WILLIAMS & JENSEN, PLLC
Fr:
Rebecca Konst, Eric Robins, and Joel Oswald
Re:
SEC Roundtable on Decimalization
Dt:
February 5, 2013
Summary
On February 5, the Securities and Exchange Commission (SEC) held a roundtable on
decimalization to discuss “how to best study its effects on IPOs, trading, and liquidity for small and
middle capitalization companies, and what, if any, changes should be considered.”
Topics discussed during Panel I included, but were not limited to: (1) JOBS Act and IPO
Market; (2) Decimalization and IPO Market; (3) Trading Spreads and IPOs; (4) Maker-Taker
Pricing; (5) Different Tick Sizes; (6) Purpose of a Pilot Program; and (7) Size of a Small Capital
Firm.
Topics discussed during Panel II included, but were not limited to: (1) Decimalization and
IPOs; (2) Marketplace Pilot Program; (3) Issuers and Tick Size; (4) Parameters of a Pilot Program;
(5) Other Market Structure Issues; (6) Lessons Learned from Europe; and (7) Pilot Program
Alternatives.
Topics discussed during Panel III included, but were not limited to: (1) SEC and Tick Size
Information; (2) Identification of Market Failures; (3) Criteria for Displayed Liquidity; (4) Goals of
Pilot Program; (5) Types of Pilot Programs; (6) Parameters of Pilot Program; (7) Pilot Program
Costs; (8) Alternatives to Pilot Program; (9) Pilot Program Study Controls; and (10) Evading SEC
Pilot Programs.
SEC Commissioner and Staff Statements
Chairman Elisse Walter noted her regret from not being able to attend the roundtable in person as
she is currently overseas discussing OTC derivatives with her foreign regulator counterparties. She
stated that she is very interested in decimalization and is eager to hear about the discussions that take
place during the roundtable. She noted that promoting economic growth and consumer protection
are mandates of the SEC and she suggested that special concern should be taken for the needs of
small companies. Chairman Walter stated that many industry participants feel that the current
market structure and tick sizes do not recognize the needs of small companies. She stated that she is
interested in a discussion of a possible pilot program and how such a pilot might be formed. Given
the complex nature of the modern markets, she suggested that there be tests of changes in a
controlled fashion so the SEC can gather data to make an informed decision.
Commissioner Daniel Gallagher stated that he was “agnostic” about the issue, but he observed
that the interest in the roundtable is a great indication of how important the SEC views what might
appear to be small issues. He stated that given the agenda of the SEC with implementation of the
Dodd-Frank Act (DFA) and the Jumpstart Our Business Startups Act (JOBS Act) issues such as tick
size could be over-looked. However, he noted the importance of such issues, especially since
Congress mandated a study of the issue in the JOBS Act. He noted that the Advisory Committee
on Small and Emerging Companies made recommendations last week that the SEC move down the
Page 1 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
path to a pilot. He noted that since a change in tick size would impact capital formation the SEC
needs to consider it.
John Ramsay (Director, SEC Division of Trading and Markets) stated that he hopes this effort
is seen as a sign of how serious the SEC is taking this topic. He stated that he hopes this dialog will
help staff create a pilot program and that this pilot can then be used as a model for other market
structure changes.
James Burns (Deputy Director, SEC Division of Trading and Markets) noted that the
discussion will focus on whether the tick sizes can be increased for certain stocks to help market
operation. He noted that the roundtable participants will discuss whether a pilot program should be
implemented. The objective of such a pilot, he said, would be to establish an empirical basis of
whether any changes should be done on tick size in the future. Burns stated that this type of data
driven approach can provide a useful template for the SEC to consider how Commission might
approach other market structure issues. He noted that the SEC has undertaken a number of other
market structure initiatives including: limit up/limit down, market wide circuit breakers, erroneous
trades rules, large trader reporting, and consolidated audit trail (CAT), but he stated there is more to
do.
Craig Lewis (SEC Chief Economist) noted that the “genesis” of the study conducted by the
Division of Risk, Strategy, and Financial Innovation was in response to the Congressional mandate
in the JOBS Act to examine the impact of decimalization on IPOs and small-mid cap companies. He
explained that the study took a three pronged approach: (1) reviewed existing academic studies; (2)
met with the Advisory Committee on Small and Emerging Companies to discuss the impact of a
change in tick size on small companies; and (3) surveyed the markets. He explained that the report
was released in July 2012 and concluded that the impact of a mandated minimum tick size increase
on market structure or the willingness of companies to go public is uncertain. He stated that the
study recommended that the SEC not proceed with specific tick size rules but take additional steps
to consider whether changes should be made in the future.
Lewis stated that the literature review of academic studies on the impact of the change in decimal
pricing on market quality documented lower spreads after decimalization, smaller trade sizes,
decreased quoted depth, less volatility, and no apparent decrease in profits for market makers. He
claimed that the academic studies found that there was improved market quality for large capital
stocks but for small and mid-capitalization stocks the effect is minor. Lewis noted that members of
the Advisory Committee on Small and Emerging Companies commented that it is hard to
disentangle the impact of decimalization on small companies because of the implementation of
Sarbanes-Oxley and the advent of high frequency trading (HFT) and dark pools. He explained that
last week the Advisory Committee made recommendations to the SEC to increase the tick size for
small capitalization stocks and allow those companies choose their own tick size within a range.
