[ by Howard Haykin ]

At Tuesday's SEC Roundtable on Decimalization, discussions centered on the idea of abandoning 1¢ increments in the stock markets and returning to larger tick sizes. Twelve years ago, in 2001, the SEC made the switch for minimum increments from eighths and 'steenths of a dollar to a penny, in an attempt to save investors money. 

But in today's markets, the need is to improve liquidity in less-active stocks, which is why regulators, brokers, market makers and academicians are considering a pilot study of bigger quoting increments.  Proponents say larger increments will spur market makers to supply more buying and selling volume, particularly for less-active stocks.  Skeptics respond that the larger increments will cause people to pay more when they trade. 

Last week, an SEC advisory group dealing with small and emerging companies, recommended the creation of a stock exchange where only small companies are traded.  This would raise awareness of a secondary market for such stocks that, in the past, have had trouble raising capital in public markets. 

Former NYSE specialist Jim Maguire, 82, said, “A test would tell you if there’s a benefit or not. I assume there would be. The 1-cent spread has been a toxic element in trading.””  Mr. Maguire, who began working at the Big Board in the 1970s was opposed to the move to 1-cent increments since 2000.

Smaller Increments.   The shift to smaller increments enabled retail investors to buy shares at lower prices and sell for more. Combined with the growth of computing power and rules that boosted competition among venues, the process of decimalization decreased the profitability of equity dealers, who used money earned on wider bid-ask spreads to fund analyst research. Smaller tick sizes also complicated the way institutions trade by driving them to use more automated electronic strategies to handle blocks.

Last April's enactment of The Jumpstart Our Business Startups Act, or JOBS Acct, authorized the SEC to increase the tick size to as much as 10¢ from 1¢ for emerging-growth companies - i.e., , those with annual revenue of less than $1 billion.  A July study by SEC staff members said that while rulemaking wasn’t immediately necessary, discussions with market participants could generate ideas for a pilot study.

In addition to the reluctance of investors to participate in IPOs of smaller companies out of concern for a lack of any secondary market, market makers and broker-dealers have not had enough economic incentives to bring smaller companies public, provide bids and offers and publish stock research, - that, according to David Weild, Chairman and CEO of NY-based Weild & Co..  He's also head of capital markets at Grant Thornton LLP.  About 150 to 350 IPOs each raised less than $25 million a year from 1991 to 1997, Grant Thornton reports - yet, fewer than 50 did so annually on average starting in 2000.
 

‘Massive Consequences".   “The crisis in capital formation is a product of ill- advised market-structure changes that had massive consequences for small-cap stocks,” Weild, a former vice chairman at Nasdaq Stock Market, said in a phone interview. “The SEC needs to increase tick sizes and make them permanent to improve liquidity. It’s Armageddon for sub-$25 million IPOs.”

SEC rule changes focused on Nasdaq trading in the 1990s blunted companies’ interest in going public by hurting the dealers that facilitated their trading, while later one-size- fits-all marketplace rules ignored the needs of smaller companies, Weild said. The regulator should consider allowing all companies to decide what increment their shares use from 1 cent to 25 cents as a partial remedy, he said.
 

Pilot Study.   The STA, or Security Traders Association, representing over 4,000 financial-industry professionals, recommends a pilot study lasting at least a year with 900 companies of different market capitalizations and trading characteristics  - such as daily volume and price volatility.  Jim Toes, president and CEO of the the STA said:  “There’s not one regulatory or competitive event you can point to and say that’s why IPOs are down, but decimalization is on the list.  Enhanced liquidity is impossible to measure but it affects investor confidence. It’s time to try a pilot study.”
 

For further details, go to:   [Bloomberg, via Traders Mag, 2/5/13].