the industry as the VIX. And it’s called the fear gauge. So it measures the relative volatility in the market. If the market is very fearful, the stock market’s going to jump around a lot. If everybody’s really calm, it’ll stay nice and low. And so anytime the VIX gets above 20, bankers start to say, “Hey, maybe we gotta hold off on the IPO for now, because we don’t want to go out in a volatile time, because we’re out there trying to price your IPO and then all of a sudden, if the market drops by 10%, it could change the amount that would be able to get you for that.” But if the VIX is nice and low under 20, markets are relatively calm, it’s easier to go out. Make sure the investors are focused on your story.

Jeff Thomas  21:59

For the vast majority of 2019, we did see the VIX was below 20. Multiples were at an all time high. I mean, tech had its best year in like 10 years. So specifically, tech IPO has had a good environment to go public in 2019. As we look out into 2020, the one thing that’s certain is we’re going to have a presidential election. Nobody can foresee the outcome of the election, there’s obviously going to be a lot of opinions on both sides. But one thing that’s true is that there will be a lot of media coverage, there will be a lot of uncertainty around the future of our tax policy or monetary policy, the future direction we go as a country. And if there’s one thing that the market hates, it’s uncertainty, because again, you go back to all those *inaudible*, analysts trying to build their models. They’re not just looking at companies-specific issues. They’re looking at the economy as a whole. You know, what’s US GDP going to be? What do we think we’re going to do with interest rates? All of these really important questions get built into those models. And if all of a sudden the projections for those are changing wildly from day to day based on who they think is going to be sitting in the White House, that can change your view on those individual stocks, the view on the market that can raise then the volatility index, the VIX can get up higher. And so it can make it harder to price an IPO. So on average in election years, we see fewer IPOs than you do on non-election years.

Shawn Flynn  23:14

Talk about the disconnect between public and private valuations.

Jeff Thomas  23:19

Sure, so it goes back to what we talked a little bit about before, right? So in all cases, investors that are buying shares in a company that has yet to achieve profitability, they’re generally valuing future growth. So in private companies, there’s what’s known as the J Curve. So companies go out and they talk to their VCs and they say, “Hey, we’re going to lose a lot of money for a while, but then we’re going to hit this rapid expansion and growth phase.” And so, if you think about the way a letter J looks, you’re going to dip down at first into the negative 6, 12, 36, 72 months out, man, things are going to be going like gangbusters. And so private investors are saying, “Okay, when do we think this company is going to be able to build a product that meets the market need in a defensible way, where they’re going to see this really rapid growth, and then they’ll see that crossover point?”

Jeff Thomas  24:04

What we’ve seen over the past 10 years is there’s been this flood of capital into the private markets. And so that’s happened for a number of reasons. One, the regulations to be a public company have increased over the past couple decades, to the the challenges that public companies face due to some of those regulatory and market structure issues that we’ve talked about have gone up. And so companies, on average, are now waiting twice as long to go public. And so that means that you see fewer new issues every year. And it means that if you are an investor who’s trying to generate outsized returns, or alpha for your clients, you now have a smaller subset of companies to go invest in. So you’re going to now start looking into the private markets to say, “Hey, can we invest in this company before they go public?” Over the past decade, you’ve seen all the big mutual fund complexes Fidelity, T. Rowe, Wellington and the like investing in private companies. You’ve seen sovereign wealth funds coming in and saying, “Hey, we’re not getting a great return. In the public markets, there’s not a lot of alpha there. So let’s invest in private markets.” And you’ve seen a couple really big funds like the SoftBank Vision fund get raised. And again, there was a lot of sovereign wealth there.

Jeff Thomas  25:10

There was also just other unique long term investors who are saying, “Look, we want to invest for the long term, we’re going to pay now for future growth.” And a lot of those funds came in and started giving private companies more capital than frankly, they’ve ever had before, right? If you go back even, you know, 10 to 15 years ago, you know, a series A was $3 million, right? A series C was $20 million. There’s now series A rounds that are getting done over 100 million dollars, you see multiple rounds of over a billion dollars in private capital getting done every year. So it’s just a massive amount of capital. You used to have to go public to raise that much money. And now you can get that capital as a private company. And so what does that do? You now have all this cash on the balance sheet, your investors are telling you, they want you to grow, because they want you to get through that J Curve and get to that rapid expansion.

