When my last book, The Small-Mart Revolution, was published in 2006, I began traveling almost nonstop to nearly every state in the United States and most of the provinces of Canada to promote strategies of economic development rooted in locally owned businesses. And the one idea I sketched that consistently drew the greatest interest was the creation of local stock exchanges. From the most conservative states of Utah and Idaho to the liberal bastions of Oregon and Vermont, audiences were excited by the possibility of ditching Wall Street and investing in their own community markets. Lots of people came up to me after these talks and asked for advice on how to begin, but only one individual that I’m aware of actually has tried to do it. Meet Trexler Proffitt, a business professor at Franklin and Marshall College in Lancaster, Pennsylvania. After my speech I told him that getting SEC approval for an exchange might cost upward of a million dollars in legal fees. Proffitt set out to prove me wrong.
“So I began researching through 2008,” recalls Proffitt. “I received a grant to do surveys in the local communities. I thought that if I could contribute anything to this discussion, it would be a template for local organizing and maybe a little bit of intellectual overhead. But by fall of 2008, I was convinced that local exchanges were feasible, although they would have to be done in a new and interesting way. And that’s when I set about trying to put all the pieces in place that would make it normal and easy for people to log on to a website run by their local community and invest in local firms.”
Two years later, Proffitt’s odyssey to create the LanX, the Lancaster Stock Exchange, continues. The financial crisis deepened his conviction about the why for the project and the where, but he is still tinkering with the how.
Proffitt is one of the very few scholars in the United States to study the economic impact of the early stock exchanges. In a recent working paper, he found that regions with their own stock exchanges had experienced double the rate of economic growth over the comparable national growth rate. Proffitt concedes his research is still at an early stage. Histories about stock exchanges in the United States are hard to find, and archives of original documents from these operations are almost nonexistent. But by using U.S. Census data, he compared a region’s economic performance for the years before and after its exchange was founded. The conclusion: A well-designed local exchange could stimulate significant economic growth in the region.
Proffitt has several theories that explain his findings. His most basic, and interesting, is that while banks allocate capital to successful enterprises, exchanges allocate capital to promising entrepreneurs of early-stage enterprises and growing firms. “Exchanges are all about valuing the future. Banking, in my view, is about where you stand at the present. It’s a very backward-looking way of giving people money. The already successful enterprises have no trouble getting bank loans. Also, during the nineteenth century, banks were a little bit shady. Nobody trusted them. So having a stock exchange was actually a pretty significant development. While it might seem riskier to us, it’s ultimately about transferring that risk quickly to other people. Those who can afford to take the risk, bear it. And those who can’t afford it, stay out. That’s how, I would argue, a local exchange can facilitate economic growth.”
Proffitt accepts that the four currently remaining stock exchanges, far from promoting economic development, are largely facilitating speculation. “And yet, everyone would agree that some degree of risk management is required to make markets work efficiently. That’s where the Wall Street services of today are really making a huge difference: It’s getting the market to go from 90 to 100 percent efficiency. But in local community economies, an improvement from 0 percent efficiency to 20 percent efficiency would be a huge help. Right now, there’s practically no liquidity in my local market to speak of. Pieces of companies are being bought and sold, but it’s so far below the radar, so private, and so low-volume that we really don’t see it. So maybe what these local exchanges will do is take us from 10 to 80 percent efficiency.”
Like John Katovich, Proffitt sees significant capital-market gaps that remain now that all the exchanges have merged together. “There’s no way that we’re going to have a thriving community economy unless there’s more financing in that gap—particularly for companies looking for between about $500,000 to $10 million. Unless you are at the $250 million level, the New York Stock Exchange doesn’t even want to talk with you. I’d say that hole is a market opportunity for the rest of us. I don’t know if there’s a lot of money to support Wall Street–style fees, but I do know there’s a need. And anytime there’s a need, somebody will be willing to pay.”
But is Lancaster the right place to launch this kind of experiment? The region is anchored by four small cities: Reading, York, Lancaster, and Harrisburg. Culturally, says Proffitt, “it’s a fairly conservative region. The cities are heavily Democratic, but many counties are heavily Republican. James Carville once said Pennsylvania is Philadelphia and Pittsburgh with Alabama in between. At the same time, a significant number of folks are interested in what I’d call back-to-basics relationships. The idea is to use your leisure time for civic engagement. Community and family are all-important. Who do you trust? You trust your neighbors. What’s neat about our local exchange effort is that we have both ends of the political spectrum uniting around it. If we could create institutions locally that would facilitate trust, particularly in people’s financial lives, we can resonate with people of all political stripes.”
