|
An interview with Nasdaq vice chairman Alfred R. Berkeley III
from Biotechnology Investors' Forum Worldwide Issue 2 2002
www.biotechnology-investor.com
With biotechnology and many other industry sectors in sharp decline on stock markets worldwide, Charles
Craig, chairman of the editorial board for Biotechnology Investor's Forum, sought out Alfred R. Berkeley III for
advice in making sense of the perturbations. This interview was conducted August 28, 2002 the day Nasdaq
received approval from the Securities and Exchange Commission (SEC) to implement major changes in the
way stock trades are executed.
Having been president of Nasdaq
Stock Market Inc. since 1996, Berkeley
was appointed vice chairman on July
27, 2000. Before joining the stock
exchange he was managing director
and senior banker in the Corporate
Finance Department of Alex, Brown &
Sons. Berkeley served as a US Air Force
captain from 1968 to 1972. He
received an MBA from the Wharton
School at the University of
Pennsylvania and a bachelor of arts
from the University of Virginia. He is
also a trustee of John's Hopkins
University and the Nature Consevancy.
Biotechnology Investor's
Forum (BIF): What can
Nasdaq do to address
volatility?
Berkeley: There are two elements to
the volatility. One is the flow of
funds in and out of the biotech
industry, and there's not a thing we
can do about that other than help
publicize the benefits of long-term
biotech investing.
The second, smaller part of
volatility is that which occurs in the
market itself, and we're doing a lot
about that. Specifically over the last
three years, we have invested in
rewriting all the software in
Nasdaq, and that will be introduced
no later than October 12. We
received approval from the
Securities and Exchange
Commission this morning.
What we are doing is offering
many more choices to investors in
the way they use the market. We're
going to give them all four major
market models from around the
world. They'll continue to be able to
use our dealer structure. Nasdaq is
structured like the currency markets
not like the traditional exchanges.
We have multiple competing dealers,
just as the currency markets and
the international bond markets do,
and that results in enormous
liquidity.
We're offering the ability to execute
electronically against any offering you
see in the market. This is what the
Electronic Communication Networks
have been doing. We're offering you
the ability to leave with Nasdaq a
limit order that you would like displayed
to the world; that's called a
limit order book. We have introduced
an electronic auction that says if you
would like your stock auctioned off to
the highest bidder, you can do that
through Nasdaq.
These are very powerful additions
to our technology. What this means
is we're going to attract many more
orders to the market. Orders that
have been kept on the desks of the
different brokerage firms will have a
place in the center of the market to
be seen and to be traded. We think
this will produce even more liquidity
and will dampen volatility.
BIF: When do you foresee
a turnaround in the capital
markets in general and
in the biotech markets
specifically?
Berkeley: I don't have any idea.
When I was a lot younger and I was
a lot smarter, I might have
answered that glibly. But I think it's
very difficult to guess the somewhat
random movement of the
market. Underlying any market
turnaround is some positive indication
that the economy is
strengthening. The obvious question
concerning people now is
whether we're going to have a double-
bottom recession. Until that is
sorted out, you're not going to have
a major move in the economy.
You're not going to have a major
move in the market. And you're not
going to have a major move in
biotech. In the long run, creating
value in biotech stocks means creating
drugs that work.
BIF: Will we ever see on
Nasdaq the heady days for
biotech stocks we saw in
2000 before the current
decline began?
Berkeley: Yes. Human beings deal
cyclically with the market. The biotech
industry itself has had probably four
cycles of boom followed by inattention
and no interest since the late 1970s.
The cyclical movement depends
on what's going on in the speculative
character of the general market and
what's going on in terms of new
product introductions from the
industry itself.
The real problem for the biotech
industry is long development cycles,
with so few products that turn out to
be effective in human trials. You will
continue to see great interest in drug
candidates that look promising
because, after all, biotech is dealing
with issues closest to our hearts,
which is our health. As time goes by
and more products get to patients, the
industry will develop a more substantial
base. But right now you have a
handful of companies that are proven
and can sustain themselves when the
speculative enthusiasm goes out of
the market, which is the case now.