Jeff Thomas  25:58

And so you get all this capital. You start to spend a lot of money, which means you’re burning way more cash than you’re bringing in revenue. And so you have all these big losses, right? So private investors have always been more tolerant of that than public investors. And so what you’ve seen now this year, and through 2019, companies that are still burning, a lot of cash have come public. And they’ve had this ready supply of private capital to fund all this expansion, all of this growth. And public investors are sitting there saying, “Okay, when are you going to cross that chasm and get to the steep part of the J Curve because we want to start seeing profit?” And a lot of companies that went public in 2019 said, “Yeah, we’ll be profitable in you know, 2022-2023.” And that was kind of looking five years out.

And towards the end of 2019, what you started seeing was investors starting to pull back a little bit on the growth narrative, saying, “Okay, great. We still want to see growth, but we want to see you get to profitability faster.” We saw some companies kind of come in and announce, “Hey, we’re going to get to profitability faster.” And I think what you’ll see throughout the balance of 2020 is a little bit more of a focus on profitable growth, when companies are going to get to that steep part of the J Curve. And that’s something that they obviously have to kind of moderate in terms of how much they’re spending on sales, how much they’re spending on marketing, research and development. You always want to be investing in your future growth. But there’s always that trade off. And so I think as we kind of move forward in 2020, you’re going to be looking for companies to come public that have a clear path to profitability, where investors can kind of wrap their head around the timelines.

Shawn Flynn  27:24

It was mentioned that regulations are getting tougher and tougher, especially over the last decade, as a general consensus, has it been a good change? Or has there been kind of a pushback or people saying, ‘Hey, that’s gone too far’?

 Jeff Thomas  27:38

You know, I think our view at Nasdaq is there’s definitely too many regulations that are kind of inhibiting a company’s desire to go public. So we’ve had a platform out there for the past few years, called Project Revitalize, which is our multi-point plan on capital markets’ reform efforts. It’s on multiple fronts. 

It’s around regulatory reform, market structure reform, and then how do you promote more long term thinking in the public markets. So the challenging thing is there’s definitely no you know, one answer. There’s a lot of things that create burdens around being a public company. What is true is that if you keep keeping more and more regulations on public companies, we’ve seen that companies will stay private longer. And the real impact of that is that mainstream America and everyday investors don’t get the opportunity to participate in the growth of those companies. So if you look at all of the biggest tech companies in the world right now, Apple, Microsoft, Amazon, Google, they all went public fairly early in their life cycles. And a lot of the returns that investors realized happen post-IPO, versus, if you look at companies today that are waiting 10 to 15 years to go public. A lot of them are pretty fully valued when they go public.

Jeff Thomas  28:47

And so that means that retail investors in the US don’t have the same opportunities to earn those returns, and where are those returns going? They’re going to the big institutional investors. The sovereign wealth funds, the family offices. And so when you talk about wealth inequality in America, we think that this is one of the key factors that drives that. If everyday Americans don’t have the opportunity to go invest in high growth IPOs at an early stage in their life cycle, it’s very, very hard for them to catch up and somebody will say, “Well, but wait, but Fidelity, T. Rowe, Wellington, all these mutual fund complexes that everyday Americans are invested in are investing in these private companies.” And yeah, sure they are with one to 5% of their assets under management.

You know, even if those go up 10 x, it’s still not a material part of the overall returns of those funds for an everyday American. It’s just not the same as if you could go and buy shares that the Amazon IPO in 1997 when they were valued at $400 million. And today, they’re valued at nearly a trillion dollars. Those kind of returns over the 20 years, that’s what people want to see and expect out of the IPO market in the US. And it’s just hard to imagine if a company is going public today at a 10 or a $50 billion valuation. Now you’re going to see those same kind of returns, in terms of a multiple, just because I’ve got… They are a much bigger company when they come public.

 Shawn Flynn  30:10

And some of the companies this past year have gone public through a direct listing, kind of talk about what the difference between that and a traditional IPO is, and maybe some of the benefits?

