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August 1, 2012

Bill Proposed to Support Small Caps

By Peter Chapman

A Republican congressman plans to introduce a bill that would encourage stock exchanges to develop programs that permit their listed companies to pay market makers to support their stocks. The bill would also void rules of the Financial Industry Regulatory Authority that bar the payments.

The goal of the bill, sponsored by Rep. Patrick McHenry, R-N.C., and titled "Liquidity Enhancement for Small Public Companies Act," is to improve liquidity in small-cap stocks. It mirrors recent proposals by exchanges operated by Nasdaq OMX Group and NYSE Euronext.

"My thought process here is to incent small companies to seek our exchanges, to seek the public markets," McHenry said during a House Financial Services Committee hearing recently. "So the idea is that you have some liquidity support." 

Rep. Patrick McHenry(R-N.C.)

Specifically, the congressman's bill would "promote the development of market quality incentive programs on registered national securities exchanges in the United States and would prevent a national securities association registered under Section 15A from barring a market maker's participation in such a program," according to a summary of the bill. FINRA is a "national securities association."

McHenry has written his bill in draft form and is expected to formally propose it in the "near future," according to a spokesperson.

The congressman is best known on Wall Street as the architect of the "crowdfunding" section of the recently enacted "Jumpstart Our Business Startups," or JOBS, Act. Crowdfunding will let small businesses raise capital outside the securities industry by aggregating small investments from multiple investors.

McHenry distributed details of his 'liquidity enhancement' bill last week to members of the Financial Services Committee, as well as industry executives. The reception from exchanges and market makers was positive.

"In Europe, this is the rule, not the exception," NYSE Euronext chief executive officer Duncan Niederauer, told McHenry during the congressional hearing last week. "We hope your legislation will allow us to revisit old rules that don't allow companies to pay for market making."

McHenry's bill could put pressure on the Securities and Exchange Commission to approve the proposals by Nasdaq and NYSE Arca, which look to permit issuers of smaller, less liquid exchange traded products to pay market makers to support their securities.

The practice is currently illegal and the two proposals are getting some pushback from industry players and the American public. FINRA banned payments by issuers to market makers in 1997, because of concerns of manipulation.

The current Nasdaq and NYSE Arca proposals attempt to avoid those concerns by focusing on ETPs, which are generally index-based products. Because they represent multiple securities, their prices would be harder to manipulate, the exchanges contend.

Response to the exchange proposals has been mixed. Knight Capital Group supports the Nasdaq proposal as do a few academics. The Investment Company Institute, which represents ETP issuers, likes the idea, but wants it to be tested in a pilot program.

Other commenters told the SEC it was a bad idea. Even one of the ETP issuers has its doubts. Despite disclosures Nasdaq intends to make regarding the identities of the market makers and the payments they receive, Gus Sauter, Vanguard's chief investment officer told the SEC:

"It is not clear whether these safeguards will be sufficient to overcome the presumption...that issuer payments to market makers have the potential to distort the market and create conflicts of interests that corrupt the 'integrity of the marketplace.'"

(c) 2012 Traders Magazine and SourceMedia, Inc. All Rights Reserved.