Lewis stated that the SEC has considered other countries’ approaches of using different tick sizes
and has concluded that there may be viable alternatives to uniform tick size rules.
Panel I: Evaluating Concerns Relating to Tick Size for Small and Middle Capitalization
Companies
Brian B. Conroy — President at Fidelity Capital Markets
R. Cromwell Coulson — President, CEO, and Director at OTC Markets Group
Joshua L. Green — General Partner at Mohr Davidow Ventures
Page 2 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
Scott Kupor — Managing Partner and Chief Operating Officer at Andreessen Horowitz
Maureen O’Hara — Robert W. Purcell Professor of Finance at Johnson Graduate School of
Management, Cornell University
Jeffrey M. Solomon — CEO at Cowen and Company, Director at Cowen Group (statement)
David Weild — Senior Advisor at Grant Thornton LLP and Chairman & CEO at Weild & Co
(statement)
Kent Womack — Professor of Finance at Rotman School of Management, University of Toronto
Discussion
Womack noted that his career started in investment banking then he received his PhD at Cornell.
He noted that his research has been about the equity markets and IPOs, conflicts of interest and
research firms.
Weild, a former Vice President of NASDAQ, explained that Grant Thornton has written papers
which informed much of the JOBS Act. He stated that they have looked at the reduction in the
number of IPOs, particularly small company IPOs. He claimed that the order handling rules
adopted in 1997, Regulation ATS and then decimalization in 2001 all impacted IPOs. He noted that
his paper, “A Wakeup Call for America,” documented the decline in listed companies, a 44%
reduction since the peak in 1997. He said that reversing this trend is important because it impacts
jobs in the U.S.
Solomon stated that the United States has been the single greatest market for capital formation over
the past century. He stated that the market structure and regulatory framework in the U.S. have
enabled countless growth oriented companies to emerge as global market leaders by utilizing the
equity capital markets to fund their growth through access to capital. However, he explained that
over the past decade, due in part to difficult equity market structure, the IPO engine that has fueled
America’s global economic dominance has slowed tremendously. Solomon said it is not too late to
make regulatory changes to the equity markets to make them more conducive to the fundamental
long term investor. He recommended that the SEC initiate a pilot program that widens the
bid/offer spreads for smaller capitalization stocks to help foster a healthy trading eco-system that
benefits investors and creates reasonable economics necessary for investment firms to ensure that
Emerging Growth Companies (EGCs) find the necessary trading liquidity to return to the equity
capital markets.
O’Hara noted that she has conducted a lot of research on a wide range of issues in market
microstructure such as the effects of HFT and market fragmentation. She stated that lately she is
researching issues relating to liquidity of stocks, particularly those with low prices. O’Hara
explained that she is conducting research about the liquidity of IPOs, particularly once they enter the
market, and the roles of market makers.
Kupor stated that he will provide the view of a venture capital firm focused on investing in IT
companies.
Green stated that he began his career in Silicon Valley as a corporate and securities attorney. He
noted that his current firm was a strong supporter of the JOBS Act. He claimed that Title I of the
JOBS Act has been an effective “on-ramp” for companies accessing the public markets. He
suggested that the issue now is that “the public markets are the highway and they have potholes.”
Page 3 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
He stated that he is looking at how decimalization can be changed to help with capital formation for
small and mid-capital companies.
Coulson stated that OTC Markets serves a wide range of companies. He stated that in the search
for an efficient market regulators may have made the markets too “slippery” for investors. He stated
that regulators should focus on how to improve liquidity for small capitalization companies. He
noted an academic paper that found natural price clustering points. He stated that market changes
have made it so transactional providers are the biggest customers and pricing specialists are leaving
the markets. He stressed the need to incentivize those pricing specialists to reenter the market. He
expressed support for increasing increments, but also suggested that if that occurs, market makers
should display more.
Conroy explained that his firm is a provider of financial services focused on small investors and
retail investors. He noted that his firm does not provide research or investment banking services so
they have no financial “skin” in the game.
Question and Answer
JOBS Act and IPO Market
Lona Nallengara (Acting Director, SEC Division of Corporation Finance) asked about the
IPO market generally and what impact the JOBS Act has had on the IPO market. Solomon stated
that companies are taking advantage of the confidential filings provision because issuers are more
willing to “go down the path to” file confidentially. He noted that the confidential filing has helped
with concerns about disclosing company strategy. However, he claimed that it is hard to say
whether more companies are doing confidential filings than otherwise would have. He stressed that
it is still too early to measure the impact of the JOBS Act. He stated that the venture community is
still weighing how to generate liquidity, noting that they can run a dual track to try to sell or go to
the public market. He claimed that the JOBS Act in itself will not change market liquidity but it is a
step in the right direction. Weild claimed that 90% of companies that qualify as emerging growth
companies are filing as confidential filers. He claimed that the other provision that people are
excited about is the testing the waters provision. He stated that some firms will not go public
without seeing if a market is there. He stated that the JOBS Act will take time to take hold and other
provisions will take longer to play out.
