SEC Favors Pilot to Vary Tick Sizes for Small StocksDave Michaels
The U.S. Securities and Exchange Commission’s staff is poised to recommend a pilot program to test whether larger trading increments promote more active trading of small stocks.
A pilot program would increase the ‘‘tick size,’’ or minimum increment for quoting shares, for smaller public companies. A 2012 law, the Jumpstart Our Business Startups Act, required the SEC to examine the impact that penny increments had on the liquidity of shares issued by small- and medium-size companies.
“There seems to be a lot of support for a pilot program and we think that makes sense,” John Ramsay, the SEC’s acting director of trading and markets, said in an interview. “We’re still working through the details of how it should be structured.”
In theory, wider tick sizes would increase the spread between bid and offer prices, boosting profits for market makers. Higher profits may revive interest in funding analyst research on small stocks, generating greater interest in the stocks, supporters of the idea say.
Proponents say widening minimum tick sizes would help boost the number of small companies going public, while skeptics complain it will cause people to pay more when they trade.
James J. Angel, a finance professor at Georgetown University, said a well-designed pilot program should last at least five years in order to provide meaningful data about the impact of varying tick sizes. Companies should be allowed to pick their own tick size because they have “the incentive to get it right,” Angel said.
“It will take a long time to see the longer-term impact on analyst coverage, visibility in the media, and on valuation,” said Angel, who has published research papers on optimal tick size.
R. Cromwell Coulson, chief executive officer of OTC Markets Group Inc., said the pilot should also require market makers to show a minimum quote size to ensure the depth and liquidity of the market improves. The Financial Industry Regulatory Authority, the brokerage industry’s self-regulator, began a similar pilot last year for over-the-counter equities. The program decreased the minimum number of shares required for a quote to be displayed at most price points. A security offered for 51 cents, for instance, would require a minimum quote size of 1,000 shares to be displayed, instead of 2,500.
“It would be great for the investor experience because they would see more liquidity on their screens and there would be a higher willingness to trade,” Coulson said in a phone interview.
U.S. exchanges began quoting stocks in pennies in 2001, after over 200 years pricing equities in fractions. The move to penny increments benefited professional traders willing to pay a penny more to jump in front of a competing bid, Angel said.
At a roundtable on decimalization last month at the SEC, many participants expressed support for a pilot even as some questioned whether varying tick sizes would yield more IPOs or research coverage.
Skeptics of varying tick sizes point out the benefits are unknown, while it’s clear the move to 1-cent increments lowered spreads and created savings for investors.
“We are arguing we need to provide more returns to the market makers -- not necessarily because we want to make market makers better off, but because we want them in turn to subsidize research,” Maureen O’Hara, a finance professor at Cornell University and chairman of Investment Technology Group Inc., said at the roundtable. “I think that linkage is really tenuous.”
Judith Burns, an SEC spokeswoman, declined to say how soon a tick-size pilot program would be approved.
The SEC’s staff issued a study on decimalization last year and declined to immediately recommend a new regulation increasing tick sizes for smaller exchange-listed companies. The study said the SEC should solicit outside views on decimalization, including how to develop a pilot program to test varying tick sizes.
A pilot program would probably move forward under the SEC’s next chairman. Mary Jo White, President Barack Obama’s nominee to lead the agency, told senators on March 12 that she was inclined to believe that one tick size “doesn’t necessarily fit all.”
“Clearly, it’s a priority to focus on that issue,” White said at her nomination hearing before the Senate Banking Committee.
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