In response to an order from the Securities and Exchange Commission (SEC) in June, on August 26, 2014, the SEC announced that it had received a proposal from the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) to establish a tick-size pilot program. The 12-month pilot program would widen the minimum quoting and trading increments, which are known as “tick sizes,” for select stocks of companies with smaller market capitalization. The SEC may approve the pilot program after a 21-day public comment period. The SEC plans to use the pilot program to assess whether changes in minimum quoting and trading increments would improve liquidity and the trading of the stock of small capitalization companies and thereby benefit issuers, investors and other market participants.
Securities to be included in the proposed pilot program will have the following characteristics during the measurement period (which will be a three-month period ending at least 30 days prior to the effective date of the pilot period):
- total market capitalization of $5 billion or less at the end of the measurement period
- a closing price per share of $2.00 or more at the end of the measurement period
- a closing price per share of $1.50 or more on each trading day of the measurement period
- an average daily trading volume during the measurement period of one million shares or less
- a weighted average price per share greater than $2.00 during the measurement period.
Once the securities for the pilot program are selected, the securities will be divided into three test groups and one control group. Each test group will consist of 400 securities and will be chosen using a stratified random sampling process with price, market capitalization and trading volume categories and low, medium and high subdivisions within each category.
Securities in the control group will be quoted at the current tick size of $0.01 per share and may be traded in any price increments currently permitted.
Securities in the first test group will be quoted in $0.05 minimum increments, but, like the control group, will continue to trade in any price increment currently permitted.
- Orders priced to execute at the midpoint of the increment and orders through retail liquidity programs may be ranked and accepted in increments less than $0.05.
Securities in the second test group will be quoted in the same increments as the first test group (along with applicable quoting exceptions), but will be traded in only $0.05 increments.
- Trading will be allowed in increments less than $0.05 in the following circumstances: (1) trading at the midpoint between the National Best Bid and the National Best Offer or the midpoint between the best protected bid and the best protected offer; (2) retail investment orders - provided with a price improvement that is at least $0.005 better than the best protected bid or the best protected offer; and (3) negotiated trades (such as volume-weighted average price and time-weighted average price trades). National Best Bid and National Best Offer are defined in Rule 600(b)(42) of Regulation NMS under the Securities Exchange Act of 1934, as amended, as the best bid and best offer for such security that are calculated and disseminated on a current and continuing basis pursuant to an effective national market system plan. Best protected bid and best protected offer mean the highest priced protected bid and lowest priced protected offer, respectively.
Securities in the third test group will be quoted and traded in the same increments as the second test group (along with the applicable quoting and trading exceptions), but the third test group will also be subject to a “trade-at” prohibition, as follows:
- The trade-at prohibition forbids price matching by a trading center that was not quoting from the price-matching protected quotations and allows trading centers that were quoting from the price-matching protected quotations to execute orders up to only the displayed size, unless the trade falls under specified exceptions. The purpose of the trade-at prohibition, according to the SEC, is to allow examination of the impact of trading centers, such as dark pools, on small capitalization issuers.
The structure of the pilot program, including the types of securities and the parameters of the control and test groups, is based on the specifications in the initial order from the SEC on June 24, 2014. The data gathered from the pilot program will be recorded and transmitted to the SEC and will be made available to the public. Within six months after the end of the pilot program, the national securities exchanges and FINRA will provide an assessment of the program to the SEC, which will be made available publicly.
The results and assessment of the pilot program will likely provide insight for how the SEC may change quoting and trading tick sizes in the future. In the SEC’s initial order, there was discussion that the decimalization program implemented in 2001 may have unintentionally hurt the trading and liquidity of medium and small capitalization issuers. Notably, the minimum $0.05 tick size to be used in the pilot program is similar in size to the minimum tick size under the pre- decimalization fractional system that was 1/16 of $1.00, or about six cents.