BIF: When will the initial
public offering (IPO) market
reopen for biotech
stocks?
Berkeley: Right now you can't get
institutional investors who really
are the key to the IPO market to
accept many deals at all. IPOs are
priced by investment banks on an
initial transaction. Institutional
investors are saying with their wallets
and their feet that they want to buy
products that are priced by the market.
They are taking advantage of the
pessimism that exists in the market
generally, to enjoy what is called a
buyer's market, which is in contrast
to the seller's market we had during
the speculative bubble.
BIF: In 2000, one reason
biotech IPOs attracted so
much attention was completion
of the human
genome sequence. Will it
take another monumental
scientific milestone to
renew enthusiasm? If so,
what would it be?
Berkeley: It will take scientific milestones,
but I don't think you will have a
blockbuster milestone like the human
genome sequencing. What people want
next is pragmatism, which always follows
pessimism. When you're in a pessimistic
phase as we are now, you don't go right
back to euphoria. You don't go from cynical,
pessimistic hoarding of cash to
euphoric buying of stocks. You go
through a couple of psychological stages.
The next stage is a pragmatic stage
where people say, 'Show me the
results.' Biotech companies showing
good results in clinical phases of
development, and introducing and
marketing drugs, will do much better
than biotech companies making
promises.
BIF: Are biotech stocks
still overvalued even at
these depressed prices?
Berkeley: I don't know; it's difficult
to say what the market is worth.
There's a difference between the
price at which a stock trades and the
value of the company. That's the fundamental
difference between the way
speculators look at things and the
way investors look at things.
Investors look at the true cash
value of the company: 'When will I
get cash out of this and how much
cash will I get?' Whereas speculators
are saying, 'What will someone else
pay for this piece of paper?'
My guess is that some companies
are undervalued, but most are not.
We're going to see this pragmatic
phase where people say, 'Show me
real results.' Companies producing
results will attract investment capital
from those that are not. Companies
try hard to sound like they have
results, but some haven't proved it yet.
When we go into a pragmatic phase of
the market, people want proof.
BIF: When the market
enters the next growth
period, many experts say
it will rise in a flatter fashion
compared with the
spikes we've seen recently.
Berkeley: That's absolutely true
because of this pragmatism I'm talking
about. The spike two years ago
was the culminating stage of a speculative
cycle. It wasn't the initial stage
coming out of a bust. Things rise very
slowly in recoveries and they only get
ebullient and spiky when people forget
the lessons of the previous crash.
BIF: What are the major
factors affecting market
cycles?
Berkeley: There's no magic to it. You
have the emotional side of things
and the rational side. Right now the
emotional side is dominant because
so many people have lost so much
money; they're looking for other
things to do with their money
besides putting it at risk again. When
you have a combination of a bad
economy and a bad psychology, you
have bear markets.
When you get a good economy,
you don't necessarily have speculative
enthusiasm, psychological
enthusiasm, or emotional enthusiasm.
It takes time for people to get to
the point where you have both a
good economy and optimistic emotions
that cause people to take a
chance on equities. After all, equities
are all about the future. People have
to feel the future is going to continue
to be good, and people don't feel
that way right now.
BIF: Will a resurgence of
confidence in biotech
stocks come from events
within the biotech sector
or from within the general
economy?
Berkeley: For biotech to benefit, it is
going to take both. What your readers
need to understand is whether
they are speculators, gamblers, or
investors.
There are always three games
going on in the market. According to
game theory, there are games of
chance, games of skill and games of
strategy. Nobody talks like that; they
talk about gambling, speculating and
investing. And it's not polite to talk
about gambling and speculating, so
people use the language of investing,
even though their behavior is that of
a speculator or a gambler.
How do you tell which one you are?