 Jeff Thomas  30:20

So one thing I like to say is that every IPO is a direct listing. So we talked about the fact that when you go public, the company sells shares to an underwriter, who then sells those on to their client, and the next day, they come into Nasdaq, and they go through that process of the opening cross. With a direct listing, you’re basically just cutting out the process of the company selling shares to the underwriter who’s selling them on to their clients. And instead, you’re doing an opening cross with all the existing shares on the company’s cap table. So what does that mean?

Jeff Thomas  30:48

First, it means the company is not raising capital because they’re not selling new shares into the market. Second, it means that the existing investors are not subject to a lock up agreement. So all of the employees and all the investors in the company can actually sell and do the opening cross on day one, day two, at any point they want to because those shares are not subject to that lockup agreement. So what does that make that first day of trading look like? Well, you’re going to have many more shares available, right?

Jeff Thomas  31:14

In a traditional IPO, we talked about how companies only sell 10 to 15% of their shares, and through an IPO, and those are the only ones that are eligible for that opening cross. With a direct listing, you could theoretically have 100% of the shares available to go into that opening cross. So you could actually see a much higher volume of shares, trading over those first few days. 

And so the proponents of direct listings would say, “Well, that means that’s good. That means that a company is going to get to a mature trading profile much faster in their life cycle because you’re not going to have this limited supply, you’re going to have higher volume, you’re going to get to true price discovery faster rather than waiting six months for the lockup to expire and all those other shares to come to the market. And for the market to find its true price.” You’re also going to see potentially more volatility, right, because you’re not going out through that kind of traditional process to allocate those shares, you know, by hand, the specific investors with an understanding of what those folks are likely to do. You’re saying to all your existing shareholders sell if you want to, hold if you want to. The company then has to also go out and generate the demand for those shares. And an IPO, the investment bank is hired as an underwriter. So they take on a liability to buy those shares. And they then have the responsibility to go educate the investors and market the stock.

Jeff Thomas  32:27

In the case of a direct listing, companies will still hire an investment bank, but they hire them as a financial advisor. And because they don’t have that underwriting liability, they can’t go market the stock. So the company has to go market the stock to investors themselves, they’ll oftentimes do that through both face to face meetings, but also through an investor day, which will be you know, broadcast on the internet available to all investors. Again, one of the things that folks that support direct listings talk about is it’s a much more democratic process. There’s equal access. It’s not a question of are you one of the firms on the road show or not, it’s everybody’s going to get access to this information. You can also, you know, make the case that investor day is often multiple hours long. Versus in a road show, you’re typically doing 40 minute meetings. So you’re able to cover a lot more material and provide a lot more information. And then the last thing that’s really different about an IPO and a direct listing is that in an IPO, your registration statement, your S-1 doesn’t become effective until the night before when you are actually pricing the stock.

Jeff Thomas  33:26

With direct listing, your registration statement goes back to about 10 days prior to the opening cross. And what that means is the company has 10 days, which they can do that investor day. And they can actually provide forward looking guidance. So in a traditional IPO, you say here’s how we’ve done. In a direct listing, you can and really need to say, here’s how we think we’re going to do. And that’s because you don’t have the investment banks out there doing that marketing on your behalf, writing that research saying here’s what we think they’re going to do. It’s literally the company saying, here’s our forward looking guidance for the next period of time and how we think we’re going to do.

Shawn Flynn  34:01

Do you think there’s going to be more direct listings in the future? Or do you think there’s going to be kind of a modified version of what’s happening?

Jeff Thomas  34:08

I think we’ll see more direct listings next year than we have this year. That’s not a bold statement, since we only had a handful this year. But I do think that we’re going to continue to see innovations in the space. So one of the things that we’re looking at closely is what would it take to allow a company to sell shares into a direct listing. So to kind of combine the best of both worlds where a company can go to market with a direct listing, you know, have the ability to have all their shareholders sell immediately, but then also allow the company to raise capital. Now, that’ll be probably be a multi-year process, the SEC to kind of go out and think about all the potential implications of that. But I think that’ll be one of the big innovations that we’re looking forward to.

Shawn Flynn  34:49

What other emerging technologies is Nasdaq looking at?

