Is decimalization to blame for the sharp decline in initial public offerings during the past decade? Are small-capitalization stocks suffering from investor neglect because brokerage houses can’t make money trading them? Would rescinding the rule changes to the minimum trading increment spark some life into these “zombie” stocks?
Congress is wondering if a rescission of these rules passed by exchanges in 2000 and 2001, which slashed the minimum trading increment to a penny, would goose trading in smaller stocks. That’s why, as part of the Jumpstart Our Business Startups Act, passed in April, Congress ordered the Securities and Exchange Commission to study the issue and consider increasing the minimum tick to some amount between 2 and 9 cents.
In July, the SEC reported to Congress there was insufficient evidence that decimalization had impaired liquidity in small-cap stocks to warrant a rollback of the tick rules. The issue needed more study, the SEC said. Any further investigation could include an industry roundtable as well as a pilot program, the regulator added.
As Traders Magazine was going to press, no roundtable had been scheduled. Nor was any pilot proposed. The regulator did broach the topic this summer at two meetings of an advisory committee it formed last year, as the JOBS Act was working its way through the system.
At the second of these meetings, held in San Francisco, Kathleen Hanley, a deputy director and deputy chief economist in the SEC’s Division of Risk, Strategy and Financial Innovation, told the committee the SEC was hoping any roundtable would provide the answers to three broad questions. First, would larger tick sizes lead to wider spreads? Second, if they did, would that lead to an increase in market-maker profitability? And, if so, would market makers use the extra profits to support newly public companies?
Those three questions boil the alleged problem down to its essence: Brokers aren’t pushing small-cap names because they can’t make money trading them. So, the solution is to increase the minimum trading increment so market makers can make money.
“If you can increase liquidity in a name, you will probably increase research coverage,” Patrick Fay, director of sales and trading at Williams Financial Group in Dallas and a veteran market maker, told Traders Magazine this summer. “They absolutely go hand in hand.”
There is no shortage of skepticism, however. Widening the spread means increasing the cost to the investor, which could work against more trading, some trading officials point out.
Also, in its report, the SEC noted the reduction in IPOs might not be solely attributable to decimalization. Other influences, such as the Sarbanes-Oxley Act in 2002 and the Global Analyst Research Settlement in 2003, may have contributed.
Others note that widening the minimum trading increment means returning a subsidy to Wall Street, which may not be politically feasible.
While many in the industry are excited by the prospect of SEC altering spreads, some are skeptical. “I wouldn’t hold my breath,” Ed Provost, chief business development officer at the Chicago Board Options Exchange, said at a recent industry conference.