If you are playing a game of strategy
and you are an investor, you're looking
at basic supply and demand for a good
or a service. In the case of a biotech
company you might be looking for the
basic supply and demand of a cure to a
terrible disease. The supply is dictated
by our regulated clinical trial system.
The biotech company has to get
through the regulators and then supply
a product that is proven to work. Even
if it does that, the company has to
match demand with other elements.
It's not sufficient just to have a product.
The company must have a distribution
system, must price the drug right, and
must market it right. The company
must have all the things that go into
building a business. Investors look at
all that, and they look at the strategies
of the management team. They look at
the capabilities of the management
team. And, by the way, their holding
periods are roughly coincident with
the time it takes to work those strategies
out. Investors are holding their
shares of stock in a management
team's efforts for years because
that is how long it takes to work strategies
out.
The next group, people playing a
game of skill, are speculators. They are
not looking at the supply and demand
for the product. They are looking at
what the crowd is going to do with the
stock. They are speculating that more
people will buy this stock than sell it.
They may not even know the company's
products. This is where stocks get
priced differently from the value of the
underlying cash flows.
Speculators typically hold stocks
for months or quarters. They try either
to pile on when the crowd changes
direction (on the upside or the downside)
or they try to anticipate the
crowd's movement, which is a very
risky game. The speculators' game is
totally different in structure from the
game investors play. The interesting
aspect of speculators is that they dominate
the action in the market. Many
more transactions are executed by
people trying to guess what the crowd
is going to do than by people who
buy and hold. That is almost common
sense, because people who buy
and hold are not trading.
Speculators are in there trading.
They are creating Professor Burton G.
Malkiel's A Random Walk Down Wall
Street. And guess what happens? The
gamblers come in and play that randomness.
Gamblers know that any
given morning there is a 50-percent
chance that any given stock is going to
go up or down. They try to figure out,
using hedging strategies and options,
how to play the randomness of the
market. They are called day traders.
They hold for minutes and hours.
The complexity here is that people
can be investors with one part of
their portfolios, speculators with
another, gamblers with another. But
what often happens because it is
not popular to talk about speculating
when people go to a cocktail party,
they do not say, "I had a great speculation
today." They don't say they
had a great gamble today. They say
they invested in such and such. Well,
if they invested this morning and
sold at lunchtime, they are probably
gamblers, even though they are calling
themselves speculators, or more
likely calling themselves investors.
It is important for people to know
which game they are playing. The
questions you are asking me about
the future of the biotech industry in
the market do not depend on investment
answers of supply and
demand. The market is reflecting
speculation.
Look at the way we amplify voice
in this country. I live in Maryland
and we have a state lottery. The State
of Maryland has an advertising tag
line that says, You've got to play to
win.' The state is telling my children
they should gamble. And the state
implies that if they are not gamblers,
they are losers. It's terrible public
policy. Many brokerage firms stress
their low costs to get people into day
trading and online investing. I suggest
that is the amplification of gambling
in our economy.
Then look at speculating. Every
morning I get up and click on the
television for the financial news. I
just told you that was Malkiel's A
Random Walk Down Wall Street. But I
love it, and millions of people love
it. We want our data fix of what's
moving in the market.
If I said to you the cumulus clouds
went across the sky from right to left
over my house this morning, you
would yawn and say, Who cares?' If I
said, My god, IBM was up and
General Motors (GM) was down,'
somehow that conveys meaning and
importance and you want to know
more. But what IBM and GM do day-to-day is just as random as the movement
of the clouds in the short term.
We have developed a national
hunger for the combination of news
and sports about finance. We want
the urgency of news and we want the
conflict and drama of sports. The
television industry has given it to us.
It is the cheapest possible television
model a couple of hosts responding
to the ticker tape and inviting
guests to comment. You can't get a
cheaper television production
model: one room, three cameras,
two hosts, guests and a ticker tape.