Jeff Thomas  34:53

So we’ve been early, early adopters in blockchain. We’ve worked a lot through a number of proof of concepts around what is really the use case for blockchain outside of crypto. So everybody knows blockchain is the underlying technology for Bitcoin. And everybody always asked, “When’s Nasdaq gonna launch a Bitcoin exchange?” But we kind of looked through that, the technology of blockchain and said, “Okay, what’s a really good use case for a distributed ledger technology that’s an immutable source of truth?” And one of the things we started working on early was the topic of proxy voting. When you’re a shareholder in a public company, you get the chance to vote your shares on a number of issues. It’s known as the proxy. It happens once a year. In the US, you’re sent a paper ballot in the mail, you mail it in, you really don’t know if your vote got counted. It’s a very opaque process. It’s not very transparent. And you know, it’s one of the big pain points for public companies.

Jeff Thomas  35:46

So we early on did a proof of concept with Estonia, which is a very forward thinking nation. I think they literally have like a two factor authentication technology for their citizens, their citizens own all their own data. So again, these guys are very forward thinking country. And we ran a proof of concept with them using our blockchain technology to enable proxy voting. And then one of the markets in South Africa took note. And they looked at that technology and ran a proof of concept as well. And looked at launching that in q4 of 2019, to actually facilitate their proxy voting.

Jeff Thomas  36:20

So when the SEC came calling to us in 2019, and said, “Hey, what do you guys think we can improve about the the proxy process?” We said, “Well, there’s a lot. This is like the number one thing that our companies complained to us about.” And so we wrote a common paper back to the SEC, we mainly focused on kind of the process and the participants in the proxy process. So investors own thousands of positions. And it’s hard for them to track that and stay on top of all the different issues that are facing the companies that they own. So they outsource a lot of that to proxy advisory firms. There’s really only been two proxy advisory firms for a long time. They sit at a pretty powerful intersection and over the years, have developed a business model where they would come up with their recommendations. And if the companies didn’t like those recommendations, they developed consulting arms where the companies could pay to learn more about their model. Well, you know, when we went to DC to explain this to the politicians, they said, “That sounds like a protection racket.” I said, “Well, those are your words, not ours.” 

And why does a politician know so much about protection rackets? But okay. So that kind of resonated as really one of the top issues. And there’s also this really interesting rule, long standing rule in the US capital markets where if you own $2,000 worth of stock in a company, you can petition the company to put something in their annual proxy process. And this is one of those rules that just hadn’t been reviewed in decades, right? And today, you know, you’ve got Apple worth, you know, nearly a trillion dollars. And somebody who owns you know, $2,000 worth of stock can go to Tim Cook and say, “Here’s what I think who should be running the company.” And that’s good. It’s democratic. It kind of gets to the core of what America is. But we want to talk to especially the people in Congress, we said, “Well, if citizens in your district was able to put something up for a vote in front of Congress. They only lived in your city for, I don’t know, 2000 days, something like that. Is that the way you think Congress should run this? Well, no, of course not. That’s why we’re elected. We’re here to figure out. Well, yeah, that’s why we have management, public companies to figure out what are the big issues?”

Jeff Thomas  38:18

So anyway, that was a lot of what we focused on was, okay, how can we reduce the influence of proxy advisory firms? How can we increase the threshold for proxy access? Those we thought, were really two big issues. And at the end of 2019, the SEC actually took the step to propose new rules around that and went through a comment period to hear from market participants. What do they think about these proposed rules? 

A lot of which aligned with our suggestions, and of course, there’s always two sides to every argument. A lot of people came in from the investment community and said, “Hey, we can like the current system, we get good advice cheaply and don’t have to worry about any kind of threshold if we want to put something on there.” But the companies we when we started this process, *inaudible sent a letter to the SEC from our *inaudible. And we for the course of two weeks went out to all our companies and said, “You want to put your name on this and kind of add your support for this.” Companies usually don’t want to put their name on something that’s going to the SEC, it’s just probably best not to, you know? We had over 300 companies sign a letter and support. And so that’s that was one of the really proud moments for our government affairs team, over the course of 2019, was getting the forward progress on the proxy reform.

