Tuesday, July 24, 2012

SEC Staff Publishes JOBS Act Decimals Study

The SEC staff published a report in response to a JOBS Act requirement that the SEC must study the effects of the transition from fractional trading to penny trading for securities, including the effect of the transition on initial public offerings. The statute required the Commission to study the impact that this change has had on liquidity for small and middle capitalization company securities and whether there was sufficient economic incentive to support trading operations in these securities in penny increments. The statute provided that if the SEC determined that the securities of emerging growth companies should be quoted and traded using a minimum increment of greater than $0.01, the Commission could designate a minimum increment for the securities of emerging growth companies that is greater than $0.01 but less than $0.10 for use in all quoting and trading of securities in any exchange or other execution venue.

In its report, the staff concluded that the Commission should not proceed with specific rulemaking to increase tick size but should consider additional steps that may be needed to determine whether rulemaking should be undertaken in the future. According to the staff, the SEC should solicit the views of investors, companies, market professionals, academics, and other interested parties on the broad topic of decimalization, 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. According to the staff, there are several ways for the Commission to gather additional views and data, such as a roundtable with opportunity for public comment. Participants could examine (1) the economic consequences that might accompany alternative methods for analysis, (2) the types of data that should be collected and used to assess the effects of an increase in or variation of tick size for companies of different capitalizations, including how best to gather the data, and (3) whether other policy alternatives might better address congressional concerns.

In its study, the staff undertook a three-pronged approach, including (a) a review of empirical studies regarding tick size and decimalization, (b) participation in, and a review of the materials prepared in connection with, discussions concerning the impact of market structure on small and middle capitalization companies and on IPOs held as part of a meeting of the SEC Advisory Committee on Small and Emerging Companies, and (c) a survey of tick-size conventions in non-U.S. markets.

While the published literature is useful, the staff cautioned that there are few studies focus on differing effects related to market capitalization. The effect of decimalization on capital formation has also not been explored in the literature, which may make it difficult to quantify the mechanism by which, if at all, decimalization may have hindered capital formation. Finally, many of the studies examine only the time period surrounding the implementation of decimalization and do not examine its longer term effects.

The staff also recognized that unlike many other countries, the United States employs a “one size fits all” approach to tick size. According to the report, “such an approach may not necessarily be optimal for smaller capitalization securities in all contexts.” The staff noted that decimalization may be just one factor attributable to the recent decline of smaller public company IPOs. Recent studies on the IPO market have attributed the decline in U.S. IPOs to greater globalization of financial markets and to the increase in the use of global IPOs. According to the staff, further study to assess the impact of tick size as distinct from other potential factors.