This paper will attempt to educate anyone, professional investor
or Internet enthusiast, about the Internet's growing role in the
world of finance and investing. It was written with both none
and every audience in mind. I have drawn on both my undergraduate
education and extensive work experience in its preparation; I
was the primary source in its preparation. It is authored in terms
that are easily understandable, and multiple links are provided
to further assist the reader in understanding the topics and issues
being discussed. I truly believe a professional or a layperson
can gain additional incite through reading this work. If a reader
needs further explanation of a term or topic, they can look here
for a glossary of financial terms. I treated this paper as a learning
experience in writing it, and I welcome any comments
you may have.
The financial services industry has become a highly competitive, shrinking margin business. There are many more participants pursuing far fewer dollars than there were ten years ago. The globalization of financial and capital markets has made it difficult for companies operating in this industry to differentiate themselves from one another. The continual development and evolution of information technology and the Internet has made this phenomenon even more pronounced. It would be impossible to identify the total number of companies operating on the Internet offering research, advise, brokerage operations, and other vital financial data and services to anyone with access to a World Wide Web browser and some free time on their hands. Exploring the web can lead anyone, including financial novices, to security prices, company and market gossip, retirement plan advice, general market information, or economic statistics. All of these trends are the result of a single catalyst. Information. Finance and investing revolve around the retention and dissemination of information. The survival of this field solely depends upon it.
Information is commodity-like in the world of finance in that the winners (e.g. those who make money) usually have it, while the losers (e.g. those who lose money) often do not. Investing should be conceptualized as a zero-sum game. When one participate makes money on an investment, somewhere, another market participant lost money on the same investment. In the past, individual investors (you and I) were in many cases the losers, while large, sophisticated institutional investors profited at the small players expense. The term institutional investor refers to large market participants such as mutual funds, commercial banks, investment banks, pension funds, corporations, and hedge funds who invest billions of dollars at a time. Participants such as these may invest tens, or hundreds, of millions of dollars in a single investment. Institutional investors previously had an advantage over other participants through their access to information. These investors obtained this information from brokerage firms and investment banks who they use to execute and settle transactions. Providing market and company research is a value-adding business for these banks and brokerages. Large sums of money can be made from timely and concise research. Firms would not provide this research, which is extremely expensive to produce, if they were not going to make money for themselves. Institutional investors allow banks and brokerages to make large sums of money through fees and commissions. Because individual investors cannot provide the same money streams, they are not catered to by the providers of this research and information.
The Internet has leveled the playing field between institutional and individual investors. The term sophisticated does not solely apply to institutions anymore. The Internet and other forms of information technology have made it so individuals have access to channels of information once out of reach. A large amount of the costly information institutions alone once had access to is available free of charge on web pages scattered around the globe. In addition to this, individuals can receive competitive prices and commissions on tradable securities through numerous discount brokers. These no frill brokers execute trades and provide research for a fraction of the costs charged by institutional firms, but do not offer financial advice and guidance to their clients. One technologically savvy company has even gone as far as to sell a portion of their company to the public over the Internet. Internet IPO's (Initial Public Offerings) have become the rage as entrepreneurs avoid paying large fee's to investment banks for financial advice and distribution of equity. These individuals market and sell equity shares of their companies to the public themselves. Most of these transactions are private placements that do not trade on established exchanges, leaving many questions to be answered regarding their legality and regulation. Even larger questions remain as to how this type of investment banking will conflict with current forms where investment firms establish relationships with clients to advise them on transactions, collecting fees in the process. While Internet IPO's are in their infancy and are not yet exchange traded, they could represent a model for future transactions of their type. If so, investment banking as we know it presently would be altered. The need for many of the employees currently working for these firms would be eliminated.
The Internet has influenced the world of finance and investing
in a way in which nothing has in the past. It has attracted an
influx of people and gave them new and innovative tools to succeed
in a complex and difficult business. Advantages once held by institutional
investors over smaller individual investors have been largely
eliminated. Although many questions surrounding the monitoring
and regulation of Internet based finance and investing remain,
it can be said confidently that a new paradigm of the financial
world is upon us.