And we love it. The commentators
do not respond to a consistent theme
that may provide investment insights
about the supply and demand for
semiconductors, pills or automobiles.
They respond to whatever is
randomly moving up and down.
They talk about the big gainers of the
day, the big losers, the high-volume
stocks, the low-volume stocks, and
how the indices are doing. They are
documenting the elements of the
random walk in excruciating detail,
and I and millions of others are
glued to it. It is all about the random
movement of stocks. We are amplifying
the voices of speculation.
There are almost no voices amplifying
the hard, difficult task of finding
good investments. Mainly
because in a culture that loves fast
movement, it is really boring to talk
about investments. I had a wonderful
guy, a true investor, tell me he
bought some Intel in 1975 and still
owned it. Well, where is the drama?
Where is the urgency? Where is the
excitement? There is no television
market for this. There is no amplification
of voice. Yet he is actually the
guy who has more money than anybody
else. He has done extremely
well by understanding the long buy;
holding and playing the long-term
growth of the basic components of
the information age.
BIF: Is it possible to be a
long-term investor today
in biotech?
Berkeley: You have to pick one side
of the game or the other. If you want
to be a long-term investor, you must
invest in the quality of the management
team because product life
cycles are shorter than your investment
cycle. Said another way, you
need to invest in management teams
of companies that have a portfolio of
products because they can adjust,
regardless of the specific life cycle of
their products. However, a particular
problem of the biotech industry,
including the pharmaceutical industry
is this: it is one of the few industries
in the world, including the
United States, that has government
working against it. This is a very difficult
situation.
You have state governments and
the US government trying to reduce
the ability of biotech and pharma
companies to earn a profit on their
inventions by imposing price controls
and challenging patent protections.
There are extraordinarily well-managed
companies out there fighting not
only the normal competition that
comes into these industries, but also
the long odds of successful drug discovery
and the short-term nature of
government interest, which leads to
price controls.
It is possible for people to be
long-term investors in biotech and in
pharma. But they should put their
money in companies with management
teams that have the ability to
make changes because the business
they are investing in is fluid and
requires sophisticated people to
manage it.
BIF: Has consolidation of
financial institutions
affected the capital markets?
Berkeley: Yes it has on several levels.
First, at the level of the large
mutual funds. The very large funds
account for a huge rule (much more
than the 80/20) of the business in
the market today. And there is continuing
consolidation within these
large fund companies by managers;
you get more centralization of policy
and you get a move to larger and
larger cap stocks. I talked with a venture
capitalist in Menlo Park. She
said the supply chain for new companies
is broken. Her venture capital
fund was having trouble finding
analysts to cover their companies;
brokerage firms were not investing
in research in the middle of a recession.
She is absolutely right; we have a
bottleneck. We probably have 3,000
companies targeted by analysts out
of 18,000 public companies in the
United States. Wall Street has
become a bottleneck for investors
seeking critical and serious information
on companies. Some of the current
academic work on this issue
says companies should purchase
research from investment banks or
from sources other than investment
banks, such as trade associations
that offer research on a contractual
basis. Some new mechanism must
emerge to get the word out about
companies, and it is probably a
growth in the investor relations
business.
BIF: When you talk about
trade associations, are you
referring to the
Biotechnology Industry
Organization (BIO)?
Berkeley: BIO would be one. Or if
your readers go to the Nasdaq website,
www.nasdaq.com/xbrl/, they
will see a demonstration of the
extensible business reporting language
we established with the semiconductor
industry. We have 20
semiconductor companies. With a
click of the mouse an investor can
find relevant information in comparative
formats from the semiconductor
companies.
BIF: Let's move on to
another topic of great
concern, corporate fraud.
Who can protect investors
from corporate crooks?
Berkeley: There are a few crooks in
any business. The vast majority of
executives in companies in the US
public markets are hard working and
honest. We have had some egregious
excesses. But those excesses can be
laid at the door steps of greedy managers,
and perhaps some greedy
accountants and lawyers.
