What Is an Alternative Trading System (ATS)?

An alternative trading system (ATS) is a trading venue that is more loosely regulated than an exchange. ATS platforms are often used to match large buy and sell orders among its subscribers. The most widely used type of ATS in the United States are electronic communication networks (ECNs)—computerized systems that automatically match buy and sell orders for securities in the market.

Understanding an Alternative Trading System (ATS)

ATS account for much of the liquidity found in publicly traded issues worldwide. They are known as multilateral trading facilities in Europe, ECNs, cross networks, and call networks. Most ATS are registered as broker-dealers rather than exchanges and focus on finding counterparties for transactions.

Unlike some national exchanges, ATS do not set rules governing the conduct of subscribers or discipline subscribers, other than by excluding them from trading. They are important in providing alternative means to access liquidity.

Institutional investors may use an ATS to find counterparties for transactions, instead of trading large blocks of shares on national stock exchanges. These actions may be designed to conceal trading from public view since ATS transactions do not appear on national exchange order books. The benefit of using an ATS to execute such orders is that it reduces the domino effect that large trades might have on the price of an equity.

Criticisms of Alternative Trading Systems (ATS)

These trading venues must be approved by the SEC. In recent years, regulators have stepped up enforcement actions against ATS for infractions such as trading against customer order flow or making use of confidential customer trading information. These violations may be more common in ATS than national exchanges because ATS face fewer regulations.

Dark Pools

A hedge fund interested in building a large position in an equity may use an ATS to prevent other investors from buying in advance. ATS used for these purposes may be referred to as dark pools.

Dark pools entail trading on ATS by institutional orders executed on private exchanges. Information about these transactions is mostly unavailable to the public, which is why they are called “dark.” The bulk of dark pool liquidity is created by block trades facilitated away from the central stock market exchanges and conducted by institutional investors (primarily investment banks).

Although they are legal, dark pools operate with little transparency. As a result, dark pools, along with high-frequency trading (HFT), are oft-criticized by those in the finance industry; some traders believe that these elements convey an unfair advantage to certain players in the stock market.

Regulation of Alternative Trading Systems (ATS)

SEC Regulation ATS established a regulatory framework for ATS. An ATS meets the definition of an exchange under federal securities laws but is not required to register as a national securities exchange if the ATS operates under the exemption provided under Exchange Act Rule 3a1-1(a). To operate under this exemption, an ATS must comply with the requirements in Rules 300-303 of Regulation ATS.

To comply with Regulation ATS, an ATS must register as a broker-dealer and file an initial operation report with the Commission on Form ATS before beginning operations. An ATS must file amendments to Form ATS to provide notice of any changes to its operations, and must file a cessation of operation report on Form ATS if it closes. The requirements for filing reports using Form ATS is in Rule 301(b)(2) of Regulation ATS. These requirements include mandated reporting of books and records.

In recent times, there have been moves to make ATS more transparent. For example, the SEC amended Regulation ATS to enhance “operational transparency” for such systems in 2018. Among other things, this entails filing detailed public disclosures to inform the general public about potential conflicts of interest and risks of information leakage. ATS are also required to have written safeguards and procedures to protect subscribers’ trading information.

The SEC formally defines an alternative trading system as “any organization, association, person, group of persons, or systems (1) that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 under the Exchange Act; and (2) that does not (i) set rules governing the conduct of subscribers other than the conduct of such subscribers’ trading on such organization, association, person, group of persons, or system, or (ii) discipline subscribers other than by exclusion from trading.”

What Is the Automated Customer Account Transfer Service (ACATS)?

The Automated Customer Account Transfer Service (ACATS) is a system that facilitates the transfer of securities from one trading account to another at a different brokerage firm or bank.

The National Securities Clearing Corporation (NSCC) developed the ACATS system, replacing the previous manual asset transfer system with this fully automated and standardized one. This greatly reduced the cost and time of moving assets between brokerage accounts as well as cut down on human error.