The preponderance of information received by all types of investors in the financial community comes from traditional print and broadcast news sources. Every major news service provider maintains a web page on the Internet which widely disseminates price-sensitive, market-moving information for free. The most well known and highly regarded web site is run by the financial desk of CNN. The site, known as CNNfn, provides news and information on the economy, business, and financial markets around the country and the world. The site was created so that crucial market indicators such as the Dow Jones Industrial Average or the Standard & Poor's 500 Index can be viewed quickly. In addition, the page automatically updates itself every few minutes so that the users who constantly have the page on their computer screens are receiving up-to-date and accurate information. The page is catered to individual investors in that it offers links to aid them in selecting and managing their investments. Users have a choice of options, ranging from research and performance numbers on mutual funds, to a mortgage calculator which will assist users in selecting a mortgage.
The trend of Internet accessibility is similar in the print medium of news. All primary newspapers provide a web page which can access not only that day's news stories, but historical articles as well. Some even offer a search mechanism which can be used to search a newspapers archives for a particular topic. While The Washington Post and The New York Times offer web pages with business and financial news combined with other news topics, traditional financial newspapers with web pages give their users comprehensive and in-depth business news. The Wall Street Journal is a staple in the world of finance which not only offers a hypertext edition of its newspaper, but tools to research and analyze companies and industries as well. It also allows its users to view hypertext versions of its foreign newspapers. Dow Jones, the owner of the WSJ, prints editions of the newspaper which are focused in particular regions of the world. Japanese businessmen receive the Asian edition of the Wall Street Journal each morning, while in London they receive the European edition. Foreign print editions of the Wall Street Journal are usually not available to readers in the United States. The Internet has enabled a wealth of news and information, previously not accessible, to be a few clicks away. Barron's, an additional holding of Dow Jones, offers readers a hypertext version of its weekly publication also. The Barron's page follows the WSJ page in that it offers users additional market and company specific research. Barron's is making new strides in its offerings through the development of analytical tools which will allow users to manipulate data in ways never done before. Although this segment of the page is not complete, Barron's will give users the opportunity to use technical tools to analyze markets or individual securities and produce earnings and other financial forecasts for companies under multiple scenarios. This is a tremendously important event in Internet financing and investing. Barron's will be allowing individuals to evaluate investment decisions in a form similar to that of high paid analysts working in multi-billion dollar investment banks. The third major financial newspaper which offers a comprehensive web page, The Financial Times, is published in London and gives its readers a global perspective of economics and finance. Unlike other print publications offering web pages, The Financial Times does not provide its users with many external research links. It does not provide tools for international market and company analysis either. The Internet edition of this newspaper is advantageous because of the location it is published. Because of time differences, the daily edition of the paper is available the night before in many parts of North America (e.g. the edition which will be available on American newsstands Monday morning is available over the Internet Sunday night). This is an edge which individual investors never had previously. The ramifications of this edge are easily discernible by using an example: The foreign exchange market is a global market which operates 24 hours a day. Most of the participants in this market are banks and brokerages that can afford to establish trading desks across the world. The market moves from New York-to Tokyo-to London-and back to New York, following the sun across the globe. There are some individual investors in this market that possess the necessary capital to participant; minimum currency investments usually are $10 million. Having information on the performance of the currency market the night prior to its switching back to New York gives an investor a perspective and can allow him/her to adjust positions if necessary. The Internet allows an investor to easily obtain, free of charge, information which would normally cost thousands of dollars to receive on a regular basis.
It is becoming increasingly clear that individual investors are making strides in leveling the playing field between themselves and institutions because many of the news and information services which in the past were only used by so-called "sophisticated" investors are also now available to the public on the Internet. Bloomberg, the most widely known and highly regarded news and information provider in the financial world, now offers Internet users the opportunity to access some of the features available on the terminal boxes they lease to firms around the world. I believe that a Bloomberg machine has the capacity to locate information on any topic imaginable. The power and usefulness of these machines cannot be adequately explained in this writing. Anyone who uses these terminals, even briefly, will understand the validity of these words. Dow Jones Telerate, Knight-Ridder and Reuters, news services commonly used by financial institutions, now have web pages which contain a wealth of financial news and commentary as well. Another news and information service of interest available on the Internet is the Dow Jones Industrial Network. The DJIN is a broadcast news service carried to subscribers over closed-circuit television. It carries informative interviews with analysts, economists and portfolio managers who give their outlook on companies, the economy, or the market. It is vital to some areas of the investment world because it carries the announcement of economic indicators and treasury auction results. Dow Jones has made the service available, free of charge, over the Internet. Users only need to download the Real Audio player, available free from their homepage, to listen to the networks programs, in real-time, over the Internet. Corporations of this sort may now be realizing where the majority of their revenues will be derived in the future, and are taking steps to capture their respective shares of that market early.
