The U.S. Securities and Exchange Commission’s staff is poised to recommend a pilot program to test whether larger trading increments promote more active trading of small stocks.
A pilot program would increase the ‘‘tick size,’’ or minimum increment for quoting shares, for smaller public companies. A 2012 law, the Jumpstart Our Business Startups Act, required the SEC to examine the impact that penny increments had on the liquidity of shares issued by small- and medium-size companies.
“There seems to be a lot of support for a pilot program and we think that makes sense,” John Ramsay, the SEC’s acting director of trading and markets, said in an interview. “We’re still working through the details of how it should be structured.”
In theory, wider tick sizes would increase the spread between bid and offer prices, boosting profits for market makers. Higher profits may revive interest in funding analyst research on small stocks, generating greater interest in the stocks, supporters of the idea say.
Proponents say widening minimum tick sizes would help boost the number of small companies going public, while skeptics complain it will cause people to pay more when they trade.
James J. Angel, a finance professor at Georgetown University, said a well-designed pilot program should last at least five years in order to provide meaningful data about the impact of varying tick sizes. Companies should be allowed to pick their own tick size because they have “the incentive to get it right,” Angel said.
“It will take a long time to see the longer-term impact on analyst coverage, visibility in the media, and on valuation,” said Angel, who has published research papers on optimal tick size.
R. Cromwell Coulson, chief executive officer of OTC Markets Group Inc., said the pilot should also require market makers to show a minimum quote size to ensure the depth and liquidity of the market improves. The Financial Industry Regulatory Authority, the brokerage industry’s self-regulator, began a similar a pilot last year for over-the-counter equities. The program increased the minimum number of shares that must be bid or offered depending on the security’s price. A security offered for 51 cents, for instance, would require a minimum quote size of 1,000 shares.
“It would be great for the investor experience because they would see more liquidity on their screens and there would be a higher willingness to trade,” Coulson said in a phone interview.
U.S. exchanges began quoting stocks in pennies in 2001, after over 200 years pricing equities in fractions. The move to penny increments benefited professional traders willing to pay a penny more to jump in front of a competing bid, Angel said.