The Securities and Exchange Commission plans to hold a roundtable to discuss the possibility of increasing the minimum trading increment for certain stocks. The roundtable could lead to a pilot program whereby some small- and mid-cap stocks trade in increments greater than a penny.
“We are trying to decide whether or not to have a pilot study and, if so, how that pilot should be conducted,” said Kathleen Hanley, deputy director and deputy chief economist for the SEC’s Division of Risk, Strategy, and Financial Innovation, at a special agency meeting in San Francisco on Sept. 7. “So we are convening a roundtable sometime in the next few months.”
Hanley was speaking at a meeting of the SEC’s Advisory Committee on Small and Emerging Companies, held to discuss market-structure and disclosure rules for small companies.
The meeting of the committee was its second since Congress passed the Jumpstart Our Business Act. The JOBS Act was passed by Congress earlier this year with the goal of increasing jobs by making it easier for small “emerging growth companies” to go public.
The concern is that the IPO market is not functioning properly, making it difficult for companies to go public. That, in turn, is hampering job creation at a time of relatively high unemployment.
Under the JOBS Act, the SEC was required to study the effect of decimalization, or the switch to penny ticks, on capital formation. Congress is concerned that the smaller tick size has led to smaller spreads, which has reduced broker-dealer profits. That, in turn, has hurt aftermarket support for newly public companies.
As part of the congressional mandate, the SEC was to consider increasing the minimum tick size from 1 cent to between 2 and 9 cents.
The regulator completed the study in July and concluded that there was not enough evidence to justify any sort of rollback of decimalization in the near term. Still, the SEC noted that further study was warranted, including a roundtable that would include investors, companies, market professionals and academics. It indicated a pilot program with bigger ticks might prove useful.
The switch from trading in increments of a sixteenth to a penny was made in 2000 and 2001. Quoted spreads declined with the changeover.
Since then, the number of IPOs has fallen sharply, averaging 99 per year, according to data provided by Jay Ritter, a finance professor at the University of Florida. That’s down from an average 311 per year during the 1980s and 1990s, Ritter told the advisory committee on Sept. 7.
Hanley told the committee the SEC was hoping the 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?
In its report, the SEC noted that the decline 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.
Ritter told attendees that the decline in IPOs had little to do with regulatory changes. His research indicates that companies choose to be acquired rather than try to grow by themselves as a public company.
The vast majority of small-growth companies seeking capital are acquired in a “trade sale” these days, according to Ritter. That’s natural because of structural changes in the U.S. economy that pressure companies to bring their products to market sooner rather than later.
“Getting big fast is important,” Ritter said. “Merging is the way to do so.”
Others see it differently. David Weild, chairman and chief executive of consultancy Capital Markets Advisory Partners, and a key proponent of “fixing” the IPO market, argued that mergers were entered into only reluctantly.
Venture capitalists “don’t trust the IPO market,” Weild said, “so they build the companies for sale.” Companies’ chief executive officers and chief financial officers also distrust the stock market, Weild added, fearing that the lack of aftermarket support will turn them into “zombie stocks.”
Whatever the case, at least one representative of the trading community believes a pilot is the way to go. “You can’t alter decimalization without conducting some sort of pilot program,” Jim Toes, president and chief executive of the Security Traders Association, told Traders Magazine. “We have no idea whether or not greater ticks for quoting and trading make sense. You need information.”
The STA’s position, Toes emphasizes, is that the marketplace is not “broken,” as many believe. But any change in the minimum increment might be an improvement.
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