It must be noted that a few of the of the news and information providers available on the Internet, mentioned previously, charge service fees to fully access their information. While this is somewhat contradictory to comments made previously regarding accessibility, the comments are valid when understood in context. In the instances where they are used, the fees charged by these services for access to their Internet pages are almost always affordable by the masses. Access to these services through traditional means can cost corporations millions of dollars a year in subscription and service fees. Internet access to these resources is a bargain, to say the least.
While the Internet has become a popular medium for accessing financial news and research, it is also used to obtain the most important form of financial information: security prices. Price levels for stocks, bonds, and other securities is the area in which the Internet can add the most value. In the past, up to the minute prices on securities could only be obtained from a broker with whom you did business. When you were ready to make a trade, you called your broker to get a price and executed your trade at the price provided by your broker. Because you were essentially blind to precise market levels, the broker had numerous opportunities to cheat you in prices. This will only happen to individual investors because institutional investors use multiple brokers to execute trades, and they check among them to ensure they are receiving fair price levels. The Internet enables individual investors to check price levels over the web. Multiple sites, including the CNNfn page discussed before, provide stock quotation services. Once again, almost all of these services are available for free. Quote.com is one of the few fee-based services available on the Internet. It offers a comprehensive quotation service, with unlimited amounts of stock quotes and vast amounts of historical company data. Like the CNN quotation service, most of the other services are provided free of charge. There are countless numbers of sites providing this service, but two of the more popular pages are DBC and Stockmaster. The Stockmaster page is extremely popular because it provides very detailed and informative historical and intra-day charts of every major exchange traded stock. Data Broadcasting Corporation (DBC) offers users a site to retrieve multiple stock quotations simultaneously. Most Internet based quotation servers only allow users to view one stock quotation at a time. The feature which separates free from fee quotation servers is the time delivery option of the quote. All of the major stock exchanges (NYSE, NASDAQ, and AMEX), have rules which prevent quotation services from providing real-time quotations free of charge. Because of this, quotes received from pages for free usually are delayed fifteen minutes (e.g. the price you see at 2:00pm is actually a quotation that printed at 1:45pm on the exchange). This can be problematic for market-timing investors who would like to receive market quotes for free. Most individual investors use the services as they were intended, to find an indication of a stock's price level. An exact level is usually obtained at the moment of execution. The difference between then and now is that the potential investor is no longer blind.
Other types of quotations are available on the Internet also. Investors now are able to receive market levels on complex securities ranging from bond options to commodity futures. Both the Chicago Board of Trade and the Chicago Mercantile Exchange, the two primary exchanges for financial and agricultural derivatives, operate web pages which offer quotations and information on the numerous products traded on the exchanges. These innovations go far beyond anything available even a few years ago. The Internet has brought transparency to all of these markets which has made them more efficient and lucrative for all of their participants.
An increasingly popular issue in the spread of financial content
across the Internet is the delivery of this information. One of
the hottest trends in Internet access products is the concept
of "broadcasting" the content of web sites to users'
computers continuously, without requiring the recipient to navigate
to a site manually. The idea has resulted in the emergence of
a company named PointCast.
PointCast constantly pumps news headlines and other material,
financial and otherwise, from web sites onto a screen saver on
a PC. The screen saver is detailed in that there is a moving ticker
along the bottom of the screen with stock quotes (delayed 15 minutes),
and other useful information. Financial and other news headlines
flash onto the screen; complete stories being accessible through
selecting a headline with the click of a mouse. There is only
one problem that services such as this present: they work well
only for the minority of computer users who have access to continuous,
fast connections to the Internet. Many users lack the bandwidth
this service requires to operate correctly. However, it is important
because as access to dedicated connections to the Internet become
cheaper and widely available, this type of service will become
the norm. Individuals having a ticker tape floating across the
bottom of their computer screen will be part of what the future
holds for the Internet-based investor.