At least ten businesses in the Lancaster area have indicated that they could use the exchange to raise capital right now. Sure, the area has its share of local banks and revolving loan funds. The Community First Fund serves a ten-county region, including the four cities, and it gives out low-interest, subsidized, or packaged loans (often with other lenders) up to about $400,000. But for capital greater than that, there’s no obvious source. Proffitt believes “there’s a lot of money here waiting to be invested. Plus, we would open the door to the rest of the state as well.”
The big questions are how: How can the LanX get started? How can it stimulate the issuance of more direct public offerings and other securities? How can it facilitate the trading of those securities without running the risk of fraud?
One obvious possibility would be to hire Mission Markets to build a LanX-branded portal. “What’s great about what Michael Van Patten has done is that he really emphasizes the information flow, as opposed to the transaction flow, and that’s what we prefer, too.” But Proffitt believes he can do most of what Mission Markets does with simpler, off-the-shelf technology, and by deploying a platform locally, his information about listed companies will be locally grounded, locally managed, and locally trusted. He suspects that if LanX keeps developing its own ideas, other platform developers out there might even donate technology to the project. “We’re going to be very cautious about the technology. We want to proceed in stages and show that each stage of the implementation will work. We don’t want to jump ahead of where folks are.”
The technology, however, is just a small part of the uphill journey. It’s the legal bells and whistles, the relationships with broker-dealers, the information available on traded companies–all the working parts of a local exchange. But even here, Proffitt remains convinced there are low-cost solutions. He is communicating regularly with other grassroots groups, exploring how they are handling the legal and administrative challenges. In Toronto, for example, there’s an initiative under way to create an exchange for social enterprises like housing developments for poor people.
By sharing everything he has learned with colleagues in Canada, Hawaii, and elsewhere, Proffitt hopes that each new local exchange “won’t need four years to get where we are. They can just do it in six months or less. Our goal is to share what we discover with anyone who wants to organize at their local level. Each of us takes some of the work and pursues our own local thing. In Hawaii, they’ve advanced their legislation to create a working group with the state securities regulators–and then there’ll be a precedent for state-level change we can implement here. We’re finding here, several years in, that there may be many ways of doing this without any change in regulation, or with a few safe and simple exemptions.”
Securities lawyers go nuts when Proffitt talks like this. John Katovich, who’s sympathetic, sees hundreds of thousands of dollars of filings needed to make the LanX operational. Michael Van Patten has spent more than that already to get all the legal approvals for his platforms. Yet everyone understands that the regulators hold the keys to the kingdom. State regulators could give their blessing to a low-tech LanX as an experimental prototype, and then ask federal regulators for a waiver on the grounds that intrastate securities being traded intrastate are no one’s business but Pennsylvania’s. But will they?
Proffitt approaches the legal questions with disarming simplicity: “2008 was the first time I started talking to regulators in Pennsylvania. They said, ‘Look. We don’t really care what you do with your exchange–that’s a federal matter. But if there’s fraud, we’re going to go after you. So you better be sure that nobody’s using your exchange for fraud.’ And it’s that simple. If the exchange is designed well, and you have checks and balances built in to monitor everything, produce an auditable trail of your activities, and maintain transparency, then regulators have nothing to fear. I think you get into problems when everything is so secret, hidden behind the scenes, with too many intermediaries you can’t see into. That’s where it gets murky. And so a lot of our decisions locally have been around mitigating that kind of fraud risk.”
One way Proffitt thinks he can accomplish this is by keeping start-up companies out of the LanX. “We want firms that have a stake in the community. We want to see the firm be five years old before we list anything that they offer. Sure, there will be a procedure for exceptions, but generally speaking, we want to assure the public that they’re buying into an established business, they’re buying into the third generation of something where the employees and customers can vouch for it, and where the CEO is still there and can vouch for it.”
Proffitt’s obsession with a low-cost approach is a point of pride. He and his colleagues are all volunteers right now, working on the LanX in their spare time. They are mindful that several big-dollar efforts have stumbled. One example is Invest BX, a huge undertaking by the West Midlands regional government in the United Kingdom to create a local stock exchange. The project currently employs five full-time staff, with a government grant of five million pounds. “I spent some time with them to learn more about what they were doing, and how they were doing it. Everyone was very generous in sharing their concept and experiences. They were really sharp and experienced people–the platform should be extremely popular. They had five years to show results, but I fear now that they won’t have much to show as a securities market.” After four years Invest BX is listing just three securities—and only two of them are real companies. There’s practically no trading. While the registered buyers and sellers of Invest BX are regional, the exchange decided to outsource trading to a London-based broker, which in turn charges high fees. Since then, the staff have shifted their work to more conventional subsidized loan programs for small and medium business finance.
