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Google and Twitter have filed a amicus brief with the appeals court on TheFlyOnTheWall.com case. Briefly, at issue is FlyOnTheWall’s near real-time redistribution of investment bank research ratings. Investment bank research departments spend time, money and resources creating stock ratings and price targets. The purpose of this effort is to create an information asymmetry in the market to the advantage of the i-bank’s clients. FlyOnTheWall does not employ analysts and has no research capability, it discovers stock ratings, aggregates and redistributes them in near real time. Since their cost of production only includes real-time redistribution infrastructure, and therefore they can offer their high-value information feeds at a lower cost than investment banks. Subscribers to FlyOnTheWall pay for these aggregated news feeds, they aren’t free. In their testimony, FlyOnTheWall claimed they only gathered information from publicly available sources and only published tweet-sized snippets summarizing the reports.

Google and Twitter make the following argument in their brief:

News reporting always has been a complex ecosystem, where what is ‘news’ is often driven by certain influential news organizations, with others republishing or broadcasting those facts — all to the benefit of the public,

and further

How, for example, would a court pick a time period during which facts about the recent Times Square bombing attempt would be non-reportable by others?”

At issue is the re-emergence of the hot news doctrine, which was originally put in place in 1918 to stop William Randolf Hearst’s International News Service from taking Associated Press wire news stories and redistributing them as their own. The court set forth five criteria to determine whether ‘hot news’ has been misappropriated:

(i) a plaintiff generates or gathers information at a cost;

(ii) the information is time-sensitive;

(iii) a defendant’s use of the information constitutes free riding on the plaintiff’s efforts;

(iv) the defendant is in direct competition with a product or service offered by the plaintiffs;

(v) the ability of other parties to free-ride on the efforts of the plaintiff or others would so reduce the incentive to produce the product or service that its existence or quality would be substantially threatened.

In the case of TheFlyOnTheWall.com the court ruled for the plaintiffs, Barclays, Merrill Lynch and Morgan Stanley, and decided that a 2 hour embargo was a reasonable amount of latency to build into the Network. In the fast-paced world of equity trading, two hours is an eternity. These days trades are often executed in a matter of milliseconds. The enforcement of this kind of rule, however, is problematic. In the brave new world of social media, both individuals and news organizations have interconnected real-time distribution networks. Once bits of information touch this public social network they can spread with breathtaking speed. Twitter, Google and Facebook are currently the media through which this information is dispersed. And each of them can be said to profit by the circulation of high-value information through their networks.

Over the last few days we’ve seen the drama of General Stanley A. McChrystal play out. The events were put into play by a story written by Michael Hastings, a freelancer for Rolling Stone Magazine. The story about McChrystal’s comments began leaking out Monday night. Both Politico and Time magazine posted a PDF of the Rolling Stone article to their web sites before Rolling Stone. Rolling Stone asked the sites to remove the PDF. The New York Times reports:

Will Dana, the magazine’s managing editor, said that the magazine did not always post articles online because it could make more money at the newsstand and that when it did, the articles were typically not posted until Wednesday. But other news organizations made that decision for him.

The McChrystal story is an interesting example of the ‘hot news’ doctrine. Rolling Stone magazine puts out 26 issues of its print magazine per year. Even before the issue hit the newsstands, it dominated cable news, has been fully reported in the New York Times and resulted in McChrystal’s resignation and replacement by General David Petraeus. One could argue that Rolling Stone should have a business model that allows them to benefit from these kind of real-time events. And it’s quite possible that the broad dissemination of this story will lead to a significant increase in newsstand sales and web site traffic.

In this case the ‘hot news’ was so hot that the story itself became a story. Major government policies regarding the conduct of the war in Afghanistan had to be decided in real time. There was no hesitation, no waiting for Rolling Stone’s newsstand business model to play out. By the time we finally see the printed magazine it will have become an artifact of history. With the advantage of hindsight, we may even wonder why the headline writer put McChrystal’s story third after Lady Gaga’s tell all and the final days of Dennis Hopper.