With the advent of Internet investing has come the onslaught of Internet brokering. Investors can now trade securities through web pages provided by a host of companies. These companies are providing investors the opportunity to actively trade stocks from the desktops of their computers. Lombard, eTrade, AccuTrade and eSchwab are all companies which offer security trading over the Internet. Each of these services let investors open trading accounts through the mail or fax and can E-mail trade confirmations to clients. Because these services are catered to individual investors, a small but increasing segment of the population, they compete fiercely for clients. These services are not authorized to advise clients, therefore most of the competition centers around cost of execution. Flat fees are charged for trades ranging from 100 to 500 shares. The average execution price of trades for these services is approximately $22.50 a share, and these fees do not increase substantially as the number of shares traded increase. Execution charges are far below what the average investor, individual or otherwise, would pay for trades using more traditional means. These services are fairly new and all have problems which have yet to be fully resolved. Some users complain that it takes too long for trade confirmations to reach them. They may believe that they have transacted on a certain stock at a certain price only to discover no transaction took place at all. Payment schemes are an additional issue which will be discussed extensively in the future. While currently these accounts are established using the mail or a fax machine, DigiCash and other forms of electronic payment are certain to become an option. How these companies will deal with this remains to be seen. Bandwidth is a larger problem facing many of these services. Users have complained that they cannot access these services all together in times of high market activity. Many of the companies have underestimated the demand for their services when certain market conditions come about. The analogy of every person at a party running for the door at the same time comes to mind. A few of the services, eTrade in particular, have limited bandwidth, making their door roughly the size of a door on a doll house.
Because individual investors now have access to tools identical to those of institutional investors (e.g. research and execution), they are also exposed to some of the more negative areas of the financial world. Hyperbole and manipulation are a few of the unfortunate realities of investing. Security manipulation has existed since the beginning of markets and exchanges, there is no reason to believe that it would not carry over to this new medium. The Internet's primary function is interaction and communication. This trend cannot be more clearly illustrated but in the realm of Internet investing. Investors of all kinds converge on chat and message boards to discuss various investments. A large share of the discussion in these forums centers around technology and Internet related stocks, but all types of companies are essentially fair-game. Most of this talk is speculation based upon rumor at best; some is outright deception perpetrated by those hoping to take advantage of the unwary investor. One of the more established locations of investor communication is the Motley Fools. The Motley Fools is an America Online based center for investor information and communication. They also operate a web page with nearly the same content as the AOL forum. Users can research new companies and gauge public perception of these companies through message boards. The service is not tightly regulated and anyone can post messages to the forums. There are countless investors that have vested interests in seeing a company's stock move up or down. Many of these investors are posting messages to Motley Fools and other message boards. Because the Internet has become so popular, rumors and lies posted on these forums have the potential to move markets. The Motley Fools have taken the initiative in curbing such practices, but even they have been susceptible to them in the past. Other sites, such as one run by the Silicon Investor, seem to find their purpose in financial gossip and hyperbole. Investors flood this and other sites when they are interested in finding out the latest gossip on a particular stock. Usenet newsgroups have also become open forums for public opinions on companies and markets. Just as other sites of discussion, nothing is edited and nothing is sacred. Companies themselves have not been immune to this phenomenon. Wired Ventures Inc., the owner of Wired magazine, recently had to withdraw its initial public offering because of potential Securities and Exchange rules violations. The companies CEO posted an E-mail to a popular bulletin board defending the company's financial statements and praising the company's business. The memo violates SEC rules forbidding companies that are going public from trying to condition the market for their offering.
"Caveat emptor" is a phrase which comes to mind in all of these cases. The Internet has become the wild west of finance and investing; participants are in essence taking their wallets in their own hands. The Securities and Exchange Commission is attempting to bring law and order to this uncharted frontier, but its strategy to date has been largely reactive and not proactive. It will take some time for them to catch up.
A second, more innovative way in which financial transactions
are taking place on the Internet is in primary security issuance.
Wit Capital Corporation is
the first company which is taking steps to become the world's
first investment bank focusing on the arrangement and execution
of initial public offerings through the Internet. They not only
hope to provide the traditional underwriting
functions of due diligence and valuation, but plan to develop
and operate an Internet based stock market where investors can
trade stocks listed on the NASDAQ and other established exchanges.