Decimalization and IPO Market
Nallengara asked about the impact of decimalization on the IPO market and whether the impact of
decimalization can be separated from other market events. Kupor stated that of the issue is how to
create liquidity. He claimed that decimalization along with events like the Global Research
Settlement all impacted trading sizes, liquidity and therefore small capitalization stocks. He claimed
that decimalization has taken a lot of financial “lubricant” out of the market which reduced amounts
for research and then dried up investment in small cap stocks. Womack claimed that decimalization
is a part of the issue but misses the big picture, suggesting that the economics of capitalization may
have changed. He stated that as IPOs have collapsed private equity has taken off. He expressed
suspicion that some market participants are trying to make something happen that is not there
anymore. He claimed that five or so years leading up to decimalization the IPO markets were
declining. Green noted that mergers and acquisition (M&A) activity is a source of liquidity but there
is a delicate balance. He explained that the 2000 dot-com bubble and other events exaggerated the
effect on the IPO market and as a result the absence of a viable IPO avenue has had a significant
impact on the robustness of the M&A market. Conroy claimed that a variety of events contributed
Page 4 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
to the decline of the IPO market. He stated that decimalization has not impacted IPOs. He stated
that discussions for changing tick size center around research, yet firms could raise their
commissions to pay for research but they do not. He advocated against a pilot program which
would artificially inflate market prices to help market makers. O’Hara stated that decimalization
changed the picture for everyone. She stated that transaction costs are a lot lower now than they
ever were, but now she is hearing that traders would be better off with different tick sizes and
market makers would be better able to subsidize research. Solomon stated that regulators should be
trying to reduce transaction costs. He claimed that decimalization is only one part of the equation
and that it drove research coverage in the after-market. He stated that unless one can control
research in the after-market it is very hard to convince a company to go public. Coulson stated that
the regulatory process has been trying to make broker-dealers into agency dealers going to an order
book. He expressed support for bringing in “price setting” firms again to bring liquidity into the
system.
Weild pointed to a series of events leading up to decimalization including the Manning Rule in 1996,
the order handling rules in 1997, and Regulation ATS in 1998. He stated that these changes made
the market go from a quote driven market to an electronic driven market and resulted in a “massive”
realignment of capital. He claimed that the markets are still adjusting to the changes made in the
1990’s. Solomon stated that his firm does not cover many small cap companies because they
cannot get paid for coverage. He stated that if there were an opportunity to make liquidity in the
market at reasonable spreads then firms would cover those small cap companies. He noted that this
would take time which is why any pilot must be long enough to allow for such developments.
Conroy stated that many buy side firms grow in-house research staff rather than having to pay big
commissions to research firms. He stated that increasing tick size will increase transaction costs
with no advantage to investors.
Lewis stated that there are high costs to an issuer going public. He noted the rise of private equity
as a channel for raising capital. He asked about the shift from using public equity as a source of
capital versus private placement offerings. Kupor stated that he has seen both as sources of
secondary markets. He noted that companies are participating in late stage financings which had not
been seen. He noted that one important policy question this raises is whether there is a risk of a two
tiered market being created over time. Green claimed that the growth equity sector is a reasonably
small amount of the total available market in terms of capital. He stated that he does not see that
changing in the short term. Public markets by contrast, he stated, provide a far lower cost of capital
than growth equity and enable the fundamental issue of the promise of liquidity. He stated that the
SEC should encourage growth equity but it will not become anything close to the potential of the
public markets.
Trading Spreads and IPOs
Gregg Berman (Associate Director of the Office of Analytics and Research) asked why
existing wide spreads are not motivation enough to enter the market. Coulson stated that if the
market is not organized in increments there is no incentive to show size. He stated that prices
should not be at an artificial price point but should be at a real price based on price and trading
volume. O’Hara stated that it is true that there are stocks with wide spreads but many small stocks
trade with very small spreads. She referenced numbers from NASDAQ, noting that stocks that trade
less than $250,000 per day (211) have spreads less than a nickel. She stated that if spreads are
increased then transaction costs are increased. Coulson claimed that the 600 community banks on
Page 5 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
his platform have spreads which average 20 cents, so they are not incentivized to show spreads. He
stated that companies should be able to opt out of the pilot.
Maker-Taker Pricing
Solomon claimed that there are a number of issues other than decimals in the markets that
disadvantage retail investors. He suggested that the SEC consider other matters such as addressing
maker-taker rules that would level the playing field for the average investor and lead to “real” price
discovery. Weild stated that historically the largest accounts have cut their allocations of small cap
stocks while smaller investors have increased their allocation. He claimed that rule changes “gutted”
the economic incentives to distribute small cap stocks, the after-market has declined, and the
markets have concentrated in fewer institutional stocks. He stated that IPO sizes have gotten larger
but success rates have dropped over the past 15 years.
Solomon stated that it is more difficult for the buy side to outperform indexes. He claimed that
firms are not seeing returns above benchmarks to offset the costs of having active managers in small
capitalization stocks. He stated that a healthy IPO market provides asset managers with more
returns over time and widening tick sizes encourages fundamental price discovery rather than
electronic price discovery. He claimed that maker-taker should be “dialed back” because order
matching has no real price discovery function.