The question about the ‘hot news’ doctrine isn’t going away; and the decision of the appeals court will be closely watched. In the meanwhile, the marketplace is searching for a solution to the fact of real-time aggregation and relay of digitally-copied work product. The return of the pay wall is an attempt by producers of stories about the news to create a firewall around their work product. Most corporations employ a firewall to keep their valuable internal discussion from reaching the public networks. Limiting access of your product to paying customers isn’t a new idea. However, when your work product is a story about news events or ideas encoded in digital media, creating reliable access controls is problematic. Where in the early days of the Network the focus was on direct access and disintermediation of the middle man; now the economics favor the man-in-the-middle. Meta-data can be sold at a fraction of the price of the data to which it points. The complex ecosystem of ‘the news’ is looking for a new equilibrium in which both data and meta-data can flourish.

Om Malik interviewed my old boss Bill Hambrecht about the state of the economy and the future of the IPO in Silicon Valley. Watch the whole thing. Hambrecht has worked on transparency in the pricing of securities for many years. His ideas about using a modified dutch auction to price initial public offerings are still revolutionary.

Hambrecht’s explanation of the subprime mortgage crisis is one of the clearest I’ve heard. Mortgage backed securities are traded in a dealer-to-dealer market without transparent and continuous pricing. Stocks are priced through a continuous auction on the stock exchanges. When a company has to voluntarily mark down the value of these mortgage-backed securities, they hesitate. When they’re finally forced to mark an asset down, there’s a big jump down in value. That change in value wrecks the balance sheet. Interestingly, it’s not a business or revenue issue– it’s a price/value of assets problem. Hambrecht’s solution has always been to allow the market to discover the appropriate price and make the process transparent.

Hambrecht thinks the consolidation of the bulge bracket investment banks means that big iBanks will only be doing big deals. Their cost structures will dictate a move toward the mega deal. The ground is being prepared for a new crop of boutique investment banks to bring the new crop of small companies public. My favorite quote in the interview? “It’s like 1968 all over again.”

My two cents on Microsoft’s hostile bid for Yahoo: Microsoft, finding itself in the new world of the social graph, needs to buy some friends. People don’t like Microsoft, they fear and respect it. People don’t buy Microsoft products, they buy products that already contain the OS and Office. People choose Yahoo, they choose delicious and flickr. They like Yahoo Finance. And it’s all supported by advertising.

The question about whether Microsoft could successfully integrate Yahoo is a people question. Is there a strong enough personality within Microsoft to envision an entity that creates a new integrated whole. Clearly it’s not Steve Ballmer, and that means it’s got to be Ray Ozzie. Ozzie is trying to move the key Microsoft revenue streams on to the network with his “Live” initiatives. Yahoo is the advertising framework and user base that could contain and support the new web-based Microsoft Office live.

If Ray Ozzie can make elephants dance, many of are wondering who will call the tune. Microsoft is willing to pay $31 a share, but the cost to Microsoft will be much higher if they decide that Yahoo has to be rebuilt on a Microsoft technical stack. That was their approach with HotMail and it was very expensive. Is this the moment in time where Microsoft embraces a mixed technical operating environment? Yahoo is a big supporter of open standards and open source, the community is justifiably concerned about how Microsoft will affect this. When you integrate YahooMail and HotMail, do you make your decision based on technical stack or the quality of the product? Are the decision makers at Microsoft capable of making a decision based on product quality?

Can a shot-gun wedding result in a happy marriage? When we discuss $1 billion in efficiency as a result of the merger, we’re referring to the brutal process of merging groups, firing people, closing facilities and trying to keep the lights on during the process. The digerati of the Bay area and Redmond will be significantly affected by these changes, and it will ripple into the surrounding economies. There will be a lot of pain for both those who stay and those who leave.

It’s up to Ray Ozzie to provide a new vision of the combined entity that will convince those left standing that it was worth it. For the deal to ultimately be successful, Microsoft will have to be transformed as much or more than Yahoo.

The Google offering happened a while after I left WR Hambrecht + Co, but I can’t believe I never saw this Charlie Rose interview with Bill Hambrecht. It seems like ancient history viewing it now. Looking at the offering price and today’s price one might think the deal was underpriced by the modified dutch auction. As I recall, at the time, many thought the IPO offering price of $85 per share was too high.