Andrew Klein, the CEO of the company, hopes to develop interest
in his plans through Wit-Trade, a forum where buyers and sellers
can post bids and asking prices for stocks that his company issues.
Doing this would essentially create an off-exchange market for
stocks which Wit-Trade would operate. The first issue underwritten
by the company was Spring Street Brewing
Company, Inc., a three-year old microbrewery operated by Klein.
Wit Capital raised $1.6 million for the company without paying
any underwriting fee's or brokerage commissions. On its web site,
the company posted contracts that buyers and sellers filled out
using their home computers. The buyer then mailed a check to Spring
Street, which processed the trade as a Wall Street firm would
and sent the seller's stock certificate back to the buyer. After
the offering was issued and had only been trading for one week,
the SEC shut down the site so that it could closely study the
practice of online trading. Surprisingly enough, the SEC allowed
the company to resume trading the Spring Street Brewing stock
with only a few modifications to its system a week later. While
only one stock is currently trading on the Wit-Trade site, the
securities regulators have clearly opened the flood gates for
similar transactions. The SEC is not known for being receptive
to new ideas and its cautious approval will alter the scope of
Internet investing. While still novel, the use of the Internet
to trade and underwrite securities is going to increase quickly.
Several large Wall Street firms are considering the development of Internet trading systems.
When the large banks and brokerages enter the fray, the market
will grow exponentially. Internet underwriting and trading will
allow companies to market more or less directly to the public.
The potential explosion of Internet trading is a daunting one
for the SEC. Most established exchanges throughout the world are
self-regulating organizations which take responsibility for policing
much of the trading. At the moment, if trading increases on the
Internet, there is not anyone to monitor it except the SEC. The
capacity of this organization to carry out this job is unknown.
A more important aspect in the development of Internet underwriting
and trading is that traditional investment firms may no longer
be needed to advise clients and structure transactions. Competition
for business is already fierce among established firms, new entrants
competing for business electronically could force some smaller
players out of the market. Internet underwriters will never replace
traditional full service investment banks. Countless relationships
established by these firms go back several decades; their clients
are not as price sensitive as the companies who are exploring
this new investment medium. But this new form of competition could
further reduce the continually narrowing profit margins maintained
by these firms. This means that in the future they will be making
even less money than they are making now. The future of many investment
banks hangs in the balance of this medium.
Most of the rumor and gossip taking place in financial message boards and chat rooms around the world is ethically questionable and subject to scrutiny, but it would be difficult to prosecute any of the posters under charges of fraud or manipulation. This is not true in all instances. The popularity of the Internet has led to a surge of scams, schemes, and outright criminal actions. The borderless nature of the Internet is one of the characteristics that makes it so susceptible to crime. Financial fraud is a big worry as the World Wide Web and other Internet services proliferate. There is a growing number of people operating on the Internet that are attempting to deceive potential investors and cheat them out of their money. One of the largest and most well known Internet scams is one that is still being operated by Fortuna Alliance. Fortuna was operating what is known in the financial world as a pyramid scheme. Potential investors were enticed with claims that Fortuna could make their income soar "like the space shuttle." As new investors submitted funds to Fortuna, they would use the new cash to redeem the investments made by earlier investors, giving them an attractive return on their money. This usually leads, as it did in the Fortuna case, to the fund becoming popular. Money flowed into the fund from around the world; Fortuna had tens of thousands of "investors" before it was shut down by the Federal Trade Commission. Fortuna's operators disappeared offshore with most of the $9 million they had collected over the six months the fund operated. Fortuna continues to communicate with potential investors through a web page maintained on an Australian server linked above. The Fortuna case is not an isolated incident The Federal Trade Commission has shut down approximately six financial Internet scams in total. Investors have been bilked by criminals offering anything from prime bank securities, investments that do not even exist, to unregistered securities offering huge profits to be made from a telephone lottery.
The SEC and the National Association of Securities Dealers (NASD), which regulates the over-the-counter market, are now investigating financial fraud and other forms of market manipulation involving bulletin board services. The issues being addressed are inherently complex, and becoming more so everyday. A further layer of complexity and opportunity for electronic crime springs from the development of Internet-based payment systems. None of the Internet crimes thus far investigated has involved exchanges of money via cyberspace. Once secure methods of transferring money are widely accepted, which could be much sooner than many observers predict, a whole host of other issues will arise. Monetary control, federal insurance, tax avoidance, counterfeiting, and money-laundering are all issues which will have to be addressed.
