Will Wall Street Surrender Its `Pieces Of Eight'?Michael Schroeder
It's about as fundamental to Wall Street as the faux Greek pillars fronting the New York Stock Exchange. For two centuries, U.S. stock markets have traded shares in increments of an eighth of a dollar: 12.5 . The "fractional pricing" system has remained intact even as global markets have moved to trading securities at whatever price they command--no matter how tiny the increment. Critics say Wall Street firms like the system because it artificially inflates spreads between bid and ask prices--thus boosting the Street's profits.
But fractional pricing may finally be on the way out. Slowly, pressure is building in Washington to convert share pricing to a "decimal" system that uses dollars and cents. By narrowing spreads, the move could save investors millions of dollars a year. "The current system reflects inefficiencies that are costing investors a whole lot of money," says Harold S. Bradley, head trader for Twentieth Century fund group in Kansas City, Mo.
Some government officials apparently agree. At a hearing last spring, Representative Edward J. Markey (D-Mass.), chairman of the House subcommittee on telecommunications and finance, said he would consider requiring decimal pricing in possible legislation next year. In October, the Securities & Exchange Commission sought comments on it. And the agency's big Market 2000 study, due in early 1994, is expected to deal with the issue. "I think it is inevitable in the long run," says SEC Commissioner Richard Y. Roberts.
In the short run, however, securities firms are expected to challenge any reforms as hard as they fought moves to end fixed brokerage commissions in the 1970s. Indeed, fractional pricing is a vestige of the fixed-commission concept. "Decimal pricing would affect [Wall Street's] profitability. Spreads would close," says John L. Watson III, president of the Security Traders Assn.
Legend traces the practice to the ancient Spanish custom of cutting the peseta into "pieces of eight." Whatever its origins, there's no disputing that brokers and dealers are huge beneficiaries of the current system. A dealer who "makes a market" in General Motors Corp., or offers to buy and sell the stock, might buy at, say, $48 a share and sell at $48.125. Under a decimal system, trades could take place between those prices, say, $48.07, slicing pennies per share off the dealer's gross profits. Proponents of the decimal system believe that while firms' margins may suffer, they could offset that with increased volume.
Just how much money the change would save investors, who trade 100 billion shares a year, is the subject of some debate. Financial consultant Jeffrey P. Ricker figures that when an investor trades a Standard & Poor's 500 basket of stocks, the broker's commission averages 2 or 3 a share. But the spread adds an additional dime a share, he estimates. A study by Wayne Wagner, partner at Los Angeles researcher Plexus Group, put the spread costs for institutional investors at 7 a share. If decimal trading shaves off only a penny, investors would save $1 billion a year, says Junius W. Peake, a finance professor at the University of Northern Colorado.
SPREAD SHRINK. Decimal trading could also abolish a practice abhorred by many regulators--payments by nonexchange dealers to brokers to get them to execute orders away from exchange floors. The SEC is worried that brokers seeking the payments, usually a penny or two a share, will ignore their duty to get the best price for customers. The SEC solicited comments on decimal pricing as part of its study of order-flow payments, which are linked to 15% of all trading. Some SEC officials think a decimal system would shrink spreads so much that dealers couldn't pay for orders and still make a profit.
While acknowledging some benefits, Wall Street sees a huge downside. Industry execs say market makers and exchange specialists might abandon infrequently traded stocks, reducing liquidity. And fierce rivalry in the pricing of stocks could squeeze out smaller firms that need a minimum 12.5 spread to survive. What's more, a changeover, which would involve converting complex computer systems, would be expensive and time-consuming. In testimony before the Markey subcommittee, New York Stock Exchange Chairman William H. Donaldson argued that "to change something just to change it is probably wasteful."
So, despite growing interest in Washington, a quick change isn't likely. Market 2000 will probably recommend only that Wall Street take a hard look at decimal pricing. Says Commissioner Mary L. Schapiro: "I can't imagine we'll force it on the industry." Thus, the driving force for change will likely be large investors, who stand to reap a windfall. If they start wielding their clout, the Street may have no choice but to bring its ancient pricing system into the 20th century.
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