Different Tick Sizes
Commissioner Gallagher noted his fear that changing tick sizes would be addressing “a symptom
and not the illness.” He asked whether the order handling rules should be reconsidered. Weild
stated that discussion of a change in tick size began because it seems easy to implement. He stated
that he is a big believer that the Manning Rule was a good thing. He explained that larger price
increments which are more natural will be better for market operation, which he suggested would
create adequate economic incentives to more easily market small company stocks. Coulson stated
that it is about creating long-term equality in the market. He suggested that the person making the
offer should be the first in line to trade, and the taker should be the one with the choice of getting
the best price and where to go because that incentivizes best prices.
Purpose of a Pilot Program
Commissioner Gallagher asked whether the purpose of the pilot would be to promote more
research or to help liquidity. Womack stated that the main goal of the pilot would be to improve
liquidity, and he expressed skepticism that regulators can incentivize more research. Solomon
stated that small capitalization companies need to cultivate a personal relationship between
management teams and end buyers, and published research is the way to get “in the door.” Conroy
noted skepticism that decimalization is linked to the economics of research. Kupor claimed that
better trading liquidity and larger trading volumes would help the liquidity of small cap stocks and
would incentivize more companies to go public. Green claimed that “liquidity is the bottom line”
but research may help. He stated that a pilot should examine what tick sizes do to pricing, to
volume, and whether it encourages investors to trade. O’Hara stated that if the focus is on liquidity
then there is data to show that the transaction costs for trading small cap stocks has actually been
falling over time and has decreased at a faster rate than large cap stocks from 2008 to 2012.
Commissioner Gallagher urged the panelists to not assume the SEC will be conducting a pilot
program because there are many matters to consider. Weild suggested the SEC should just move
forward with a pilot and focus on small capitalization stocks. Coulson stated that the real value of a
Page 6 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
pilot would be getting investment banks to sponsor small cap companies and take them on road
shows.
Size of a Small Capital Firm
Berman asked what size is considered small capitalization. Solomon claimed that small cap is less
than $1billion, but he noted that this amount differs among industry sectors. Weild stated that
small cap is less than $2 billion. Coulson stated that small cap is less than $500 million because that
is when index funds start to own those stocks. Green claimed that $300 to $400 million is the
“logical floor for a micro-cap company to go public.”
Panel II: Evaluating Concerns Relating to Tick Size for the Securities Market Generally
Chris Concannon — Partner at Virtu Financial LLC
Kevin Cronin — Global Head of Equity Trading at Invesco
Frank M. Hatheway — Chief Economist at NASDAQ OMX Group Inc.
Patrick J. Healy — CEO at Issuer Advisory Group LLC
Chris Isaacson — Chief Operating Officer at BATS Global Markets (statement)
Paul Jiganti — Managing Director at TD Ameritrade
Maureen O’Hara — Robert W. Purcell Professor of Finance at Johnson Graduate School of
Management, Cornell University
Adam V. Reed — Julian Price Scholar in Finance and Associate Professor of Finance at KenanFlagler Business School, University of North Carolina
Healy, in a statement, was supportive of decimalization, though he noted that the costs of
decimalization are borne by smaller companies “which are essentially starved for research coverage.”
He suggested that “a minimum tick size would go a long way toward restoring those economics.”
He stated that “the single most important thing” that the SEC can do to improve market structure
“is to utilize the issuer community as an equal partner in setting the rules.” He added that he had
“serious reservations regarding the ability of the respective equity markets to handle an even more
complex agenda to include various tick size thresholds.” He recommended that “the SEC should
move forward with a wider spread pilot project of several hundred thinly traded stocks” that are
listed on either the NYSE or the Nasdaq.
Jiganti stated that making changes to market structure and tick size could harm the small investor.
In a statement, he expressed support for “an increment reform pilot program that focuses on
trading volume, price, volatility, and to a lesser extent, market capitalization.” He noted that “[a]
well-designed pilot program would be mandatory for all exchanges and market participants, and
include criteria for choosing issuers without the ability to opt-in or opt-out of the program.” The
pilot program should also “have a defined duration, the same market-wide rules and clear evaluation
methodology that do not bring it from pilot automatically to rule.”
Reed noted that his research focuses on trading, mutual funds, why companies would want to go
public, and short selling.
Isaacson noted an interest in reducing the costs to investors. He stated that decimalization impedes
capital raising abilities and a wider tick size will benefit small and medium capitalization companies.
He noted the role of BATS in helping Europe successfully adopt a new tick size regime. He claimed
that more narrow tick sizes may benefit highly liquid securities. He suggested a minimum tick size
Page 7 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
pilot program with a five cent minimum tick size, a one cent minimum trade increment, a half cent
minimum tick size for certain highly liquid securities, and address locked markets.
Hatheway stated that small stocks did not benefit from decimalization. He claimed that tick size is
only one element of market structure which should be reviewed by the SEC.
Concannon stated that decimalization delivered more profits to investors than any other market
structure change to date, but it failed in going to a one-size-fits-all environment for all types of stock
and that a customized market is needed.
