Certain Small and Mid-Cap Stocks Saw Their Tick Sizes Increase in SEC Experiment

small-capsSome small companies saw share tick sizes increase from one-cent increments to five-cent increments on the 3rd of September, which marks the first such change since the US stock market adopted a decimal-based system about 15 years ago.

This shift to 5-cent increments is one stage in an experiment that’s being conducted to determine whether larger tick sizes will positively impact trading levels of small-cap stocks, despite the fact that the move could lead to investors seeing an increase in trading costs.

This initiative, dubbed the Tick Size Pilot Program, started on Monday, the 3rd of September and was applied to 10 stocks, with the program to be rolled out to another 1,200 companies by the end of October. The Securities and Exchange Commission has been working on the program since 2014, sparked by lawmakers who posed the issue of whether wider tick sizes for small-company shares could garner more interest and lead to more and better initial public offerings and a boost in the economy.

Decimalization of the stock market took place in 2001, an event imposed by the SEC that forced stock exchanges to trade stocks at penny tick sizes instead of dollar fractions, which was usually an eighth or a sixteenth. And this initiative is the first time tick sizes have been changed since then.

The decimalization of the stock market was considered a good move for investors because it reduced the profits market makers could make. Market makers are middle-men that commit to selling or purchasing shares throughout the day. Their main profits come from the wide spreads between the bid and offer, namely from the difference between the selling and buying price of a share. Thanks to decimalization, the differences narrowed, meaning lower profits.

Now, though, some say that the move hurt small-cap companies because they weren’t attractive enough for market makers to trade in their shares.

When trading shares from larger organizations with high trading volumes, market makers can still make a profit, despite the narrower spread, because of the frequency with which the shares are traded. Smaller companies, however, tend to have really low trading volumes.

Various investment banks as well as some former officials from the stock exchanged lobbied for the experiment because they felt it necessary for there to be more incentives for small stocks to be traded.

Those who support the program claim that making small-cap shares trade at five-cent increments will make it easier for investment banks to make a profit and therefore make markets in small-cap stocks. This will natural lead to further research into small companies that will result in higher levels of interest in these types of stocks because many investors follow market makers in terms of news and recommendations. More exposure for small-cap stocks could lead to higher trading volumes. The overall objective is to increase liquidity as well as to generate the possibility of placing orders without the price moving.

International Speedway, a promoter of auto races, and Bank Rate, a publisher of personal finance content based in New York, are among the first group of 10 companies whose tick sizes were modified.

Lionel McBee, spokesperson for the Houston-based Erin Energy, an oil firm which is also part of the pilot, stated that he was excited to see how things proceeded and he felt that it could represent a significant help for small-cap shares in terms of liquidity. He hopes that in the end it will help with share issuance problems such as the non-existent coverage by analysts.

Detractors, on the other hand, say too much is being expected of the experiment, partially because the spreads between sales and buy prices are already higher than a nickel. According to a report issued by Convergex, a brokerage firm, approximately 61% of the stocks that are eligible for this program are already trading at spreads varying from $0.05 to $1.

Others say that a large number of today’s market-makers are no longer investment banks or brokers with equity analysts but e-trading companies that don’t post their research anyway.

In any case, experts still believe the program could assist in the creation of stickier offer and bid prices that tend to hang around $0.05 multiples instead of jerking up and down in 1-cent shifts that are very frequent.

Frank Hatheway, NASDAQ’s chief economist, stated that he expects to see the shares moving to $0.05 increments exhibit a lower degree of price volatility and increased depth in their quotes.

Larger tick sizes could also reduce the likelihood of traders getting pennied, which is the situation in which a trader places an order to buy but a faster trader has already placed a buy order for the same shares but for an additional cent. If the order of the faster trader is fulfilled, they can turn around and sell the stock to the trader that was slower at the increased price.

Larry Tabb, a consultant and an expert on the structure of the equity market, explained that it’s aggravating for a trader to place a limit order at $10 and to have someone automatically get their order fulfilled ahead of them because their order was for $10.01.

The Jumpstart Our Business Startups Act from 2012 forced the Securities and Exchange Commission to analyze how trading in 1-cent increments affects small and medium size companies. In 2014, the SEC demanded that stock exchanges come up with rules for this pilot program. The regulator gave their stamp approval to these rules last year.

The approximately 1,200 companies chosen to participate in the pilot are listed either on the NASDAQ, the NYSE MKT – an exchange specializing in small and medium-cap shares run by NYSE – or the New York Stock Exchange. These share issuers were divided randomly into three different groups comprised of approximately 400 members each. The rules are slightly different for each group, going from the most relaxed conditions to the strictest.

The first group will have their price quotes shown in $0.05 increments but market makers can still trade at penny increments.

The second group will both show and execute trades at 5-cent increments, except for a few situations. Midpoint executions will be exempt. These are trades that are made at the half-point between the best offer and best bid. Retail investors will also be exempt from this situation.

The third group will follow the same rules as the previous group, but with certain exceptions it will also be subjected to a “trade-at” rule. This means that trades will have to be executed on orders shown on-exchange instead of being directed to dark pools or executed on hidden orders.

In the meantime, there will also be a ground zero group – i.e. the control group – which will trade as usual and against which the other groups will be compared. It’s the equivalent of a placebo in a drug trial and the goal is to determine how the larger tick size will affect the companies in the program versus the ones to which the various special conditions are applied.

The tick-size program will be conducted over a span of two years, with a prelim results report to be issued in April 2018.


Donna Crepeau covers the Semiconductors and Computer Chip industry. She joined Micro Cap Mag in late 2014 and previously was a hardware analyst with William Blair Research.

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