National securities exchanges and the Financial Industry Regulatory Authority plan to experiment with tick size alternatives, allow some stocks to trade in five-cent increments, and see whether that trading structure increases their liquidity and should be made permanent.
The proposal, announced by the Securities and Exchange Commission on Tuesday, will create a 12-month pilot program for widening minimum quoting and trading increments for a sampling of companies with market cap of $5 billion or less. The SEC plans to use the results of the pilot program to assess whether the changes benefit of investors and issuers.
The SEC ended the practice of trading stocks in fractional dollar values (down to one-sixteenth of a dollar) in the 2000s, in favor of trading in one-cent increments. Critics of that move say it actually reduced the liquidity of certain types of stocks—particularly small-capitalization companies—because it squeezed out the profit for traders to the point where they no longer bothered. In June, SEC commissioners ordered the exchanges and FINRA to develop a tick size pilot program. Now that the plan is filed, it will undergo a 21-day public comment period that precedes Commission approval.
The pilot program will include stocks with a market capitalization of $5 billion or less; an average daily trading volume of one million shares or less; and a closing share price of at least $2 per share. It will consist of one control group and three test groups with 400 securities in each group. Pilot securities in the control group will be quoted at the current tick size increment of $0.01 per share, and trade at the increments currently permitted.
Securities in the first test group will be quoted in $0.05 minimum increments and trading would continue to occur at any price increment that is permitted today. Securities in the second test group will be quoted in $0.05 minimum increments, and traded in $0.05 minimum increments subject to certain exceptions. Securities in the third test group will be subject to the same minimum quoting and trading increments (and the same exceptions) as the second test group, but in addition would be subject to a “trade-at” requirement that prevents price matching by a trading center that is not displaying the best bid or offer.
The new tick plan is partly driven by the JOBS Act. Section 106 of the law directed the SEC to conduct a study on the effect of decimalization in stock prices, and with an eye on the question of whether one-cent increments dried up liquidity for smaller companies and curbed enthusiasm for initial public offerings. The report ultimately found that many countries allow a variety of tick sizes for smaller companies, along with academic research suggesting decimalization squeezed smaller companies' trading appeal.
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