Leinweber, David

Caltech Authors - Main

DIVISION OF THE HUMANITIES AND SOCIAL SCIENCES
CALIFORNIA INSTITUTE OF TECHNOLOGY
PASADENA, CALIFORNIA 91125
MARKETS, TECHNOLOGY AND TRUST
David Leinweber
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SOCIAL SCIENCE WORKING PAPER 1143
October 2002
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 1 
Markets, Technology and Trust 
 
 
Revised Oct. 20, 2002  
Working Paper Number 1143 
 
David Leinweber 
California Institute of Technology 
Pasadena CA 91125 
626-395-4156   djl@caltech.edu 
  
  
Trust in financial information 
 
Investors in the U.S. stock market are in the midst of a crisis of confidence. Back in the 
days before Enron, the level of trust in financial information was sufficiently high to 
satisfy a broad base of investors. That satisfaction is slipping.  
 
During the nineties, the rapid growth of the Web expanded the availability of financial 
information.  Meanwhile, the corresponding ability of millions of people to act on  
information  with confidence made markets more efficient. But as the recent corporate 
scandals have shown, when people have doubts about any aspect of this process they pull 
back and do not participate.  Markets suffer as a consequence.  
 
People in academic and government settings are expressing concerns about the darker 
sides of rampant market technology. In their  paper, “Technology, Information 
Production, and Market Efficiency”, Harvard Business School authors D’Avolio, Gildor, 
and Shliefer observe1: 
 
“A well functioning securities market relies on the availability of accurate 
information, a broad base of investors who can process this information, legal 
protection of those investors’ rights, and a liquid secondary market unencumbered 
by excessive transaction costs or constraints.” 
 
Roger Ferguson, Vice Chairman of the Federal Reserve, discussing these issues at a Fed 
sponsored seminar, had this to say2: 
 
                                                 
1 “Technology, Information Production, and Market Efficiency” Gene D’Avolio, Eli Gildor, and Andrei 
Shleifer, Harvard Institute for Economic Research, Discussion Paper 1929, September 2001. 
http://post.economics.harvard.edu/hier/2001papers/HIER1929.pdf 
 
2 Remarks by Vice Chairman Roger W. Ferguson, Jr. at a symposium sponsored by the Federal Reserve 
Bank of Kansas City, Jackson Hole, Wyoming  August 31, 2001 
http://www.federalreserve.gov/boarddocs/speeches/2001/200108312/default.htm 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 2 
“This line of research has generated important insights concerning economic 
behavior and the functioning of markets, showing in particular that imperfect 
information can lead to outcomes that are distinctly less favorable than those 
under complete information.” 
 
Loss of trust is one of those less favorable outcomes. Restoration of trust in our markets 
will take a great deal more than just technology.  But just as technology has transformed 
information dissemination and order execution, there is a clear role for technology in 
improving public confidence in our markets.  And a good starting point is the SEC.  
While the SEC today is almost fully electronic, the agency’s transformation from paper 
and microfiche has been slow and sloppy. The specific implementations of the 
technological means of information disclosure of the less than perfect information 
available today do not bode well for the future.  In the wake of Enron, WorldCom and all 
the rest, investors should demand that the SEC heal itself technologically.  
 
In its own words, “the primary mission of the SEC is to protect investors and maintain 
the integrity of the securities markets.”  There has been a lot of technological effort to 
this end.  Nearly all company filings must now be submitted electronically. Investors who 
want to read them have to use the web. The regional SEC reading rooms have been 
closed.  In theory, the Net is the enabling technology for creating a level playing field, 
and assuring “fair disclosure” to all under Regulation FD.   
 
A closer look shows that the field has not been all that level. The SEC provides two kinds 
of access to this electronic information. Anyone can go to the SEC.gov website for free, 
using basic search facilities and tools on the website. People who pay a premium can use 
a much more extensive set of tools from private resellers to analyze SEC filings.  
 
