On June 24, 2014, the Securities and Exchange Commission (SEC) ordered national stock exchanges and the Financial Industry Regulatory Authority (FINRA) to craft a yearlong pilot program that requires specific stocks (“Pilot Securities”) to trade in five-cent increments rather than one-penny increments (the “Order”). The Order further directs FINRA and the exchanges to establish a control group and three test groups with specified variables, including one test group with a “trade at” requirement that would allow the SEC to specifically study dark pool trading activity. The Order represents a potentially significant shift for National Market System (NMS) common stocks, and firms should consider whether they will have to make any internal system changes for the Pilot Securities in each test group.
Since 2001, the SEC has sought to evaluate the impact of minimum pricing increments on market participants and the market. According to the SEC, previous studies have indicated that trading at penny increments is disadvantageous for small and midsize companies. Furthermore, Title I of the Jumpstart Our Business Startups Act (JOBS Act) obligates the SEC to study the effect of decimalization on smaller capitalization securities.
The SEC’s Requirements
The Order requires FINRA and the exchanges to collaborate in drafting a plan to implement a one-year pilot program that changes the tick size for small capitalization stocks, and to submit the draft by August 25, 2014. By mandating a minimum tick price of five cents, the pilot program aims to widen the bid-ask spread for lower priced stocks so that the SEC can assess the effect of tick sizes on “liquidity, execution quality for investors, volatility, market maker profitability, competition, transparency and institutional ownership.”
The Order also specifies how the pilot program should be designed. The pilot should be modeled as an experiment with four groups, each composed of 300 stocks. In order to study small and mid-cap companies, the Pilot Securities must satisfy the following requirements: the company must have a market capitalization below $5 billion; an average daily trading volume of one million shares or less; and a share price of $2 per share or more. According to the SEC, the pilot program also should be designed as follows:
The SEC’s Tick Size Pilot Plan has the potential to result in significant changes for trading in NMS common stocks. Firms should assess their internal systems now to determine whether they are positioned to trade the Pilot Securities as the Order mandates.
To read the full SEC order, click here:http://www.sec.gov/rules/other/2014/34-72460.pdf
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This article was originally published by Bingham McCutchen LLP.