SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies

The SEC approved a proposal by FINRA and the national securities exchanges (the “Exchanges”) for a two-year pilot program. The program would widen the minimum quoting and trading increments – or tick sizes – for the stocks of certain smaller companies.

The SEC stated that it plans to use the pilot program to assess whether wider tick sizes enhance the market quality of those stocks to the benefit of issuers and investors.

The pilot program will begin on May 6, 2016. It will include the stocks of companies with (i) $3 billion or less in market capitalization, (ii) an average daily trading volume of one million shares or less, and (iii) a volume weighted average price of at least $2.00 for every trading day.

The pilot program will involve a control group of approximately 1400 securities and three test groups with 400 securities in each selected by a stratified sampling. During the program:

  • pilot securities in the control group will be quoted at the current tick size increment of $0.01 per share and will trade at the currently permitted increments;
  • pilot securities in the first test group will be quoted in $0.05 minimum increments but will continue to trade at any price increment that is currently permitted;
  • pilot securities in the second test group will be quoted in $0.05 minimum increments and will trade at $0.05 minimum increments subject to a midpoint exception, a retail investor exception and a negotiated trade exception; and
  • pilot securities in the third test group will be subject to the same terms as the second test group and also will be subject to the “trade-at” requirement to prevent price matching by a person who is not displaying orders at the price of a trading center’s best “protected” bid or offer, unless an enumerated exception applies.

In addition to the exceptions provided under the second test group, an exception for block size orders and exceptions that mirror those under Rule 611 (“Order Protection Rule”) of Regulation NMS will apply.

The SEC explained that the Exchanges and FINRA will submit their initial assessments of the tick size pilot program’s impact 18 months after the program begins based on data generated during the first 12 months of its operation.

Lofchie Comment: It seems far-fetched to assume that widening tick sizes in small cap securities will result indirectly in an increase in the number of small cap companies that choose to go public. The notion hinges on the theory that if tick sizes increase, then market makers will make more money trading small caps, which will encourage underwriters to take small caps public, which will lead to small caps going public. The problem is that market makers are not the same as underwriters. Even if they are in the same legal entity, they are different profit centers, and there is no reason to believe that underwriters will take a company public because they hope that their firm will make money as a market maker in the issuer’s stock. Ultimately, the decision to go public is made by the issuer and not the underwriter. Despite being able to find an underwriter, many attractive issuers do not go public because the cost of doing so is greater than the amount of money they’re able to raise privately.

If the SEC wishes to create incentives for small companies to go public, then it should (i) reduce the regulatory burdens associated with going public and (ii) create a system in which broker-dealers that do research on small companies have the means to profit from the production of that research. This would encourage the production of information about small companies.

See: SEC Approval Order.