Cronin stated that the SEC should look at maker-taker pricing, internalization, the proliferation of
order types and the prevalence of order cancellations.
Questions and Answers
Decimalization and IPOs
Burns asked about whether decimalization is the cause of IPO decline. Concannon noted his
support for a pilot program. He claimed that a number of things suggest that some action should be
taken and the SEC should also examine maker-taker pricing.
Marketplace Pilot
Berman asked why the market has not solved this issue for themselves. He asked what is
preventing the marketplace from creating their own pilot. Hatheway claimed that there is not
uniformity and that a voluntary approach or unilateral approach will not create the desired outcomes
because there are always opportunities for people to do something different. Concannon claimed
the challenge is with the competitive market structure, the exchanges and alternative markets will
compete with each other, which sometimes means the regulators need to step in to impose
requirements on all markets. Isaacson claimed that in Europe there was a “race to the bottom.” He
stated that the participants came together to agree on rational tick sizes. He suggested that
participants in the U.S. could come to an agreement on tick sizes for small capitalization companies
but he suggested that it would not be good for the industry if only one market venue changed tick
sizes. He stressed that tick size experiments in a fragmented market would not make sense. Healy
claimed that the issuer community would like the option to set tick sizes. He suggested that issuers
should be a part of the discussion on tick size. Reed claimed that there will always be an inherent
conflict of interest with choosing tick sizes because tick size will always benefit some market
participants over others. Cronin stated that unless and until there is a mandate of a specific level of
changes in economic incentives for all exchanges, it will be hard to get all exchanges to make the
same change. He noted that regulators should not lose sight that retail investors gain exposure from
institutional investors so success of a tick size change should not only be measured for retail
investors. Jiganti stated that retail investors must be present at the discussion table. He stated that
institutional investors have more tools available to achieve their desired position. He noted that if
the goal is liquidity then the pilot will look one way and if the goal is research it will look totally
different. Cronin stated that the pilot program should be all about increasing liquidity.
Issuers and Tick Size
Amy Edwards (Assistant Director, Office of Markets) stated that issuers can split their stock to
impact their tick size, so she asked why they do not use that control over their tick size. Healy
stated that small cap companies do not have the ability to “spilt” their stocks like larger capital
companies can. He suggested focusing on the dollar value traded. Hatheway stated that smaller
Page 8 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
firms are concerned about listing standards if their stock price is too low, which is a practical reason
why these companies do not want to split their stock
Berman acknowledged that the $20 stock price seems to have appeal, but he asked why a company
does not simply start with a lower stock price such as $2. Healy stated that a CEO of a small
company would not want to start at $2 because they want room in case the stock price goes down,
which could make it a penny stock. . Concannon claimed that Wall Street has a research issue
regardless of capitalization size. He stated that large banks have a hard time paying for research,
regardless of the size of issuer. . He claimed that the market has to solve research issue and playing
with the micro market structure to solve research will be too costly. He indicated that the issue is
about liquidity for stocks, and then whether it benefits retail and buy-side investors. .
Parameters of a Pilot
Burns asked whether there is a size of company that should be considered for the pilot and whether
an “opt-in” would work. Healy stated that there will not be a shortage of companies willing to optin to the pilot. He suggested that the companies in the pilot be listed on the NASDAQ or NYSE,
should be profitable, the opening bid should be a nickel, and there should be issuer choice. O’Hara
stated that in order to ascertain the real impacts of a change in tick size, the SEC will need to control
for all variables. She stated that academics do not like voluntary programs because it will skew the
result since it tends to attract a certain kind of company. She suggested that the initial pilot not allow
an opt-in, but potentially after the pilot is complete the SEC could allow the option for companies
to opt-in. Reed suggested a hybrid approach, allowing companies to opt-in to the pilot and then
hold a random draw to see who would actually participate so there was some randomization.
Jiganti agreed with Reed and stated that any participant in the pilot would have to be compared
against like companies in the market. Hatheway stated that there will not be trouble with
companies opting-in. Isaacson claimed that there should be some criteria to opt-in to the pilot. He
stated that the company should have a certain liquidity profile to opt-in then some randomization
about who is in the control group and who is in the pilot. Cronin stated that the pilot should be
incremental. Above all else, he stressed that the pilot should do no harm. He noted that for large
capitalization companies the market environment has never been better, although he suggested there
is still room for improvement. He suggested that the exchanges should have a voice on who is
allowed to participate in the pilot. Jiganti stated that a volatility component will be important to
consider, along with overall volume and other criteria. Additionally, he suggested that the SEC
should create a group similar to the roundtable participants to help aid the SEC in finding the “right
mix” of companies for the pilot. O’Hara stressed that when designing the pilot the control group
must be an actual control group. She stated that criteria such as trading volume could get
complicated because it is a factor in liquidity.