Hambrecht’s modified Dutch auction method of pricing IPOs still isn’t understood very well. Basically it’s the idea of the wisdom of crowds (or markets) applied to determining the appropriate offering price for a company’s initial public offering. Think of it like Digg for pricing the initial stock price for a company. It’s a like asking the community of investors what the right price should be— a radical use for a social network.

The method works best when a broad range of people have an opinion on the proper initial price for a company’s stock (a high bid to cover ratio). It doesn’t work very well when the company isn’t well known. In cases like this investors (bidders in the auction) actually have to read the prospectus and attempt to determine a reasonable price. This, of course, is nearly impossible. It would be like trying to rate a new album from a band you’d never heard based on the tax returns of the musicians.

For those in the tech community looking for liquidity events through an IPO (as opposed to acquisition), you’d do well to at least take the time to understand how the Dutch auction works. Back in the day Joe Tennis and I put together a flash animation explaning how Hambrecht’s OpenIPO works. Check it out, it still holds up pretty well.

Attended a book launch party last night for Stephen T. McClellan‘s Full of Bull. The subtitle of the book is: “Do what Wall Street does, not what it says, to make money in the market.” The crowd was an interesting and lively mix of financial industry folks, artists and people connected to the world of opera. (Stephen’s wife is a painter and worked at SF Opera for many years)

I haven’t read the book yet, but what I gather from Stephen’s remarks, and skimming through, is that he hopes to help people decode the language of Wall Street. As in Lewis Carroll’s Alice in Wonderland, it’s important not to take things at face value. A “buy rating” doesn’t mean buy, and a “hold rating” doesn’t mean hold. A lot of the communication on the Street is through signaling, in the margins, or outside of the official channels. Information asymmetry is the primary method by which money is made. Clarity in communications levels the playing field and destroys perceived advantages. Muddy waters are the natural habitat of the players in financial markets.

As the market enters a period of uncertainty after an extended bull run, it’s good to have books like this to turn to. An investor looking for advice would do well to learn how to converse in the language of the Street before acting on the latest hot analyst recommendation spewing out of a cable news station.

I’ll be reading Full of Bull in the next few weeks, and you should too. Let me know what you think of it.

Venture capitalists are wondering what it means when the cost of creating a Web start up goes so low that they lose relevance. More start ups created faster mean more exploration, more ideas and failing faster. And failure no longer means crashing down from a great height, it’s a shorter distance to fall. Paul Graham invoked the questioning with his musing on The Future of the Web Startup. Value and power has moved from money to creativity.

Jason Calacanis has provided us with the official definition for Web 3.0 — smart people + Web 2.0 technology, a recipe that amazingly corresponds to his own Mahalo project. People around the blog-o-sphere were up in arms, gnashing their teeth, no one had realized that it was time to define Web 3.0. Bloggers quickly polished up their definitions, counter-definitions or attacks. Some claimed to have defined Web 3.0 sooner and pointed to prior art.

But when the din resided, they asked me, although we’re not sure what Web 3.0 is, and we’re not sure why it makes sense to assign numbers to the Web— what is Web 4.0? Surely if we are going to invest our blood and treasure in the Web, we should associate ourselves with the highest possible number.

So here it is, the official definition of Web 4.0: It’s Web 2.0 mashup/api/services technology + user-asserted identity + really private, important personal information. Smart people are in there somewhere, but really— that approach is soooo Web 3.0. You may ask, can we see any of these Web 4.0 companies? Sure, there are a few starting to emerge, take a look at: Microsoft’s HealthVault, whatever Google’s Health initiative turns out to be and on the financial side, things like Mint and CakeFinancial. Although on the financial side these companies aren’t really 4.0 yet. Look for a vault that contains all your financial data which the vendors with whom you do business will be obliged to deliver to you. You’ll be putting the digital media that you own in there as well. Oh, and throw Doc Searl’s idea about Vendor Relationship Management in there as well, you’ll store your VRM prefs there as well. Stuff you are, stuff you own, data about stuff you own, stuff you want, and of course, your attention data. But it’s gotta be secure and it’s gotta solve the identity problem.

