In a recent, informal BUSINESS WEEK poll, 87 15/16% of those surveyed said they are glad that the U.S. securities industry must switch to decimalization of stock prices by July of next year.
It's about time. France switched from fractions to decimals way back in 1795. Spain switched in 1848. At the beginning of 1974, only the U.S. and Canadian stock markets and Yemen's currency were still fraction-based. Yemen, however, wised up and joined the ultra-hip decimalization ranks later that year. The Canadian market capitulated in 1996.
The securities industry has clung to the arcane fraction system for this simple reason: It allows a greater spread between bid and ask prices, benefiting market makers and specialists at the expense of investors. In effect, it's an artificial pricing system that the industry has an interest in keeping in place. "It's great this is finally happening for investors," says Steven M.H. Wallman, a former Securities & Exchange commissioner who worked with Congress on a bill mandating decimalization.
TICKER SHOCK. Currently, the securities industry is deciding exactly how to implement decimalization. "Each market maker will determine what their minimum price increment, or tick size, is," says Scott Abbey, chairman of the Securities Industry Assn.'s decimalization committee. For instance, some could decide to go with a dime, others a nickel, and others a penny. If a market maker goes with a penny, the bid could be as low as $5.01, for instance, and the ask could be $5.02. If it's a nickel, then the bid could be $5.05 with the ask $5.10. "The agreement with Congress and the SEC is that it has to be stated in dollars and cents--that's all that matters," says Abbey. But with exchanges and ECNs (electronic communications networks) entering into a heated battle for trades, experts say that competition should ultimately render the penny the standard increment.
Penny increments would be the most cost-effective for investors. They would certainly be an improvement over the current 1/16th (6.25 cents) increments. For example, if an investor now places a market buy order, or bid, for 100 shares of AnyCorp stock that's trading around $5 a share, he may end up purchasing the stock at, say, 5 1/16th a share--the lowest incremental price over $5--even if there are sellers willing to unload the stock at 5 1/32. (Some stocks already trade in 32nds or 64ths in deals negotiated between big customers and market makers or in trades executed on some ECNs.) With decimalization, assuming pennies become the minimum tick increment, an investor might be able to purchase that same stock for $5.01 a share--a difference of 5.25 cents. On a 100-share trade, an investor would save $5.25. That may not sound like a windfall, but take into account the more than one billion shares that change hands each day. Investors could save almost $1.5 billion annually with decimalization, estimates Jeffrey P. Ricker, a San Francisco investment strategist.
Sure, a penny spread may not prove economical for market makers. If it doesn't, though, bid and ask prices will widen. That way the market, and not the securities industry, will decide for itself how narrow or wide spreads will be. And brokerages that make markets in stocks may accept narrower spreads because they'll make it up in increased commissions from accelerated trading volume. For every 1% decline in trading costs, there is a 2.75% increase in trading volume, according to a study by Ricker. "Bankrupt brokers are as rare as customers' yachts," he says.
The "fraction faction," as defenders of the status quo are called on Capitol Hill, cite various reasons why decimalization should be postponed. The primary excuse is that Year 2000 technological fixes are taking precedence. "Decimalization may seem like a trivial change, but it's a huge task in terms of implementation," says Abbey. One legitimate concern for the securities industry: the ability to handle increased quote traffic caused by decimalization.
According to the TowerGroup, a Newton (Mass.) financial-services consulting firm, it will cost the securities industry an estimated $170 million to update systems for decimalization. Still, it's a relatively simple fix, say experts, and after it's done, the securities industry will be much better off for three reasons: It will be able to compete better globally by using a common pricing language; the resulting increased volume will make the markets more liquid; and investors may be more apt to invest in stocks because decimals are easier to understand. And that's not half (0.50) bad.