Our Take On The SEC Decimalization Roundtable
The much anticipated SEC Roundtable on Decimalization occurred yesterday. The roundtable was put together in response to the JOBS Act which required the SEC to study the impact that decimalization has had on small cap stocks. We watched all three panels and concluded that the three most valuable panelists were David Weild from Grant Thornton, Jeff Solomon, CEO of Cowen & Co. and Kevin Cronin of Invesco. These three gentlemen clearly knew what was at stake here and kept the conversation focused around the problem of liquidity in small cap stocks. They all understood that the equity markets function of capital formation and capital allocation has been seriously jeopardized in the post Reg-NMS decimalized world. They tried to get the panel to understand how there has been a massive collapse in the distribution network of the equity market. This collapse has been caused by the loss of economics for market makers due to the market structure changes of the past 15 years. They contended that the ecosystem of the broker/dealer model has been hollowed out due to lack of economics for brokers. This, in turn, has hurt institutional investors because valuable corporate research can no longer be supported.
Unfortunately, there were many other self-interested panelists who tried to steer the SEC in different directions. For example, one stock exchange wanted the SEC to consider sub-penny spreads and the lifting of the restriction of locked/crossed markets. We really don’t think that sub-penny spreads was what the Schweikert Amendment of the JOBS Act had in mind. And the solution to locked/crossed markets is simple. An exchange should not be able to post a hidden order or price slide an order that would lock/cross the market. That order should be required to be routed out to the market center with the best bid or offer.
Here are some more of our general observations from the roundtable:
-The retail broker representatives were clearly not in favor of widening tick sizes. Fidelity Capital Markets recommended raising commissions to support equity research rather than increasing tick sizes. And TD Ameritrade defended the retail price improvement model of sending flow to internalizers. They claimed this has put millions of dollars back into their clients pockets. We thought that it would have helped the roundtable if these retail brokers would have disclosed their payment for order flow statistics from their SEC 606 reports. Lots of interesting and little known disclosures in those reports.
-The academics appeared to want to slow down the wider tick proposal. One professor said this proposal was not as straight forward as it looked and the SEC needed to recognize the complexity of widening tick sizes. The academics admitted that they have had trouble accessing quality data. But they all seemed to agree that the pilot would yield good data that could be studied.
-We were surprised that there was not one CFO or investor relations representative from a public company on any of the panels. Considering it was the fate of their stocks that was being discussed, we think it would have made sense if this group had a representative on the panel.
Now the question is, what will the SEC do? We think that the SEC will approve a pilot program for wider ticks on small cap stocks. We hope they also include a minimum price improvement requirement for dark pools that trade these pilot stocks. We would recommend a middle of the spread requirement for dark pool trades. We also think the SEC will not approve a sub-penny tick size pilot program and will not lift the ban on locked and crossed markets. While this pilot program for wider ticks is a good start, the SEC has much more work to do to start repairing our broken markets. Elimination of the maker/taker model, dark pool regulations, order type reform and restricting some data feed information are just a few things they will need to address.