SEC launches ‘decimalization’ pilot

The US regulator wants to test increased tick sizes to see how decimal-based stock trading impacts small-cap IPOs.

The US Securities and Exchange Commission (SEC) ordered the national securities exchanges to develop a plan to implement a 12 month pilot program that will widen tick sizes for specified small-cap stocks.

A tick size is the minimum pricing increment that can be used to trade listed securities.

Back in 2001 the US stock markets adopted decimal pricing increments with the hope of reducing artificially wide spreads under the previous fractional pricing system. However, critics argue “decimalization” can make it more difficult for small and micro-cap companies to gain adequate liquidity, which in a downward cycle, means they do not capture the attention of research analysts who are often used by public-market investors to select stocks.

The Jumpstart Our Business Startups (JOBS) Act signed in April 2012 required the SEC to examine the issue and later report its findings to the government. Despite a formal study and series of roundtable discussions the SEC was left with few answers and needed to “test drive” a change in decimalization, according to one US securities lawyer.

“Such a pilot should facilitate studies of the effect of tick size on liquidity, execution quality for investors, volatility, market-maker profitability, competition, transparency and institutional ownership,” according to the SEC order.

The pilot will consist of a control group and three test groups. The test groups will have 300 stocks each and will include stocks of companies that have a market capitalization of below $5 billion, an average daily trading volume of one million shares and a share price of at least $2.

The first group will have a minimum five cent trading increment, with no exceptions. The second test group will allow certain exceptions to the five cent spread, such as mid-point trading (orders executed in the middle of the best bid offer). The third test group will have similar requirements as the second group but also be subject to a “trade at” rule, which could limit how much trading occurs inside brokerages.

The stocks in the control group will be quoted at the current tick size increment of 1 cent per share and trade at the increments currently permitted.