 Jeff Thomas  39:27

But to bring it back to blockchain, right? So we talked about Estonia, we talked about South Africa. We mentioned in that initial position paper, “Hey, there’s other great technologies out there besides pieces of paper, one of which is blockchain, which provides transparency and provides an immutable ledger. So hey, wouldn’t that make a lot of sense?” If you think about it, that the New York Stock Exchange was around for a couple hundred years before Nasdaq came along. It took us 40 years to get the SEC to realize we should make the markets electronic. So these things don’t happen quickly. And so I wouldn’t expect that you know, we’re going to roll out the blockchain based proxy voting in the US in 2020. But it sure seems like it’s something that could make a lot of sense. And when you talk about needing to have a high trust, high integrity system, with high levels of transparency, the ability for investors to know that they could vote and to know how that their vote counted. All that stuff seems pretty important to us in terms of maintaining high integrity capital markets, so we’re going to keep pushing for it.

 Shawn Flynn  40:23

Can blockchain be used in other ways as well, maybe the transparency of transactions or the settlement date?

 Jeff Thomas  40:29

There’s been a number of folks that are working on that as well. Australia is actually doing a big project. I think they’re about year five of trying to revamp their whole settlement system onto the blockchain. I know there’s been a lot in the derivatives space where companies are looking to leverage blockchain to try to smooth the needs that when you kind of get to the core US equity markets, though, they move pretty fast. Our trading matching engine runs in microseconds. So that’s a really, really short period of time. And there’s one thing about blockchain specifically, if you look at Bitcoin, the hashing algorithms that they use to verify transactions and those kind of things, they don’t run in that speed yet, right? So when you have a lot of legacy infrastructure, and when you have a very high speed market, it doesn’t mean that it won’t ultimately be adopted in that way. But we think it’s probably a pretty long project in terms of the US equity markets.

 Shawn Flynn  41:25

There’s a lot of interest in environmental, social and governance. Can you talk a little bit about this trend?

 Jeff Thomas  41:32

Sure. So when I go out and talk to the CFOs of our listed companies, this is the number one topic that comes up, right, if you go back even two years ago, if I would have brought this up to a CFO, they said, :I really don’t hear about that, investors aren’t really asking me about that.” Now we’re getting inbound calls from the boards of directors of public companies saying we see all the money that’s flowing into ESG focus funds. We’ve seen all the negative press that comes out when you have poor governance controls. We see all the focus on creating environmentally friendly and sustainable companies. We need to get ahead of this. And this is not just the companies you’d expect. These are companies in the energy industry. This is people in manufacturing. This is people across the board, saying, “Hey, if this is where investment dollars are going to flow, we need to get ahead.”

Jeff Thomas  42:20

And when you look at the ESG landscape, it’s pretty complex. There’s about 40 different frameworks that are out there. They all have their own questionnaire, or stats that they try to gather through your website or other means. And when you stack all those questionnaires up, and you get to over 1000 different questions that companies have to decide one, do they want to report on them? And then two, can they report on it? Do they have the data? Is that data auditable? Are they confident that if they’re disclosing something publicly, they’re doing it accurately? And so it’s a huge challenge for companies to go out and say, “Okay, we want to make sure we have a good ESG rating.” Alright, well, which framework do we want to get focused on? What’s that framework asking for in terms of disclosure? How are we going to gather that data in a repeatable and auditable way? And oh, by the way, none of this is required, right? This isn’t like this has to go into your case or Q’s, this is all people are just doing this to try to either one, promote the good work they’re doing. Or two, they’re trying to make sure that they’re attractive to all the investment dollars that are out there.

Jeff Thomas  43:27

So you talk about other big trends in the market. So ESG is definitely on the rise. The other thing that’s been going on for a long time now is the shift from active to passive. So when you look at investment dollars, over the past decade, there’s been this enormous shift from active management people at funds that are picking individual stocks to passive investment, people that are investing strictly in indexes so that they’re having a lower cost of asset management fees. One fun fact, you can now look and see that at Nasdaq, we helped operate the Nasdaq 100 index, which is operated by Invesco, the QQQ’s, and it’s now one of the largest indices in the world. It’s got in 2019, about 76 billion assets under management. And we get a tiny fraction of that.