Several of these issues are being addressed presently, but not
by the individuals we hoped would be addressing them. Various
web pages are currently being operated that focus on offshore
related topics. One such site is the Offshore Asset Protection
site operated by Replay and Company Unlimited. It provides links
to pages that offer advise on tax shelters and other wealth builders
and protectors abroad. In short, these pages have tips on methods
of evading taxes and laundering money, activities which criminals
of all types have a great interest. The Offshore Asset Protection
site and other sites like
it are usually owned by companies operating in the Caribbean,
and are not illegal in all cases. Activities such as this are
legal in many of these countries and colonies. However, in many
cases it is illegal for American citizens to commit many of the
actions they are proponents of. Discussing and educating individuals
on these acts are not illegal in their respective countries, nevertheless;
these services are clearly stretching the letter of United States
law to its limits. Increased laws and education are necessary
to prevent online predators from getting their hands on Internet
investors.
While technology and the Internet have allowed institutional and individual investors to compete on more equal footing, all of the differences will never be completely eliminated between the two classes of investors. Because of their sheer size and financial resources, institutional investors will always retain an advantage in key areas. These factors allow them to pursue profitable short-term trading strategies that individual investors cannot. First, institutional investors will always largely have exclusive access to hot initial public offerings. A large percentage of price gains derived from IPO's occur at their outset. Because of their size and financial clout, institutional investors line up to purchase large amounts of these stocks for their own account and for the accounts of their largest clients. Individual investors are largely shut out of these transactions and can only make purchases once the stocks have disseminated around the secondary market. A great deal of the initial price gains are lost to the individual investor by this point. Second, financial institutions can always execute transactions at prices lower than individual investors. This is because of their large transaction sizes and because of trades taking place off-exchange. Off-exchange trades occur when institutional investors arrange for transfers of large blocks of securities between large-scale buyers and sellers for a reduced cost. Third, there is still some forms of information that individual investors are not privy too. Analysts earnings forecasts are widely available on the Internet, but as their announcement nears they are frequently altered somewhat. These revisions are often not released to the public and are shared only with a firms elite group of clients. These revisions will in many cases have market-moving implications. When the earnings are released, there is no surprise on the institutional side, while the individual investor can get caught off guard. Finally, institutional investors have the capacity to monitor numerous markets continually. Very short-term profit opportunities present themselves daily in the market. Institutions maintain a trading staff that can rapidly take advantage of market fluctuations. All of these actions can occur before an individual investor is even aware that movement has taken place in a particular stock. Again, size and clout has its advantages. There are certain areas, notably speed and timing, where individual investors will never be able to adequately compete with institutions. That said, all of these areas of institutional advantage encourage short-term trading and large amounts of risk taking. Institutions are more adept at these practices simply because they have skilled traders, deeper pockets and can afford to lose. A mistake from short-term trading can decimate the capital of an individual investor without affecting the practices of an institution. Individual investors make best use of Internet technology by researching and analyzing investment opportunities in a intelligent manner. Using the Internet to assist in market-timing will likely do more harm than good.
This paper has attempted to explore the ramifications of the Internet on the world of finance and investing. Information, the life-blood of finance, is now accessible to all through an innumerable number of World Wide Web pages scattered around the world. The content contained on many of these pages is highly valuable to the Internet investor, while some of the pages contain only noise. As with the institutional investor, the Internet investor now has the responsibility of deciding what is important and what is not. The concept of adding-value becomes much more important to all investors when the domain of the Internet is included. The ultimate decision to embrace or reject the Internet with respect to investing will depend on its impact on the bottom-line. Internet underwriting will be successful if it can generate money, above and beyond what can currently be generated, for the clients needing the financing and the firms conducting the underwriting. If Internet trading cannot increase cost-savings and efficiency for its users, it will be a fad which will quickly disappear. The concern of business has been the bottom-line since the beginning of time, the Internet will not change this. The Internet will provide new battle grounds and new weapons for waging an old war. The setting may have changed but the goal remains the same.