Electronic SEC filings have required since 1996. It took until summer of 2002 for the 
SEC to release this information to the public in real time.. Direct premium subscribers, 
and their customers had a 24 hour lead on the public using SEC.gov. It seems amazing, 
but subscribers willing to ante up the annual fee (roughly $40,000) and install a private 
line for the curiously named “Public Dissemination System” were first in line, all the 
time.  TRW, the SEC’s web contractor, spelled it out clearly in their specification: “By 
design, the SEC Internet site has a 24-hour upload delay; only the SEC and PDS 
subscribers receive submissions in real-time.”   
 
The elimination of the time advantage for ordinary investors, paying only with their 
taxes, and using the SEC.gov website is an overdue improvement in a system that 
delivered yesterday’s news for six years. 
 
On an average day, the SEC information machine pumps out 1.5 gigabytes of new 
filings..  There is more information than anyone can cope with.  Premium users have 
access to a variety of modern tools to access and analyze current filings. Ordinary 
investors using the government website see a veneer of modernity when they try to locate 
a particular filing, but once they get there, they’re back to 1980.  
 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 3 
Front Door to SEC.gov – It’s 2002.
 
The SEC website has a stylish looking modern front door. 
 
 
The content of the actual filings shows up looking like it was typed in a bygone era. 
Finding the relevant sections and footnotes in filings is remarkably tedious. Tables of 
contents don’t have active links to sections. Many don’t even have page numbers. In fact, 
there are no links at all inside the electronic SEC filings. People have to scroll though 
ever longer filings with less navigation assistance than would be found on any 
commercial website.  
 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 4 
Number of Links in an Electronic Filing: ZERO
 
But when you look at the content, even the most rudimentary tools for  
using the information are absent. It’s a time machine back to 1980. 
 
Comparisons of one firm’s filings over time or between firms are particularly tedious.  
The only practical way to do this is to pile up reams of printouts and get out the old red 
pen. Don’t even think about extracting and analyzing financial tables unless you’re 
willing to cut-and-paste yourself into an advanced state of carpal tunnel syndrome. 
Amazingly, enforcement actions against companies are buried in a well-hidden zone of 
the website, away from all the other filings. 
 
It’s truly an eye-opening experience to compare the crude SEC.gov tools to a modern 
website, one that actually has to work for a living. Amazon is a fine example. Bookmarks 
automatically track what you’ve been looking for recently; comparisons are practically 
done for you. Related and similar items are automatically brought to your attention. 
 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 5 
If  
ran SEC.gov
• Side-by-side 
comparisons
• Document history
• Cross linkage
• Related filings
• Related firms
• New & interesting
 
Once you get into the content of filings, and look under the modern veneer,  
SEC.gov provides none of the tools that have become standard commercially. 
 
 
This is a key area where technology can help restore trust.  For starters the SEC should 
eliminate the delay between first-class and coach dissemination of information.  They 
should also make that information transparent and accessible, by using modern software 
tools we have come to expect elsewhere.  One example: using Current HTML tags 
control only how data looks. XML (extensible markup language) tags that tell you what 
the data is.  (Examples would be “SEC Enforcement Action” or “Qualified Auditor 
Report.”) This would make it much easier to use technology to keep up with what comes 
down that humungous SEC data pipe. 
 
The XML idea isn’t news to the SEC. They’ve issued a hefty tome listing hundreds of 
meaningful tags. The problem is that the most are “optional”, or works-in-progress. The 
only ones that are mandatory are of the “name, rank and serial number” variety. So you 
can locate a filing pretty easily, but once you get there, it’s like sitting in the reading 
room, turning pages. Other industries have implemented comprehensive XML standards, 
describing thousands of components, chemicals and the like in fine detail. The aggressive 
implementation of these standards deserves a place high on the list of post-Enron SEC 
reforms. 
 
Australian financial regulators are the leaders in this, but progress in the US has been 
slow. Microsoft and a few others have started reporting in XBRL3. A glimmer of progress 
is better than none at all, but to say these efforts are moving in low gear is rounding up. 
                                                 
3 Go to www.xbrl.org for more than you probably want to know about this. 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 6 
Open Standards and Information Transparency 
 
Delivering SEC financial information in an open transparent form can go a long way in 
allowing investors to make informed decisions. NASDAQ has sponsored a demonstration 
system containing SEC and market information from 21 technology firms. They are 
motivated by exactly the same needs that have been discussed here.  
 