Other Market Structure Issues
Kathleen Hanley (Deputy Chief Economist) reminded the panelists that the Commission has
not made a decision to do a pilot program. She asked whether large cap stocks could also benefit
from a review of tick size. Concannon stated that challenges with liquidity are at the lower end of
the market, and urged keeping the pilot simple and targeted. He stated that if the pilot is
complicated with other market structure issues, there will not be a pilot. He stated that in terms of
market structure those lower capitalization stocks have been treated the same as large cap stocks,
and focusing on less liquid names will show results. Healy agreed that there are issues in larger
capital stocks that could be addressed, such as whether a one penny tick is appropriate at the larger
Page 9 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
end or whether there should be a move to a sub-penny tick. He stressed that this should be a
separate examination.
Shillman asked whether it is worthwhile to also examine the maker-taker issue. Concannon
questioned what issue is trying to be solved, liquidity or other issues.
He noted that decimalization has not been looked at in ten years but that examining other issues
would start “bumping” into Regulation NMS issues. Isaacson suggested a separate tick size pilot
for large cap stocks. Jiganti claimed that there are three different issues within liquidity: the lower
market capitalization end, sub-penny issues in highly-liquid stocks, and the “Apple or Google”
stocks. He stated that there are different sets of data associated with these issues which should not
to be confused with “spring cleaning issues.” He stated that his concern is that a retail investor who
sees a half tick spread may not have much confidence in the system. He suggested that this might
create more quote flickering. Hatheway stressed that a one-size-fits-all approach does not work.
He claimed that the market can manage different tick sizes. Additionally, he suggested that
regulators reconsider some of the other issues. Cronin stated that at best he is dubious of subpenny pricing. He stated that sub-penny pricing can result in an even bigger quote capacity problem,
and he noted that investors are already receiving benefits from sub-penny trading. Concannon
noted that changing the trade increment does impact order to trade ratios as well as volume, so it
will impact market data consumption and increase quote traffic. Healy stated that one concern of
issuers is that markets have become a “casino” and a move to sub-penny pricing would mean the
casino just got larger.
Lessons Learned from Europe
Burns asked for observations on lessons learned from Europe. Hatheway noted that there are
behavioral changes that occur when stocks move past a certain increment into the next but the price
based system was simplistic. Generally, he found the European experience instructive; however, he
stated that it is probably not a model the U.S. could use. Isaacson noted that Europe conducts a
periodic review to determine which are high liquidity stocks. He noted that any pilot needs to be
long enough because the market does not want stocks constantly moving in and out of increments.
He suggested that if quoting increments are changed then trading increments should be considered
as well. He expressed amazement at how much price improvement happens off-exchange. Cronin
stated that much of the internalization that takes place for price improvement is not material. He
stated that internalization is an issue, and questioned whether allowing internalization at the midpoint is good enough. He suggested that decimals, while important, should not be the only thing
looked at by regulators. Jiganti stated that $15 million in price improvement to his clients is
significant.
Pilot Alternatives
Daniel Gray (Senior Special Counsel) stated that there seem to be two separate approaches to a
pilot either the “spread leeway approach” or “clumping.” He asked what the prime metric for the
pilot should be to judge whether liquidity improved. Cronin stated that firms have good metrics for
measuring costs and trading. He stated the smallest portion of costs is commissions. He stated that
trading volatility is the number one determinant of trading costs, but also mentioned other costs
such as information leakage, and front running of orders. O’Hara stated that this question comes
back to what the goal of the pilot is. She stated that the metric for determining transaction costs and
effective spreads exist. However, she stated that the most interesting aspect of the study might not
be measured which is whether increasing tick size increases participation in the order book or
whether current participants simply increase their order volume.
Page 10 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
Panel III: Studying the Effects of Alternative Tick Sizes
Colin Clark — Senior Vice President at NYSE Euronext
Frank M. Hatheway — Chief Economist at NASDAQ OMX Group Inc.
Paul Jiganti — Managing Director at TD Ameritrade
Maureen McCarthy — Managing Director and Director of Sales and Trading at JMP Securities
Maureen O’Hara — Robert W. Purcell Professor of Finance at Johnson Graduate School of
Management, Cornell University
Adam V. Reed — Julian Price Scholar in Finance and Associate Professor of Finance at KenanFlagler Business School, University of North Carolina
Stephen Sachs — Head of Capital Markets at ProShare Advisors LLC
Kent Womack — Professor of Finance at Rotman School of Management, University of Toronto
Craig Lewis, Chief Economist and Director of RiskFin Division, stated that the SEC is trying
to solicit views on what the SEC could accomplish in a possible pilot. He noted that pilots
incorporate economic analysis as well as alternatives. He identified a number of issues in the first
panel to consider such as the role of capital formation and equity research and how market structure
issues impact this. He stated that the second panel focused on market microstructure issues and
how more liquid markets might support markets on equity research. He claimed that the SEC needs
to understand the objective of this pilot study. He suggested that the scope of the project is an issue
because of the need for control groups, as well as whether to have a voluntary program versus
establishing groups.
Hatheway suggested that Nasdaq will perform a lot of analysis on limit up/limit down rules. He
added that pilots are a great way for the SEC to get information from the marketplace.
