By Tony Jiao, Staff Writer
Henry Ford, the founder of the Ford Motor Company, famously said that, “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” In an increasingly technologically advanced world of finance, this quote holds truer than ever before. From the click of the buy button to the numbers showing up on your phone screen, very few people really understand the inner workings of their stock portfolios. In reality, a complex system, involving several corporate middlemen, exists between your money and your trading account. In a world where very few people understand how their money works, it is easy to see how they can be taken advantage of by those who dictate the rules.
To begin, what is a stock exchange? Simply put, it is a platform where potential buyers and sellers can connect, and conduct their transactions. Therefore, every transaction that occurs in the stock market involves two parties: a buyer and a seller. This means whenever you buy a stock, someone was feeling pessimistic about the stock that day and sold it to you. Currently, the two most prominent and commonly used stock exchanges in the world are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ), although surprisingly, they are not the oldest! That title belongs to the Amsterdam stock exchange, which was founded alongside the Dutch East India Company in 1602.
A broker, on the other hand, connects individual customers to the stock exchange for a fee or “commission”, although this is not always the case. For example, the US platform Robinhood and Canada’s Wealthsimple advertise that their platform is commission-free, which draws many first time investors looking to foray into the world of stock trading. Obviously, these companies still operate with profit in mind, however, they earn their revenue in very different ways. Robinhood has recently been embroiled in controversy over its practice of “Payment for Order Flow”, where certain financial institutions can pay brokers to route their customers’ orders to them to be executed at their leisure. This way, the financial institution can perhaps execute the order at a worse price than the customer intended, while pocketing the difference. Fortunately in Canada, the practice of PFOF is banned, and Wealthsimple makes money by charging a simple 1.5% conversion fee when buying or selling US-based securities.
That’s it, right? Broker, stock exchange, the customer. Those must be the only components of a stock sale! Not quite. There is another entity involved in this process, and it may be the least understood, yet crucial component of all.
This mysterious entity is known as the Depository Trust Clearing Commission or the DTCC. They act as a “clearinghouse”, where they ensure that both the buyer’s broker and seller’s broker honour their agreements to either transfer the agreed-upon assets to each other. The existence of this organization dates back to when securities were still exchanged by paper, which means that brokers had to employ people to physically deliver shares and money, as well as keep extensive physical records. As the stock exchanges grew in popularity, this was not a viable solution and thus the Depository Trust Company, which would later become the DTCC, was born. The early DTCC would instead store all securities in a centralized location, and automate transactions into electronic records. In return for its services, every large financial organization in the world is required to secure membership with the DTCC.
What at first seems like a logical solution quickly becomes horrifying upon closer inspection. On paper, you don’t actually own any of the stocks in your portfolio. What you own is a contractual right to the share owned by the DTCC instead. As well, the DTCC also controls birth certificates, mortgage deeds, among other official documents. To make matters worse, the DTCC is not, as you would expect, a government organization. It actually operates through a private company called Cede & Co, which was founded alongside the DTCC. If you think this is alarming, you would be correct. The current system sets up the massive potential for fraud and conflicts of interest; what’s worse, the DTCC is also responsible for reporting transactions, which means that they can effectively hide any given transaction at their discretion.
In order for the financial markets to become a truly equitable space, all parties involved must first understand the inequalities of the current system. In today’s rapidly changing world, it is more important than ever for individuals to stay informed about the system that runs their lives. By providing valuable information to a new generation of investors, workers, and leaders, hopefully, our generation can invent new, revolutionary ways to engage in the free market.