In this morning’s note we wish to keep you abreast of the latest developments surrounding the Wide Tick Pilot Program.

Yesterday, Congress voted on H.R. 3448, “Small Cap Liquidity Reform Act”, and passed it by a 412-4 margin. You can read the actual bill here. Voting for the bill were 219 Republicans and 193 Democrats. Voting against the bill were 4 Republicans: Tom McClintock (CA), Jeff Fortenberry (NE), Walter Jones (NC), and Steve Stockman (TX). The wide support in Congress for this bill yesterday should be no surprise; it sailed through Committee 57-0 in November.

Watch a brief discussion of the bill’s passing here.

What’s In The Bill?

The Wide Tick Bill provides for a 5 year Pilot Program that requires that stocks of emerging companies to be quoted in 5 or 10 cent minimum spreads, dependent on the emerging companies’ choosing. The emerging company may also choose to opt out of the Pilot, and even change their mind with regard to the minimum quoting size they choose, or even their participation in the Pilot altogether.

An emerging company must have less than $750 million in revenue to be in the Pilot.

The pilot would impact less than 2% of current trading volume.

This 5 year pilot would require bi-annual reporting of its success to Congress.

The Wide Tick Bill leaves to the SEC the determination of a minimum trading increment. It gives the SEC flexibility to create multiple baskets – i.e. one basket that allows for internalization, and another that forces “trade-at”.

What Does The Industry Think Of The Bill?

The industry is very mixed in its opinion of this bill. While SIFMA supports the pilot (as long as it allows for trading in between the ticks) and we have, others have expressed their opposition. For example, just on Tabb Forum alone you can read:

–          Themis Trading’s support : http://tabbforum.com/opinions/why-wider-tick-sizes-would-help-small-caps-and-why-internalizers-hurt

and

–          Pragma’s Opposition: http://tabbforum.com/opinions/the-small-cap-large-tick-pilot-dont-do-it

Be sure to read the comments for added insight…

What Happens Now?

The ball is now in the SEC’s court. They get to decide the details of the pilot, including whether or not to allow for internalization, and trading within the minimum quoted tick size. They get to decide whether they allow exceptions for midpoint dark pool matching (something we advocate), and even exceptions for internalizing business models – such as those from Citigroup, UBS, Citadel and Knight Getco Group.

In some form however, the Wide Tick Pilot will move forward.

Additional Commentary

 You may have also recently read the Bloomberg story titled Fidelity Joins D.E. Shaw Opposing Wider Ticks as Small-Cap Fix. In that story an argument is made that such a pilot should not be undertaken, as we can’t prove beforehand if the drought in IPOS can be isolated to just the tick increment. In fact we all know that there are many factors that have contributed to a decline in small company IPOs, including Sarb-Ox requirements, a less than robust economy for a prolonged period of time, as well as the move to decimalization. Our view is that if we required proof that something would definitively succeed, as a prerequisite to ever changing faulty policy, we as a nation would never be able to pass any laws – let alone a pilot for testing.

We are also not surprised that practitioners of any model that involves payment for order flow would be wary of a Wide Tick Pilot. If it actually would succeed, especially with an absence of internalization, and improve market quality, then it would set precedent.

Again, this pilot would be a test. It would be a willingness to experiment based on a logical and reasoned hypothesis. We view it has having no downside, as if it did not help liquidity in small caps, which are already anemic, it could be ceased. However, not even trying it is an admission that we have no stomach to tinker with a needlessly complicated market structure, even when there is consensus that something is wrong.

One last point…  Some opposers of the Pilot are painting it as a drastic and extreme measure. Many of you have been around in the business for many years, and remember when INTC and MSFT traded in ¼ point spreads. Do you remember when those large-cap bell-weather securities also traded in 1/8s? Do you remember when they traded in 1/16ths? Do you remember when they traded also in 1/32nds (that was the “b” key on your old Instinet terminals)?

Well if you do, maybe you understand that this Wide Tick Pilot would allow for only the smallest cap stocks – i.e. not INTC and MSFT – to quote in an increment smaller than 1/16th, and to even trade at a midpoint of 2.5 cents, which is even smaller than 1/32^nd. Does the Pilot still sound so drastic now?