“We believe greater transparency will enhance trust. The effectiveness of the 
world's capital markets depends on public trust, and trust depends on the timely 
availability of complete, relevant, and reliable information-in a word, it depends 
on appropriate levels of transparency. Corporations have an obligation to provide 
the most accurate financial information to their stakeholders so that they can make 
informed decisions. Given today's environment stakeholders are demanding a 
much higher level of transparency. The demonstration provides an example of 
how XBRL, Web Services and simple desktop analytical tools combine to 
enhance the transparency of company reported information to the markets.” (Note 
5) 
 
 
 
The NASDAQ  XBRL demonstration, which uses five years of SEC reporting from 
21 tech  companies, shows the flexibility of transparent reporting for both 
numerical and textual  information in EDGAR filings. 
 
 
Investors looking to use these kinds of tools would not be limited to one analytical 
viewpoint. The openness would allow “a thousand points of light” to flourish, from 
valuation models, to portfolio analysis tools, to fraud detectors.   
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 7 
 
Millions of people look to the SEC to play a leading role in the restoration of trust in the 
markets. A real commitment to open information is central to the agency’s mission to 
serve the investing public. 
 
Trust in trading 
 
Trust in the information people use to make trading decisions is one aspect of a market 
transformed by technology. Trust that those decisions will be executed fairly by their 
brokers is another.  Investors are increasingly concerned with the “quality of execution”.  
Following a talk at here at Caltech by the outgoing president of the NYSE, almost all of 
the questions were complaints about unsatisfactory trades, executed at prices less 
favorable than those they could see on their computers or rolling across the bottom of the 
screen on financial cable television networks. The little old ladies from Pasadena and 
their husbands practically hijacked his talk with complaints about bad executions from 
their brokers.  
 
This is another symptom of the technological transformation of stock markets. 
Economists call it market fragmentation.  Brokers and their clients have more 
alternatives to NASDAQ and the NYSE than ever before. ECN’s such as Instinet, Island 
and Archipelago have captured more than a third of the volume for NASDAQ stocks, 
and with the repeal of NYSE’s rule 390 (which effectively prohibited exchange member 
firms from trading away from the exchange) their share of the volume in listed stocks is 
rising rapidly.  
 
 Market fragmentation can be good news for large institutions with the technological 
resources to “comparison shop” their orders over multiple venues to get the best prices. 
It can be bad news for individuals, whose order flow may be sold to the highest bidder, 
looking to use their transactions to provide the other side of a “price improved” trade for 
a large customer.  
 
In theory, there is an “Intermarket Trading System”, designed to consolidate market 
fragments, so all orders will be able to execute at the best prices. In practice, it is a 
technological antique that dates back to the 1970s, and doesn’t assure best execution in 
today’s fragmented markets. This is precisely why those Pasadena retirees were so 
cantankerous about their brokers. 
 
Think of how well the railroads might function if every line across the county used a 
different gauge of track and you are thinking about the direction the equity markets are 
headed.  A mandate for a 21st century replacement for the creaky ITS deserves a place on 
the SEC’s technological “to do list” to help restore trust in markets.  
 
Unfortunately, this is not going to be as easy to do as a modernization of the electronic 
Edgar system. The rapidly changing market fragments are a complex and dynamic set of 
moving targets. What the SEC is doing instead is to require that brokers and market 
centers provide the sufficient information for individuals to obtain “best execution” on 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 8 
their own.  Two SEC rules, adopted in 2001, are supposed to do this. They are called 
“Disclosure of Order Execution and Routing Practices” and designated Rules 11Ac1-5 
and 11Ac1-6. You can read them on the SEC website4. It is noteworthy, and 
commendable, that these rules do have the active links and references that are absent 
from Edgar filings. 
 
