What is the Texas Stock Exchange and and How Will It Change the U.S. Investing Landscape?

What is the Texas Stock Exchange?

The Texas Stock Exchange (or TXSE) is a new, Dallas-based national stock exchange hoping to begin operations in Dallas next year. Completely electronic, it aims to not only to usher in a modernized era of trading but also to give both domestic and foreign companies access to capital in US markets, especially in the southwestern economy of the US. Funded by over four dozen investors, notably including Schwab, BlackRock, Citadel, and Texas billionaire Kelcy Warren, the Exchange has raised 161 million dollars in capital, making them the most well-funded fledgling stock exchange ever.

Why Establish a Stock Exchange in Texas?

The argument the TXSE seems to be pushing is not so much why, but why not. Texas contains the second largest economy in the United States, and the eighth largest economy in the world.  It is home to more NYSE (New York Stock Exchange) listed companies than any other state and 52 Fortune 500 companies, comprising an aggregate market value of 2.7 trillion dollars. They claim that the investor demand and economic brawn of Texas will put them in the positon to compete with the other large stock exchanges in the U.S, like the NYSE and the NASDAQ (which currently hold a duopoly within the U.S). In addition, the TXSE says it plans to have stricter requirements than the other exchanges as to which companies can trade on their platform.

According to a press statement made on the exchange’s website, they will be excluding “companies with penny stocks, foreign issuers with unverifiable finances, shell companies, and others that are already failing to meet listing requirements on existing exchanges. [The TXSE] believes this is distorting the capital allocation process while generating large fees for legacy exchanges.” In this way, they believe they can streamline the market to get an edge up on the “legacy exchanges, like the NYSE.

How Will the TXSE Become a Stock Exchange?

For the first part of becoming a national exchange, the Texas Stock Exchange first had to be funded by investors and make connections within the business community. That way, the infrastructure needed for a full trading platform could be paid for and those willing to trade on the exchange could be gathered. The Exchange has so far raised 161 million dollars and garnered support from over 1,000 public companies[5]. Now, they have applied for registration with the SEC to be recognized as a national stock exchange. I’ll go over their application, called Form 1, in the Regulatory section of this blog.

Where will the exchange be?

They plan to operate as a national stock exchange from Dallas’s financial center. Shown here is a depiction of the market building they have planned:

It will not serve as an actual trading floor, because the exchange is electronic, but it will be a conference, broadcasting, and support center.

Regulatory Compliance

Currently, the TXSE has submitted a Form 1-A application with the SEC, in compliance with the Securities Act of 1934. All new stock exchanges must submit a Form 1 to be allowed to list companies and facilitate trading, because it allows the SEC to hold the exchange accountable for any negligence. In the form, the applicant exchange details how it will work and its rules for preventing fraud and maintaining free markets. In fact, any company can start its own stock exchange upon completion of a Form 1-A. After complying with the federal requirements, the exchange must then comply with the rules of the Securities Board of the state it is in. In the TXSE’s case, it has to comply with the Texas State Securities Board, which means paying fees, completing certain forms, and complying with the Board’s SOPs (Statements of Policy). This includes getting rid of any conflicts of interest within the company planning for the exchange, illegal stock options, and other such disparities.

Form 1- This is the famous form that the TXSE is awaiting approval on. But what is asked in it?

The form itself is not so much a “form” in the traditional sense. Rather, it is a set of requirements for forms that the TXSE must send into the SEC to be approved. These forms, or “exhibits”, range from financial records to a complete rulebook that the future exchange will use to regulate their members. Also, since the TXSE has not yet form, the applying company that will become the exchange is the TXSE Group, which is referred to as the “applicant” in the Form.

Here is a breakdown of what the exhibits ask for-

Exhibit A- A copy of the constitution, articles of incorporation or association with all subsequent amendments, and of existing by-laws or corresponding rules or instruments, whatever the name, of the applicant.[9]

Exhibit B- A copy of all written rulings, settled practices having the effect of rules, and interpretations of the Governing Board or other committee of the applicant in respect of any provisions of the constitution, by-laws, rules, or trading practices of the applicant which are not included in Exhibit A.

Exhibit C- Information relating to each subsidiary or affiliate of the applicant, and of any entity with whom the applicant has a contractual or other agreement relating to the operation of an electronic trading system to be used to effect transactions on the exchange.

Exhibit D- Financial statements for each subsidiary or affiliate of the exchange.

Exhibit E- Description of proposed operation of the exchange.

Exhibit F- A complete set of all forms pertaining to the application for membership and the approval of a person as associated with a member.

Exhibit G- Financial statements, reports or questionnaires required of members, participants, subscribers or any other users relating to financial responsibility or minimum capital requirements for such members, participants or any other users.