Clark, in a statement, suggested that there are several ways to establish a pilot program. For an
effective pilot, he stated that “market participants will need enough time and incentives to adapt to
the new environment with the larger tick size.” He indicated that the time period should be longer
than one year and include a sufficient number of stocks included (300-500) in the pilot “so that
market makers will have an economic incentive to adapt their trading strategies and there is enough
data collected to analyze the costs and benefits.” As to data for the pilot, he stated that: (1) “public
information like the daily consolidated tape data (TAQ) would be useful” but that each exchange
“could provide additional data to researchers, such as order-level data (including non-displayed
orders) and trader identifiers”; and (2) “behaviors to be examined could include changes in displayed
depth at the NBBO, cumulative depth, trade size, trader participation (increase in liquidity provision,
time/size at NBBO), dollar volume traded, off-exchange activity, fragmentation, volatility and
quotes/orders/cancels.” Overall, NYSE Euronext believes “a market-wide pilot program with
larger tick increments in less liquid securities would be a worthwhile experiment” and it “would
provide the Commission with data that can be utilized in a cost-benefit analysis to determine
whether or not to make the pilot permanent.”
Discussion
SEC and Tick Size Information
Lewis asked what information would better allow the SEC to understand tick sizes. He asked what
other information the SEC should seek and whether there are gaps in academic research that the
pilot could fill. O’Hara replied that there are huge gaps in the studies and they are now dated. She
stated that there were many great studies done but these were completed prior to high frequency
Page 11 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
trading. She stated that there are an interesting set of questions as to the liquidity provisions in the
markets and that most of the research requires data that she cannot access unless markets are able to
support them. Should there not be a pilot, she suggested that the SEC encourage organizations such
as NYSE and Nasdaq to supply the necessary data for others to do an analysis. Reed expressed
support for a pilot. Clark cited a research paper from France on tick sizes and stock trading that
might serve as a resource.
Identification of Market Failures
Lewis asked participants to identify the market failures a pilot study should look at. Sachs
identified displayed liquidity at the top of the list of failures to consider. Hatheway listed costs and
availability of capital, liquidity involved with getting a trade through a market, lack of coordination
and uniformity in trading, and insufficient revenue in bringing small companies to market.
Criteria for Displayed Liquidity
SEC staff inquired about displayed liquidity and whether there should be different criteria, to which
Sachs replied that there should not be different criteria due to hurdles involved and possible
psychological changes in the market. Clark suggested that higher tick sizes do not mean higher
spreads. He suggested that spread and liquidity are at the core of this. Hatheway stated that
transaction cost analysis is volume weighted. If a pilot makes it less attractive to do a transaction, he
stated that stocks will leave the pilot. O’Hara stated that in any study, there are winners and losers.
She suggested that if the tick sizes increase on exchanges, then any stock might be incentivized to
trade off exchanges. This, she suggested, would then require a lot more data, including an increased
look at the amount of liquidity on the book.
Goals of Pilot
Edwards asked about the goals of the pilot program, to which Jiganti stated that the first goal
should be to “do no harm”. He added that it is hard to increase spreads without any additional
harm. From a design perspective, Sachs stated that he would want to see a large sense of balance
and ultimately see something realistic.
Types of Pilot
Gray asked about a pilot that widens the spread. He asked whether this would make the market
better and about market metrics. McCarthy suggested having a pilot where there is a group that is
in the pilot and one that is not so as to compare things before and after the pilot. She also suggested
looking at dollar volume traded, volume traded, whether market makers are accepting their
obligations, and indications of interest (IOIs). Hatheway stated that changes can be quite slow and
that one or two years will not be long enough for a pilot. He suggested that there was a need to
look at the holdings of shares of stock. Womack questioned what transaction costs would be
imposed on investors over three to five years to find out that there is no benefit to the pilot. He
suggested that this is an important question that this panel can opine on. Hatheway claimed that if
this pilot is undertaken, the SEC or firms can just “pull the plug” and change their minds. O’Hara
called for looking at time-weighted orders on the book. According to her, there are a variety of
measures to look at, which include looking at coordination in markets such as whether stocks with
higher tick sizes have higher trading volumes. Clark pointed to the issue of time involved when
executing a large order in a smaller cap name. With increased liquidity, he suggested that this may
ease these types of transactions. He stated that it was important to look at transaction costs of a
market with more depth. Sachs claimed that it was important to look at the length of time of a
Page 12 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
trade or its duration. Reed suggested the need to look at the information environment for which
trades are operating, which he noted should be matched carefully to news and coverage.
Parameters of Pilot
Edwards asked how securities should be selected for this pilot, the length of the pilot, what the tick
sizes would be in the pilot, and the type of data that would be needed. Clark stated that there was a
need to have sufficient time and a sufficient amount of securities to motivate behavior. He
suggested that the pilot last for at least a year and include 300 to 500 stocks. McCarthy agreed with
Clark, adding that this set of stocks be paired with a non-group of 500 stocks (a control group). She
suggested that some behavior may not change in a temporary pilot since it takes time to change
behavior. She added that this is also an issue for liquidity providers and capital commitments.
Womack called for the length of the pilot to be two to four years. O’Hara stated that it will take
quite a while before anything happens. She noted that 500 stocks are a lot but that there will be a
need to control for a lot of things such as market capitalization and a need to recognize that stocks
trade at different price levels. Unless this pilot is for at least a year, she suggested that the costs
would be too high.