Skeptics of local exchanges will undoubtedly point to the Invest BX and say, You see, there’s no deal flow! Proffitt would counter that there was no deal creation. “We look around our area, and see tons of need for capital among the local firms. We just had dinner last week with execs from six of our local firms, and brought them together to discuss their stories. We went around the table, and as each described their business, their future, and their experience with financing, the others would nod with understanding and lean in toward one another, seeing the common interest in creating new alternatives that could help them obtain millions of dollars they all desperately need.” Wolfgang Candy needs to add production capacity to meet large orders from national retailers; Kimberton Whole Foods wants to launch its fifth local grocery store; and York Water wants to raise funds to upgrade distribution equipment. “In the end it’s about financing the future sooner. That translates into jobs, tax base, stability, and a better local economy.”
The lesson Proffitt learned from Invest BX is that mobilizing a critical mass of companies to participate is more important than the exchange itself. So his focus right now is recruitment, and getting recruited companies comfortable with disclosure. “Our first stage in implementation is to put up an information–sharing site where we wouldn’t actually supervise any trades at all. For the local community, that’s important. It’s not expensive. It just tests the willingness of the businesses to disclose. We’ll put them through the wringer and say, ‘Are you willing to share this? Are you willing to share that?’”
It’s effectively a test run for the LanX. It will hopefully prove to local companies in the region that disclosure can be done easily. It will prove to Pennsylvania regulators that a small exchange can avoid fraud. It will prove to the public that the top locally owned companies need their money. And it will prove to investors that there are serious local-investment opportunities. Any transactions would happen offline.
Even in this first stage, Proffitt sees the makings of a business model. Investors might find it valuable to browse companies that have gone through the LanX process, with listed information duly verified. Companies in the region might find it valuable to get a LanX seal of approval. “Even if no transactions happen or only a few transactions happen offline, we can then interview participants and ask them, ‘How did this go? Did you see any value in this? Do you want a trading capability?’”
The second stage might be limited trading, where LanX promotes and records the transactions between listed companies and accredited investors (including institutions). An outside broker might carry out these transactions, but to avoid the Birmingham problem, the broker would have to be local and charge modest fees.
“The last stage is our ultimate test, which means involving the retail investor, the person on the street investing in the restaurant they’ve just eaten at. If we can get to that stage—and I’m not totally sure we can, because that’s where all of the federal and state fraud protections kick in—then we’ll be in good shape.”
Proffitt returns to his efforts to woo state regulators. “The way I think we’re going to get there is by having a successful stage one and stage two. We won’t get there if we don’t go through this process somewhere in this country. Someone has to go first–to show the regulators, to show the local public, ‘So, here’s our incidence of fraud. Here’s how we caught it, here’s what we did about it.’ If the pilot local exchange is successful, then we’re going to see a massive proliferation down the road. And that’s our real goal. We need to imagine having fifty local exchanges in five years.”
The most urgent need for the LanX right now is funding, to hire the staff who can solve the remaining issues. Proffitt wants state agencies to consider underwriting local exchanges across Pennsylvania in the name of economic development. “We’re talking about such a small amount of money that most states can find it in their budget just by not repaving a bridge. And because the exchange generates its own fees from participants, the initial grant is really just start-up money.”
Another way to launch the LanX might be to mobilize the region to own the exchange. It could be a cooperative. It could be a nonprofit, as the New York Stock Exchange was until recently. “We might issue shares to those investors in the community who have a long-term view, who think they’ll be here forever. It could be the community foundations. It might be local institutions like hospitals and colleges. It might be private companies. And it might be wealthy individuals who have made a home here. Our reasoning now is that, within our eight-county region–four big cities–if we make our pitch right, we should be able to find between ten and twenty investors who hold this long-term, community-improvement mind-set.”
Whatever the ultimate structure of the LanX, Proffitt intends to hold it to the same standards that he will impose on listed companies. For now, he is setting it up as a for-profit B Corporation. He also wants the exchange to have enough business to return something to investors. “I think these days, a 1 to 3 percent return is what’s welcomed by mission-oriented institutional investors. Hopefully we could do better, but we don’t want to overpromise. What’s for sure is that your money will be working for the community.”
This excerpt is from the book Local Dollars, Local Sense: How to Move Your Money from Wall Street to Main Street and Achieve Real Prosperity. It is reprinted here with permission by Chelsea Green Publishing. For more information about this book, visit www.chelseagreen.com.