But we now actually make more managing that and all the other indices that we calculate and manage than we do on US equities trading. So we’re making more on our passive index operations than we are on the active management of the US equities trading. So that just tells you how much the shift has happened, right? But when you go back to the topic of ESG, so you know, that trend is happening. So you know, a lot more investment dollars are going into passive or index investing. What are the areas in active management that’s growing? It’s ESG, right? So ESG focus funds are applying additional screening and human analysis to these companies to say, “Okay, we want to go invest in companies that have a good environmental track record, are sustainable for the long run, have good corporate governance. It’s hard  to create indices around that. And we’re obviously working on that too.

Jeff Thomas  45:04

But for those funds, there is a lot of active management that goes on in it. And the good thing for corporate issuers is, if it’s actively managed, that means that you can go and engage with those investors, and hopefully attract new investment dollars, right? If it’s an index fund, you’re either in the S&P 500, or you’re not, right? It’s not like you can go like, work on that, right, you can get your stock price to go up. But that’s about it.

 Jeff Thomas  45:26

So we just see a tremendous amount of interest from the board, from CFOs, from the Investor Relations Department. And then the other interesting group of clients is folks that have been putting out Corporate Social Responsibility reports for years, a lot of time that function is housed under the strategy or marketing departments. They’re putting out 100 page PDFs, and now all of a sudden they’re saying, “Okay, are all of those disclosures that we’ve been putting in these reports for years, are they getting translated into these ESG frameworks? Right, are we getting all the credit for the good work we’re doing? And then where we disclosing the right stuff?” Maybe the company’s doing other great things that didn’t make it into the report for whatever reason. But some of these really influential frameworks are, you know, looking for more disclosure. So can they be set up? Can they enhance it? And so that was one of the reasons that in 2019, we launched our ESG advisory practice.

Jeff Thomas  46:13

One of the reasons that Nasdaq is in a really unique spot, to advise companies on this, go back to that acquisition in 2008, of the Omax group, and the Nordics, who’s led the whole initiative around ESG? It’s really been the Nordics. European investors for a long time have been very focused on these metrics. It’s been a big part of the whole mantra of the EU. And so we have been deeply involved in ESG disclosure and reporting for the past 10 years through that acquisition, and through the operation of the markets in the Nordics. And so now we’re bringing a lot of that know how experience to the US. And so we think we’ve got a really interesting role to play there.

 Shawn Flynn  46:49

And Jeff, last question for you, what should investors or the general public expect in 2020? And if anyone wants to learn more about Nasdaq, what’s the best way to go about doing it?

 Jeff Thomas  47:00

Sure. So I think as you kind of look out at 2020, we talked about how the one sure thing is that we’re probably going to see more volatility this year. And you know, the other thing is we are now almost 12 years into a bull market. So everybody keeps wondering when the other shoe is going to drop, when we’re going to see a correction. Markets operate in cycles. And so whether it’s this year or the next year, or the year after that, we have never seen a bull market last this long. And unfortunately, the other thing we know is that the longer a bull market goes, the harder the crash and a pretty aggressive monetary policy post the financial crisis. And so I think that has fueled a lot of additional capital that’s led to some of the capital that goes into the private markets. We talked about that. But it also fuels obviously a lot of leverage and a lot of debt. Which is ultimately what comes back to get you when things slow down.

So unfortunately, it’s not a super rosy note, but you know, I think we’ll see a lot more volatility and at some point we will see a pullback and then, in terms of how to learn more about Nasdaq. One of the things we really try to do is put a lot of great content on nasdaq.com. We have a lot of good content partners. And if you go right to our home screen, we’ve got a great set of videos that will help keep you up to date on the markets, what’s going on both here in the US and globally. And you know, as I mentioned, you know, we are a global technology provider into the capital markets. So we really think that we sit at a really interesting intersection to not only power those capital markets, but also inform investors on what’s going on.

 Shawn Flynn  48:29

Great. We’ll have a link to the Nasdaq website in the show notes on The Investor’s Podcast website. I also want to thank Dan Angus for setting up this interview and introducing me to Jeff, to allow this to happen today. And Jeff, I got to thank you for your time this morning.

 Jeff Thomas  48:43

All right. Thanks for having me.

 Outro 48:45

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