Lewis expressed concern about the possible complications of a market study on a tick test while
there are other studies taking place in this space. Because of the finite amount of available securities
and that these same securities could be involved in other pilots, he claimed there could be crosscontamination. Jiganti stated that two cent increments and five cent increments make sense for
including in a pilot program to examine the impact of different price points. He noted that a year is
not long enough for a pilot, adding that while liquidity providers will jump in early, it will take time
for researchers to come in. He advocated for a pilot with a minimum of two years. Reed claimed
that the opt-in issue raises more concerns. He suggested that there was a need for firms to come
into the market as high and low issuers. Hatheway stated that there should not be just one tick
level, but multiple tick levels. He also called for looking at larger cap stocks. Womack suggested
that investors might take issue with the size of tick tests.
Edwards asked whether the tick test pilot should occur similar to that of Reg SHO or whether
exchanges should undertake this effort on their own as was done for Reg NMS. Hatheway stated
that SRO plans are “becoming popular” and that a plan by the SROs may be good to do in this case.
He added that exchanges have been working with each other on limit-up/limit-down and other
issues where agreement can be difficult, so he expressed optimism that the SROs could come to
agreement on a decimal pilot plan.
Heather Seidel, Associate Director in Division of Trading and Markets, asked if there is any
belief that any securities could come out of a pilot, and what the parameters and standards in place
would need to be for this. After a statistical period of time, McCarthy stated that companies should
be able to opt-out. Sachs stated that if one can move stocks out of a pilot program, there should be
as few variables as possible. Jiganti stated that a major event should provide for an opt-out, but he
also noted that there is a need for a defined end to the program and that this would be a time when
securities could be out of the pilot. Reed stated that an opt-in and opt-out would be similar from a
pure research point. He emphasized the need to be careful about this as research could be impacted
by this.
Pilot Costs
Page 13 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
Hanley asked what would be the costs of the pilot. Hatheway claimed that since this was not a
particularly costly innovation and that they were already undertaking this in Europe, the costs would
not be high. He suggested that related costs would be borne by firms in the pilot. Jiganti suggested
that his firm could make the necessary changes. He noted that every time there is change there are
costs, he emphasized that there would be more educational costs than operating costs. Sachs
suggested that there would be minimal costs, mostly attributable to transactions and reporting.
Hanley then asked whether there might be other costs or unintended consequences, to which
Hatheway noted that quoting algorithms were expensive to code and one loses liquidity providers if
they opt out.
Alternatives to Pilot
In inquiring about the potentials for a non-pilot, SEC staff asked if it was better for companies to
choose their own tick size and not pursue a pilot program. McCarthy claimed that this may be too
nuanced a request. She suggested that it would be better to tell companies whether they are in or
out. Hatheway claimed that there is not a lot of information for firms to make a decision, and that
issuer choice might evolve into firms following other firms without regard to any other criteria.
Clark suggested that issuer choice already exists and issuers can widen their stock price. He
suggested that there was a need to better educate issuers on this.
Nallengara asked what other alternatives or market incentives should be considered beyond a pilot.
Clark stated that there are a lot of issues in the market, and that this is not a miracle cure for small
cap liquidity challenges. He stated that there still needs to be a review of market structure issues.
He noted that the NYSE was working on an ETF program where the issuer is providing payments
to the market maker. Sachs commented that it depends upon what the SEC looks to do. He
suggested that if the SEC was looking at liquidity, then there is a fairly long list of things to do.
Womack cited Jay Ritter’s recent paper on the IPO market (“Re-energizing the IPO Market”) and
advocated for reducing the overall cost of going public. Reed, also citing Ritter’s paper, emphasized
the cost of research being paid by the issuing firms.
Pilot Study Controls
SEC Staff asked if there are things as to market structure that the SEC needs to look at such as
linkages to off-exchange trading that needs to be controlled. Jiganti suggested that if this turns into
a market structure change, then it is a different pilot. Sachs argued for the need to control for all
those factors, but that still allows large orders to cross in a dark pool. Hatheway stated that if a
wider displayed quote provides an idea where the quote is, this is a good outcome. However, he
emphasized that a lot depends on the other attributes. McCarthy stated that trading should be
allowed at a midpoint. She noted that “opening cross” would be critical and dark pools would then
be able to compete. Clark suggested that if the study is to look at changes in tick sizes, there should
be a control group focusing on those changes. He added that there should be a look at tick size
change plus a subgroup of other variables.
Evading SEC Pilot Programs
Lewis asked if once the rules were put in place for a pilot, whether market makers and investors
could reverse engineer around this. He asked where order flow will go and whether transactions will
still be in the lit markets. Hatheway suggested that if SEC gets a goal, then it gets done. He
claimed that people would reverse engineer and that there would be a change in dynamics as to offexchange trading. He noted that high frequency trading was generally not active in these securities
so this would not be a concern. He suggested that the pilot needs to look at the attractiveness for
Page 14 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249
public equity as this impacts capital formation. He added that seeing more displayed information
available in the market would be beneficial too.
Page 15 of 15
701 8th Street, N. W., Suite 500 ● Washington, DC 20001 ● TELEPHONE 202.659.8201 ● FACSIMILE 202.659.5249