Drew Field
Direct Public Offerings





What is a Stock Exchange?



The easy answer to “what is a stock exchange?” is found on the website for the U.S. Securities and Exchange Commission, www.sec.gov/answers/exchanges.htm.  It lists the ten “registered national securities exchanges” and has links to the website for each.  Three of these only trade options, not stocks: the Chicago Board Options Exchange (which expects to start a stock exchange in 2007), the International Securities Exchange and NYSE Arca (formerly the Pacific Exchange).  The other seven all compete for companies to list their shares and for brokers to send them orders to buy and sell shares.


Stock exchanges began with actual places where brokers and dealers in stocks could gather to exchange ownership of shares.  The Philadelphia Stock Exchange, which was the first to be formally organized, in 1790, describes its colorful history, including some of the first IPOs in America, at www.phlx.com/exchange/index.html.  The dominant New York Stock Exchange has a relatively dry listing of events since its 1792 founding, gathered at www.nyse.com/about/history/1089312755484.html.  All of the exchanges accept orders only from securities broker-dealers.  To buy or sell shares, you must open an account with an SEC-registered broker-dealer. 


These stock exchanges are only a part of the “stock market.”  Most businesses with publicly-traded shares do not meet the size or other listing standards for exchanges.  This led to the “over-the-counter” stock market, where securities broker-dealers post offers to buy and to sell shares.  When there is a match, they deal directly with each other, rather than going through an exchange specialist. 


The major OTC market, known as “the curb,” because it took place outside the New York Stock Exchange building, became the American Stock Exchange.  The Amex now trades a wide variety of securities, mostly derivative ones.  (It has the most extensive glossary of securities trading terms I’ve seen, at www.amex.com/dictionary/frinit.html.) The largest OTC market, Nasdaq, was started in 1971 by the National Association of Securities Dealers, to which all broker-dealers must belong.  In 2006, Nasdaq also became an SEC-registered exchange and now trades nearly as many shares each day as the New York Stock Exchange (1.83 billion, compared to 2.15 billion a day for the NYSE.  The third largest, the American Stock Exchange has an average daily trading of “only” 55 million.)


Most of the regional stock exchanges went out of business, as telecommunications replaced the need for physical trading floors.  The Cincinnati Stock Exchange, which is now the National Stock Exchange, is all-electronic, with no trading floor.  The Chicago Stock Exchange is preparing its “New Trading Model,” which it describes, at www.chx.com, as “a fully-automated matching system. The Exchange will no longer operate a physical trading floor where on-floor specialists, brokers and market makers seek execution of their orders. Instead, the Exchange will operate an automated system where its participants – from any location – can submit orders for immediate execution.”


The Pacific Stock Exchange changed its name to Pacific Exchange, to reflect that it mostly traded options.  Then it was acquired by Archipelago, an “electronic communications network” for trading listed stocks outside the exchange.  Archipelago was in turn purchased by the New York Stock Exchange. 


The remaining regional stock exchanges, Philadelphia and Boston, are trying ways to distinguish themselves and remain active.  The Philadelphia trades options on currency, futures, commodities and stock indexes, as well as stocks.  In November 2006, the Boston Stock Exchange launched its Boston Equities Exchange, a “fully automated” trading system which “allows eligible orders in eligible securities to electronically match and execute against one another.”  It continues to operate the Boston Options Exchange.


Shares listed on these stock exchanges are most of the largest American businesses.  Foreign exchanges have attracted U.S. listings in the last few years, but most companies have their shares traded in the over-the-counter market.  Nasdaq operates the Nasdaq Capital Market, which had been the Small Cap Market until 2006.  It is separate from the Nasdaq stock exchange.  Nasdaq had also started the Over-the-Counter Bulletin Board (OTCBB), which is now operated by the National Association of Securities Dealers and quotes bid and asked prices for a about 3,300 companies’ shares.  Price information for about 9,600 other over-the-counter shares can be found on the Pink Sheets (www.pinksheets.com) operated by OTC Markets Group.  There are several tiers of companies in the Pink Sheets, based primarily on availability of current information.  Fewer than 200 are in the top tier, the OTCQX, which requires at least $2 million in annual revenues and $5 million in market value.   


Much of the trading in shares listed on exchanges actually takes place through the third and fourth markets.  The third market is “electronic communications networks” (ECNs).  The two largest of these (BATS, formerly Better Alternative Trading System and Direct Edge, each have daily shares trades of about 100 million shares, or twice the trading volume of the American, National or Chicago Stock Exchanges.)  The fourth market is the direct trading among institutional investors, assisted by electronic software services.


Many small companies will have a local broker-dealer which keeps track of interest in buying or selling its shares and provides an order-matching service.   Other companies operate an electronic posting service, to allow prospective sellers and buyers to learn of each other’s interest, pricing and quantity objectives.  Actual negotiations take place directly between the seller and buyer.  The company may suggest a broker or a stock transfer agent to handle closing of the transaction.