Silicon Valley boldly creates a new stock exchange LTSE, Wall Street obstructs it in every way

Five years ago, when Eric Ries was writing The Lean Startup, which would become his best-selling book, he proposed a provocative idea in the afterword: Someone should build a new, “long-term” stock exchange. This new format, he wrote, would correct the current frantic quarterly cycle, thereby encouraging investors and companies to make better decisions about the future. When he presented his draft plan, many readers gave him the same advice: Take out the crazy part about the exchange. Ries said he was told, “This plan destroys all my previous credibility.”

Now, Ries is laying the groundwork to prove the skeptics wrong. To make the LTSE a reality, he has assembled a team of about 20 engineers, financial executives and lawyers and raised seed funding from more than 30 investors, including venture capitalist Marc Andreessen, tech evangelist Tim O'Reilly and former U.S. CTO Aneesh Chopra.

Ries has held preliminary discussions with the U.S. Securities and Exchange Commission (SEC), but it could take years for the LTSE to launch. Wanting to run an exchange typically requires months of informal talks with the SEC before completing a draft application, which the LTSE hopes to do this year. Regulators could then take months to decide whether to approve or roll out the application.

If all goes according to plan, Ries believes the LTSE exchange could eliminate a problem with existing public markets: short-term thinking trumps rational economic decisions. This is the same thinking that drives Silicon Valley's billion-dollar unicorn startups to say they have no intention of ever going public. Ries said everyone is being told,

"Don't go public. The most common traditional thinking now is that going public means the end of innovation."

Ries believes that public markets encourage self-destructive behavior. He believes the strength and weakness of these markets is one reason the number of U.S. public companies has fallen to half of what it is today from its peak in 1996. Once a company goes public, employees "visit Yahoo Finance every day, and that obviously influences the decisions of rank-and-file managers." The problem starts when stock market investors favor companies with big sales, profits, user growth, and quarterly measures. When companies run short of cash, investors flee and the company's stock plummets. Managers who want to avoid volatility spend too much time focusing on short-term results. Ries says he's heard the same story many times: Halfway through the quarter, executives realize the company isn't on track and start cutting innovation projects to meet targets.

Ries' book preached a fail-fast approach to building companies, where teams could get a 'minimum viable product' to customers as quickly as possible to avoid wasting time and effort. The Lean Startup made Ries, who previously worked as a software engineer at virtual world maker There (which failed) and co-founded a more successful social network, IMVU, respected by Silicon Valley entrepreneurs. While readers flocked to learn about his entrepreneurial experience, no one used his stock market advice because it was too extreme. When Ries decided to strike out on his own, he began talking to bankers, venture capitalists and regulators, but they told him the idea was ridiculous. Ries said:

“People treat me like a barbarian.”

But he was undeterred, and spent three years recruiting a team and weighing different ideas, such as charging higher fees for short-term trades. Ultimately, the LTSE settled on three reforms: addressing how executives are paid, how companies and investors share information, and how investors vote.

If a company wants to issue stock on Ries' exchange, it must choose from a menu of LTSE-approved compensation plans designed to ensure that executive pay is not affected by short-term stock movements. Ries complains that it is common for CEOs or senior executives to receive quarterly or annual bonuses tied to some metric, such as earnings per share. Ries wants to encourage companies to adopt stock packages that stay with executives even after they leave the company, thereby encouraging executives to make moves that benefit the company in the long term.

The LTSE also wants to push companies and investors to share more information, such as details on research and development spending. To get investors to participate, the exchange plans to use incentives to attract them, so the LTSE plans to use voting rights as bait. If investors reveal the real names of beneficial owners (rather than using pseudonyms), they will be able to get more voting rights and hold shares longer. The LTSE hopes to make money mainly by selling software tools to companies and collecting listing fees, which may be a difficult task because many companies that choose to list on the NYSE or Nasdaq are selected based on their trusted reputation. As Ries believes, companies listed on the LTSE will receive an additional level of approval.

“You’re promoting to a market where you’re willing to assume a higher standard, which is the gold standard, the longest-standing, most hardcore version that’s been on the market.”

Larry Harris, professor of finance and business economics at the University of Southern California’s business school, said:

“Ries’ reforms may not have the desired effect. For example, giving long-term shareholders stronger voting rights will make takeovers more difficult and could benefit complacent managers. The threat of a takeover regulates behavior outside a company better than anything else. I suspect sophisticated investors will shy away from exchanges that create barriers to investors who want to change the status quo.”

Getting SEC approval can also be a difficult process, especially when trying to change the status quo. Like Ries, Brad Katsuyama, the protagonist of Michael Lewis' 2014 book Flash Kid, is trying to address what he sees as the shortcomings of the existing market. Katsuyama has spent the better part of a year trying to get SEC approval for Investors Exchange. He says the exchange will offset the unfair advantages of high-frequency traders, and the powers that be are not happy. The NYSE slammed the proposal as 'unfair' and 'opaque' in a letter to regulators. Nasdaq warned the SEC last month that it might sue if they approved IEX's application, and it's likely to succeed.

Tyler Gellasch, executive director of investment trade group Healthy Markets, said:

“Any time an exchange wants to do something different, it’s going to be heavily scrutinized and take a long time.”

Tyler Gellasch

While Silicon Valley has succeeded in disrupting many major industries, it has not been so lucky in shaking up entrenched Wall Street traditions. Google’s 2004 IPO attempted to distribute its shares more equitably through a “Dutch” auction, which resulted in a disappointing first day of trading and subsequently failed to achieve its goal. Marc Andreessen considers Google’s unorthodox IPO to be ‘a great case study and a cautionary tale’, saying:

"What Eric has to do is basically prevent that from happening."

If Ries gets the SEC's blessing, he will face his biggest challenge: convincing a company to list on its exchange. Because it may take years to get the SEC's approval. Ries is not trying to curry favor with Uber, Airbnb or other peers. Instead, he is contacting founders of mid-sized startups, some of whom have invested in the LTSE. In the next few years, Ries hopes that some of these companies will become strong IPO candidates for them. He said:

“There’s a real collective action problem going on. As an industry, we all want to see some change happen, but there are always those who lack motivation and say this isn’t my battle — I’ll wait for others to make the first move. I don’t envy these people, but if everyone does this, how can change happen?”