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June 30, 2003

Decimalization Reform Is Traders Strategy

By Gregory Bresiger

Security Traders Association officials want reform - not the end - of decimalization. And they haven't given up on the idea of trying to obtain some changes. They are considering authorizing an academic paper on the subject. STA officials said some federal lawmakers, who told them they had to learn to live with decimals, recently misinterpreted their stand.

"We never said we wanted to end decimals. We said we'd like to look at possibly having a minimum price variation, but that doesn't mean we expect to get rid of decimals," said John Giesea, president of the STA, which represents trading professionals. He said that academic research so far has shown that decimals are also having some negative impacts.

A study by SEC Economist Larry Harris is cited by the STA. Harris found contradictory evidence in a 1997 study. The author examines evidence from minimum price increment changes for stocks. Smaller quoted spreads were found in an analysis of 26 Paris Bourse stocks on a smaller tick. However, traders were restricted in the display of 43 percent of their orders when trading stocks on a smaller tick. In the U.S. study, traders appear to hide their orders from front-runners when the tick size is smaller. Additionally, more liquidity is provided when the tick size is large, according to Harris.

The STA is also raising questions about a recent study by Purdue University Professor Sugato Chakravarty. The study found no evidence of higher trading costs for institutional investors. But another study on the effects of decimalization on institutional investors, co-authored by the same professor about 18 months ago, found problems, according to the STA.

"The authors find no increase in execution costs for institutional investors, but admit that such investors may face higher explicit costs of trading due to the need to trade more to complete their trades because of decimalization," according to the study cited by the STA. It hangs much of its criticism of decimals on this sentence from the study: "Therefore, they indicate that the total cost of executing institutional trades is ambiguous."

But decimalization is clearly a two-sided debate.

The Investment Company Institute supports decimalization and penny increments. ICI President Matthew Fink, in a letter to SEC Chairman William Donaldson, said it was unnecessary for investors to have, "artificially wide spreads in order to obtain the benefits of deep, liquid and transparent markets." Donaldson recently re-opened the debate on decimalization when he said that the impact of it should be studied.