The rules sound good. They “are intended to spur more vigorous competition among 
market participants to provide the best possible prices for investor orders”. Brokers are 
“required to disclose the identity of the market centers to which they route orders on 
behalf of their customers.”  These disclosures are described as the “minimum step 
necessary to address market fragmentation.” and detailed standards are set for the “basic 
measures of execution quality” in those disclosures. 
 
It sounds good, but the implementations that the SEC has allowed for these standards 
make the feeble Edgar system look like it is run by Amazon.  The information 
disclosures required by these rules are almost invisible. At many brokerage sites it is 
buried so far down, you need to use a separate search program to locate it.  Much of the 
reporting has been contracted out to vendors like Market Systems and the Transaction 
Auditing Group 5.  A recent attempt to get this information was instructive. After 
spidering a brokerage site and being linked to the contractor, most of files seemed to be 
inaccessible. 
 
 
Best execution? The lights are on, but nobody’s home. 
 
 
                                                 
4 http://www.sec.gov/rules/final/34-43590.htm, Final Rule: Disclosure of Order Execution and Routing 
Practices, 17 CFR Part 240  [Release No. 34-43590; File No. S7-16-00]  
 
5 http://www.marketsystems.com/ and http://www.tagaudit.com/  
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 9 
When a file was finally found, it wasn’t anything that could be looked at online. It had to 
be downloaded in a format that produced this encouraging message: “You are attempting 
to open a file of type ‘DAT file. These files are used by the operating system… Editing 
or modifying them could damage your system.” 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Undaunted, I plowed though the warnings and force-fed it into Excel to look at the 
information I was supposed to use to become a better-informed trader. It looked like this: 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For most people, this comes across as a digital Easter egg hunt, with explosive eggs. 
This kind of technological obfuscation certainly doesn’t sound like what the SEC 
intended in issuing these rules, but there it is. 
 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 10 
Even when you can actually get to read this information, it is reported in bulk - Monthly 
compendia with prodigious quantities of raw data that obfuscate and obscure.   
 
A Simple Solution Ignored 
 
Brokerage firms have the technology to allow large institutional traders to monitor their 
quality of execution in real time. It would require almost no effort to provide individuals 
with the quality of execution information mandated by the SEC rules. It could easily be 
delivered along with the trade confirmations. People could see what is happening to their 
money, without having to wade through the current smokescreen. 
 
 
F for Effort 
 
These examples are embarrassing examples of a lack of effort in using simple readily 
available tools to help restore investor confidence. 
 
We have seen markets transformed by technologies for hundreds of years, from 
telegraphy, to ticker tape, to telephones to computers to the Web. It isn’t slowing down, 
and it isn’t always for the better. 
 
Every business newspaper or magazine today offers a list of proposed SEC reforms. Most 
are long overdue, but let’s combine them with technological reforms to restore and 
maintain trust in markets.  Providing one without the other is a disservice to the public. 
Improving technologies without improving information quality will serve only to mislead 
and confuse a broader base of investors. 
 
Technology is arguably the most powerful agent for change in the modern world. It is our 
responsibility to use it to improve the quality of our financial system, not just its 
bandwidth.  
 
Markets will be better when market information is not a barrage of bull buried in a 
barrage of bytes. 
 
Acknowledgements 
 
I’d like to thank Lance Davis at Caltech and Gene D’Avolio at the Harvard Business 
School and Jacob Sisk at UCLA for their helpful comments on this topic.  It is gratifying 
to see that the SEC has gone to real time pass through of current filings on their website. 
We can hope for further improvements. 
______________________ 
 
 
David Leinweber (djl@caltech.edu) is a visiting faculty member in Economics at Caltech, 
and a consultant to securities and investment firms. Previously, he managed over $6 
c. 2002 David Leinweber     626-395-4156   djl@caltech.edu 11 
billion in quantitative equity portfolios and was the founder of two financial information 
technology firms. His webpage is  http://www.hss.caltech.edu/~djl/.  


Markets, Technology and Trust

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