SEC Seeks To Eliminate Fractional Trading

The days of fractional increments in stock prices may be long gone.

As of Tuesday, U.S. stock exchanges and FINRA have been directed by the Securities and Exchange Commission to work on a plan over the next two months to implement a pilot program that will last one year and allow some stocks to trade in $0.05 increments (Minimum Price Variation - MPV), which may abolish the sub-penny increments in small to mid-cap stocks.

After analyzing the IPO market, the SEC and the Equity Capital Formation Task Force analyzed small and mid-cap companies to determine ways to make those assets more appealing or just as appealing as larger capitalized companies.

The ECFTC recommended that exchanges conduct a pilot program to establish Small-cap Trading Rules where companies with market caps below $750 million would be quoted in $0.05 increments and would trade only at the bid, the offer, or the midpoint between the bid and offer.  

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The point of the implementation is to avoid an uneven playing field that has manifested after decimalization over a decade ago was merged with dark pools, sub-penny trading and rapid fire high-frequency trading.  As noted in SEC Release No. 34-72460 document, "concerns have been expressed from a variety of sources that decimalization, and the associated one penny MPV, may have had a detrimental impact on the trading and liquidity of small capitalization stocks."

SEC stated the character of the pilot as follows, "Such a pilot should facilitate studies of the effect of tick size on liquidity, execution quality for investors, volatility, market-maker profitability, competition, transparency and institutional ownership."

To carry this out, 900 stocks spread evenly over three test groups will include companies with market caps below $5 billion trading at least one million shares per day with a share price no less than $2.

Group 1 will have minimum $0.05 trading. Group 2 will allow exceptions to the $0.05 increment established in Group 1, such as trading at the midpoint. Group 3 will incorporate Group 2 characteristics, but also enable the “trade-at” rule that limits how much trading occurs inside brokerage internalizers and in alternative trading venues such as dark pools.

Speaking on the "trade-at" rule, KOR Trading stated, “We believe that a trade-at rule would incentivize displayed liquidity by requiring substantial price improvement for non-block orders in order to be internalized or trade off-exchange.”

The advocacy group continued, “It would benefit public markets by reducing the amount of liquidity that free-rides the public quote, ensuring that incentives remain aligned for public display of liquidity in equity markets.”

The test program is being applauded by critics of high-frequency trading and should increase the appeal of trading small to mid-cap stocks, which would in-turn generate fresh interest for companies to offer IPOs.