How the Automated Customer Account Transfer Service (ACATS) Works

The ACATS system is initiated when the new receiving firm has the client sign the appropriate transfer documents. Once the document is received in good order, the receiving firm submits a request using the client’s account number and sends it to the delivering firm. If the information matches between both the delivering firm and the receiving firm, the ACATS process can begin. The process takes usually takes three to six business days to complete.

The ACATS simplifies the process of moving assets from one brokerage firm to another. The delivering firm transfers the exact holdings to the receiving firm. For example, if the client had 100 shares of Stock XYZ at the delivering firm, then the receiving firm receives the same amount, with the same purchase price.

This makes it more convenient for clients, as they do not need to liquidate their positions and then repurchase them with the new firm. Another benefit is that clients do not need to let their previous brokerage firm or advisor know beforehand. If they are unhappy with their current broker, they can simply go to a new one and start the transfer process.

Securities Eligible for ACATS

Clients can transfer all publicly traded stocks, exchange-traded funds (ETFs), cash, bonds, and most mutual funds through the ACATS system.

ACATS can also transfer certificates of deposit (CDs) from banking institutions through the ACATS system, as long as it is a member of the NSCC. ACATS also works on all types of accounts, such as taxable accounts, individual retirement accounts (IRAs), trusts, and brokerage 401(k)s.

Securities Ineligible for ACATS

There are several types of securities that cannot go through the ACATS system. Annuities cannot transfer through the system, as those funds are held with an insurance company. To transfer the agent of record on an annuity, the client must fill out the correct form to make the change and initiate the process via what is known as a 1035 exchange.

Other ineligible securities depend on the regulations of the receiving brokerage firm or bank. Many institutions have proprietary investments, such as non-transferrable mutual funds and alternative investments that may need to be liquidated and which may not be available for repurchase through the new broker. Also, some firms may not transfer unlisted shares or financial products that trade over the counter (OTC).

What Is an Annual Report?

An annual report is a document that public corporations must provide annually to shareholders that describes their operations and financial conditions. The front part of the report often contains an impressive combination of graphics, photos, and an accompanying narrative, all of which chronicle the company’s activities over the past year and may also make forecasts about the future of the company. The back part of the report contains detailed financial and operational information.

Understanding Annual Reports

Annual reports became a regulatory requirement for public companies following the stock market crash of 1929 when lawmakers mandated standardized corporate financial reporting. The intent of the required annual report is to provide public disclosure of a company’s operating and financial activities over the past year. The report is typically issued to shareholders and other stakeholders who use it to evaluate the firm’s financial performance and to make investment decisions.

Typically, an annual report will contain the following sections:

In the U.S., a more detailed version of the annual report is referred to as Form 10-K and is submitted to the U.S. Securities and Exchange Commission (SEC). Companies may submit their annual reports electronically through the SEC’s EDGAR database. Reporting companies must send annual reports to their shareholders when they hold annual meetings to elect directors. Under the proxy rules, reporting companies are required to post their proxy materials, including their annual reports, on their company websites.

Special Considerations

The annual report contains key information on a company’s financial position that can be used to measure:

• A company’s ability to pay its debts as they come due
• Whether a company made a profit or loss in its previous fiscal year
• A company’s growth over a number of years
• How much of earnings are retained by a company to grow its operations
• The proportion of operational expenses to revenue generated

The annual report also determines whether the information conforms to the generally accepted accounting principles (GAAP). This confirmation will be highlighted as an “unqualified opinion” in the auditor’s report section.

Fundamental analysts also attempt to understand a company’s future direction by analyzing the details provided in its annual report.

Mutual Fund Annual Reports

In the case of mutual funds, the annual report is a required document that is made available to a fund’s shareholders on a fiscal year basis. It discloses certain aspects of a mutual fund’s operations and financial condition. In contrast to corporate annual reports, mutual fund annual reports are best described as “plain vanilla” in terms of their presentation.

A mutual fund annual report, along with a fund’s prospectus and statement of additional information, is a source of multi-year fund data and performance, which is made available to fund shareholders as well as to prospective fund investors. Unfortunately, most of the information is quantitative rather than qualitative, which addresses the mandatory accounting disclosures required of mutual funds.