I suppose this has been noted before, but Microsoft Office overserves its users. It has too many features that no one uses. It has features that no one even knows about. If an MS Word feature falls in the woods, and no one hears it, does it make a sound? This is a classic Innovator’s Dilemna.

It’s easy to say that Google apps is not as good as Microsoft Office. But that’s an answer to the wrong question. The question is: is it good enough, for a lot less money. The folks at CapGemini seem to think so. It’ll cost a company $50 per year per employee for Google Apps. Microsoft will counter with Microsoft Live, but they don’t what to cannibalize their own product. Which means they leave the field open to Google Apps and Zoho. Speaking of Zoho, you’d think Yahoo or somebody would buy them.

Frank Quattrone made a lot of people a lot of money. He was the i-banker of Web 1.0. Now he’s beaten the charges related to the IPOs he ran for CSFB during the Internet boom. Of course, those who actually remember ancient history (back around the turn of the millenium), would know that Quattrone was never charged directly with the securities violations everyone knew he committed. He was charged with the cover up. He beat that rap.

So now in this new era of Web 2.x, Frank’s back. But things have changed, there’s Sarbanes Oxley, start ups are trying get by without VC funding, and the “first day IPO pop” has been revealed to be the most expensive advertising a company could possible do (as well as an opportunity for the kind of securities violations that Quattrone was originally suspected of). It was the difference between the IPO price and the first trade price that traditional bankers like Quattrone were able to parlay into a network of favors, and a pipeline of deals.

Here in the Bay area, we think the new crop of Web businesses are probably due for a shake out. But it’s also acknowledged that there are some better business models out there that really organically fit into the Web. If there’s a bubble today, it’s a much smaller one. It’ll be interesting to see how Frank will emerge. He wants to get back into the scene, maybe it’ll be M&A this time.

There’s a lot of capital invested in “the wisdom of crowds” Web companies. This idea that “we” are smarter than “me” is generally a good one. I find the collaborative filtering that Delicious provides a great way to find new information on topics of interest, or to follow the link blogs of people of interest. Obviously there’s a big unexplored territory here.

Sometimes it seems as though the Web has no sense of history, no reference points outside itself. The concept of the “wisdom of crowds” seems to live in some kind of socialist realist illustration from the Soviet era. Happy, productive workers collectively producing the best of the best. The crowd’s idea is better than an individual’s—and you can make some money off of the value of that better idea. In this case when we say “the crowd” is “wise,” we give the crowd power over what counts as “wise.” And of course “wisdom” is always better, smarter, and by definition, more “wise.”

And yet, when you replace the word “wisdom” with the word “power” and start doing some reading you’ll immediately encounter the dark side of this concept. Elias Canetti’s Crowds and Power is one of the classics of the literature. Crowds, both consciously and unconsciously, create a dominant center and push things to the margins. (The opposite of The Long Tail) Sometimes this kind of filtering can be good and valuable, sometimes it can be cruel and dangerous. Instead of the Socialist Realist image of crowds, think of the image created by Billie Holiday in the song Strange Fruit. The crowd is a double-edged sword—it cuts both ways. The sword is real and the sword is sharp.

Jason Calacanis has a related problem with Mahalo. The wisdom of his editors creates the value of Mahalo’s search engine results pages. And there’s no question that Mahalo does create value. But if we replace the word “wisdom” with “power” we uncover the potential dark side of this concept. And that’s where we come to the concept of the Ombudsman.

If the future of the Web is really going to be filled with Social Networks and Distributed Editors filtering our experience, the future must also be filled with the Ombudman. Have the builders of these online filtering systems thought about how to make injustices right? Do they have an algorithm for that? Or is a human process of arbitration the only way to really set things right? Can this kind of process just be tacked on at the end? Shouldn’t it be an essential part of the structural design? Of course, the reason it’s not is that “justice” isn’t part of what creates value, rather it’s a pure expense. Although in the long run, it’s also part of what will make any such service a trusted authority. (See Reputation Management and Craig as Customer Service Rep)

It’s well understood what an Ombudsman is supposed to do, the question exposed by this little ramble of thought is: can an Ombudsman really provide a check and balance to the power of the crowd? Could an Ombudsman save Frankenstein’s monster from the crowd?