SEC to Study Tick Size for Small Caps
Traders Magazine, May 2012
The Securities and Exchange Commission is preparing a review to see if raising the minimum trading increment for so-called "emerging growth companies" and other small-cap stocks could increase liquidity in these thinly traded names.
The review is mandated by the Schweikert Amendment, a component of the Jumpstart Our Business Startups Act. The bill was passed by Congress and signed by President Obama on April 5.
The broad goal of the JOBS Act is to increase job creation and economic growth by improving access to the public capital markets for what the bill defines as emerging growth companies-those with less than $1 billion in annual revenue.
The Schweikert Amendment, named after Congressman David Schweikert, R-Ariz., requires the SEC to study the effects of the transition from fraction trading to decimal trading, which occurred in 2001.That move, encouraged by Congress, cut the minimum trading increment from 6.25 cents to a penny.
The SEC study will include the effects on initial public offerings and liquidity for small-cap companies. The outcome may include a repudiation of decimalization, increasing the minimum trading increment, or tick, for emerging growth stocks. Any increase in the minimum tick would naturally widen spreads. That could cause traders to increase the size of their quotes, which would likely increase liquidity for the stock.
It is unclear if any SEC decision would affect existing small-cap stocks or just those EGCs that have yet to go public.
"Many of our problems with market liquidity in small and mid-caps can be traced back to decimalization," said Dennis Dick, prop trader at Bright Trading in Detroit. "Where decimalization has helped to reduce spreads in the large-cap space, it has actually harmed liquidity."
The SEC has 90 days after enactment of the JOBS Act to report to Congress on the impact of penny trading.
After the report is delivered to Congress, the SEC then has 180 days to increase the trading increment for emerging growth companies. That increase would be greater than 1 cent but less than 10 cents. But that could occur only if the agency finds that penny tick increments have hurt small-cap or emerging growth companies' access to capital.
On April 11, the SEC issued a notice requesting comment on the provisions listed under the JOBS Act, including the study to review minimum tick size and possible changes to the trading increment.
One source familiar with the SEC's thinking said that increasing spreads would change the direction of recent market reforms, such as decimalization and Reg NMS, both of which have led to tighter spreads and, presumably, better prices for investors. While the regulator is already busy with Dodd-Frank and the Volcker rule, the SEC will take the time to study the topic further, he added.
"I am sure that the SEC will carefully consider the results of its study of whether increased spreads would promote capital formation for smaller issuers before taking any regulatory action," the source said. "Conceivably, it could do a pilot program if the study suggests that such a step is warranted."