But I would suggest and this is
radical thinking that the Financial
Accounting Standards Board (FASB) is
largely responsible for these problems
by putting out confusing financial
guidelines, by having pages of exceptions
and by going for a performanceoriented
rather than a principlesbased
approach to accounting. And a
major reason for this is FASB's accommodation
of highly technical interpretation-
of-the-day rules combined
with the plaintiff's bar in the United
States. These two factors have driven
people to create a highly technical
approach to what's right and what's
wrong. The pendulum, however, is
swinging back. People are saying,
Wait a minute. Even though each of
these off balance sheet vehicles is in
its own right legal, we are missing the
basic principle of reporting fairly.'
We are going back toward a common
sense principled approach:
Does this financial statement represent
accurately to investors what is
going on? What is required in this
country is a thorough examination of
how FASB got off track, not how the
accounting firms or the companies
did, although they clearly had a role
in it. We also need to think through
the unintended consequences of an
entrepreneurial plantiff's bar.
BIF: Let's talk about
Nasdaq's global strategy.
How is it progressing?
Berkeley: We continue to think that
if investors around the world have
1,000, 10,000 or 100,000 shares in
Amgen, they will be better served if
there's a global market in which
everybody sees everybody else's
interests. That's a simple concept. Yet
the implementation of it is very difficult
because of sovereignty and
because of entrenched financial
interests. We want to continue to
work toward that goal, but we were
getting nowhere in Japan and we had
to cut our losses for a while. We
would like to come back into Japan
at the right time, but we must figure
out a better way to do it because we
didn't do it right the first time.
BIF: What about Nasdaq
efforts in Europe?
Berkeley: We are progressing in
Europe. We think the way to grow in
Europe is to focus on smaller markets
and negotiate alliances and partnerships
with those markets to
increase liquidity. In a recession, like
we are in now, there is almost no
cross-border trading, so a pan-
European market doesn't work.
We have deals with a German
market and we have a license in
Brussels to operate throughout
Europe, which would be pan-
European. We also have a separate
license to operate in the UK, which
we're not doing. We're picking that
up through the Brussels operation.
BIF: Is Nasdaq operating
in India?
Berkeley: We have an office in India,
as we do in San Paolo, Brazil. We are
looking for listings for the US market
there and the European markets.
BIF: How has the decline
in stock prices on Nasdaq
affected your ability to
compete with other stock
exchanges in the United
States and around the
world?
Berkeley: In terms of trading in the
secondary markets stocks already
issued our trading volume and
everybody else's trading volume is
off a little. But the strength of our
liquidity engine, and in particular
the technology that we had approved
by the SEC this morning, should give
us the strongest market in the world.
People who are students of markets
will recognize this is extraordinarily
powerful technology.
That being said, there also is the primary
market, which includes IPOs.
There are not many in the biotech or
computer technology sectors. There
are not many first-time consumeroriented
companies either, or financial
industry sector IPOs. Most of the
IPOs are spin-outs of large companies,
and most are going to the New
York Stock Exchange where the parent
companies are listed. So, we are
not competing as effectively for IPOs
because there aren't as many IPOs
that are truly new companies.
BIF: Would you discuss
Nasdaq's delisting rules?
With all the volatility, even
good companies may find
themselves in trouble.
Berkeley: Unfortunately the delisting
rules are a little too clear. For example,
they say a company is to be delisted
when it's share price drops below $1
for 30 days. There are some very good
companies that have gotten caught up
in this down market and have seen
their share prices go below $1. We had
implemented a moratorium on the
30-day rule, but that has since been
suspended and we have returned to
our normal rules. I wish we were not
quite so dogmatic, but the rules have
the force of law and we do not have
much room to interpret them. We
have probably thrown some good
companies off the market that should
not have been delisted, but usually the
companies have the option of reverse
splitting their stock, and if they do,
they often stay above a dollar.
| 
Printer Friendly