Exhibit H- Listing applications of the applicant, including any agreements required to be executed in connection with listing and a schedule of listing fees. 

Exhibit I- Audited financial statements of the applicant for the latest fiscal year.

Exhibit J- A list of the officers, governors, members of all standing committees, or persons performing similar functions for the applicant.

Exhibit K- Shareholders owning 5% or more of the applicant.

Exhibit L- Exchange membership criteria and conditions under which members may be subject to suspension or termination with regard to access to the exchange.

Exhibit M- List of members of the exchange.

Exhibit N- Schedule of securities listed or traded pursuant to unlisted trading privileges on the exchange.

Some of the documents the TXSE has submitted are publicly available on the SEC website, but not all.  If deemed compliant, the TXSE will be open for business and ready to change how the world looks at Texas!

Section 2 – Hows and Whys

Another reason the Texas Stock Exchange is being create3d is because state and corporate leadership in Texas view New York as having become too costly and onerous with its regulation. Some, including TXSE CEO Jim Lee and Texas Governor Greg Abbot, cite a deeply unpopular NASDAQ rule in 2021 that required listed companies to have at least two “diverse” members on their boards. Though Nasdaq was later forced to repeal the rule by the Fifth Circuit Court, many people still see it as a testament to how the NYSE and Nasdaq have become comfortable with overstepping their power and imputing ideological rules that stifle the free market. According to the TXSE, because New York forces companies to comply with meaningless ideological or unfair rules, trading on their platforms is more costly than it should be, which is harmful to both companies and investors.

Therefore the TXSE has decided to have looser regulations on trading the stocks, but tighter rules on listing stocks. So far, although they have been rather vague on exactly what they will require of companies, they have said they will require more stringent qualifications for listed companies than the TXSE, including earnings tests and minimum prices for securities. Lee, in an interview with the Financial Times, claimed that around 1500 NASDAQ companies and 200 NYSE companies would not currently be eligible to be listed on the TXSE.

Why Are the Requirements so Strict?

While reading the hundreds of pages of regulations for exchanges, the thought may often cross your mind that government surely imposes a lot of rules on these so-called free markets. However, the federal regulations on exchanges are tough and numerous for good reason. Before the Securities Act of 1934, which contains the laws Form 1 is pursuant to and the SEC itself, there was very little federal regulation and instead states regulated their own exchanges without many federal requirements. This system seemed to operate quite well through the economic prosperity of the 1920’s but it inevitably came to an end. The Great Depression, the worst economic crisis the United States has ever endured, famously started on the floors of the New York Stock Exchange in October of 1929.

After years of speculation, margin buying, and bad investments by banks, companies, and the general public, the stock market finally crashed over the course of one fateful weekend. First Black Thursday, then Monday, then Tuesday, the whole system crashed and millions of people lost their money. According to a later analysis by Virginia Commonwealth University, around 14 billion dollars in wealth were lost on Thursday alone. The brutality of the stock market crash provided the country with not only economic suffering but also a glaring view of the shortcomings of the stock markets of the 1920s. Back then, disclosure, prospectuses, and even the SEC didn’t exist, which led to a dangerous surplus of overvalued stocks, investor speculation, and frauds on the stock market. The lack of transparency and regulation led to a risky, self-destructive environment, and the U.S learned the hard way that the business practices of the Roaring Twenties were no longer suited for its economy.

5 years later, in the midst of Roosevelt’s sweeping reforms, Congress passed the Securities Laws of 1933 and ’34, which established the base of the modern U.S. regulatory system. While the regulation isn’t perfect (there have and will always be crashes), the rules incorporate many hard-earned lessons from the past the make the future of finance safer and more reliable.

An Example from Today

The TXSE has said it plans to be stricter with the companies it lists by using measures including high financial requirements, minimum prices for IPOs, and pre-application reviews. That way, the resulting market is trustworthy and undiluted by penny stocks, shell companies, and other dangerous securities. The NYSE and NASDAQ, who currently have a duopoly over all U.S stock trading, do not have these standards, and TXSE CEO Jim Lee has claimed that over 1,500 NASDAQ and 200 NYSE companies would not make the cut. In a recent article by the Wall Street Journal, it seems his case has been reinforced. Recently, small-time investors lost large amounts of money to a pump-and-dump fraud involving unwitting small Chinese companies.

Though the majority of these companies had relatively small IPOs (the majority of them only raised at most $15 million), the NASDAQ still listed them, even though FINRA advises investors that such small companies are often “preludes to scams”. While NASDAQ said that is was very proactive in addressing “instants of market manipulation", the fact remains that had there been stricter listing requirements, it is possible the market manipulation never would have happened.