All mutual funds that are registered with the SEC are required to send a full report to all shareholders every year. The report shows how well the fund fared over the fiscal year. Information that can be found in the annual report includes:

• Table, chart, or graph of holdings by category (e.g., type of security, industry sector, geographic region, credit quality, or maturity)
• Audited financial statements, including a complete or summary (top 50) list of holdings
• Condensed financial statements
• Table showing the fund’s returns for 1-, 5- and 10-year periods
• Management’s discussion of fund performance
• Management information about directors and officers, such as name, age, and tenure
• Remuneration or compensation paid to directors, officers, and others

The Bottom Line

Public companies must produce annual reports to show their current financial conditions and operations. Annual reports can be used to examine a company’s financial position and, possibly, understand what direction it will move in the future. These reports function differently for mutual funds; in this case, they are made available each fiscal year and are typically simpler.

What Is Asymmetric Information?

Asymmetric information, also known as “information failure,” occurs when one party to an economic transaction possesses greater material knowledge than the other party. This typically manifests when the seller of a good or service possesses greater knowledge than the buyer; however, the reverse dynamic is also possible. Almost all economic transactions involve information asymmetries.

Understanding Asymmetric Information

Asymmetric information exists in certain deals with a seller and a buyer whereby one party is able to take advantage of another. This is usually the case in the sale of an item. For example, if a homeowner wanted to sell their house, they would have more information about the house than the buyer. They might know some floorboards are creaky, the home gets too cold in winter, or that the neighbors are too loud; information that the buyer would not know until after they purchased the house. The buyer, then, might feel they paid too much for the house or would not have purchased it at all if they had this information beforehand.

Asymmetric information can also be viewed as the specialization and division of knowledge, as applied to any economic trade. For example, doctors typically know more about medical practices than their patients. After all, physicians have extensive medical school educational backgrounds that their patients generally don’t have. This principle equally applies to architects, teachers, police officers, attorneys, engineers, fitness instructors, and other trained professionals. Asymmetric information, therefore, is most often beneficial to an economy and a society in increasing efficiency.

Advantages and Disadvantages of Asymmetric Information

Advantages

Asymmetric information isn’t necessarily a bad thing. In fact, growing asymmetrical information is the desired outcome of a healthy market economy. As workers strive to become increasingly specialized in their chosen fields, they become more productive, and can consequently provide greater value to workers in other fields.

For example, a stockbroker’s knowledge is more valuable to a non-investment professional, such as a farmer, who may be interested in confidently trading stocks to prepare for retirement. On the flip side, the stockbroker does not need to know how to grow crops or tend to livestock to feed themself, but rather can purchase the items from a grocery store that are provided by the farmer.

In each of their respective trades, both the farmer and the stockbroker hold superior knowledge over the other, but both benefit from the trade and the division of labor.

One alternative to ever-expanding asymmetric information is for workers to study all fields, rather than specialize in fields where they can provide the most value. However, this is an impractical solution, with high opportunity costs and potentially lower aggregate outputs, which would lower standards of living.

Disadvantages

In some circumstances, asymmetric information may have near fraudulent consequences, such as adverse selection, which describes a phenomenon where an insurance company encounters the probability of extreme loss due to a risk that was not divulged at the time of a policy’s sale.

For example, if the insured hides the fact that they’re a heavy smoker and frequently engage in dangerous recreational activities, this asymmetrical flow of information constitutes adverse selection and could raise insurance premiums for all customers, forcing the healthy to withdraw. The solution is for life insurance providers to perform thorough actuarial work and conduct detailed health screenings, and then charge different premiums to customers based on their honestly disclosed risk profiles.

Special Considerations

To prevent abuse of customers or clients by finance specialists, financial markets often rely on reputation mechanisms. Financial advisors and fund companies that prove to be the most honest and effective stewards of their clients’ assets tend to gain clients, while dishonest or ineffective agents tend to lose clients, face legal damages, or both.