NEW YORK (The Deal) -- A Securities and Exchange Commission investor advisory panel is expected to urge the agency not to move forward with a pilot program to experiment with widening the one-penny increment currently used to price securities, according to three people familiar with the situation.
Already two subcommittees of the SEC's investor advisory panel, whose suggestions are not binding with the SEC but nevertheless carry significant weight with the agency's commissioners, have voted against the program. The vote of the full panel, set for Jan. 31, would contradict one made an SEC advisory committee on small and emerging companies in March. The small business panel joined other groups in urging the agency to widen trading increments - at 5 cents or 10 cents - a move that they believe would help increase the visibility of small publicly traded companies by giving small boutique investment banks the incentive to trade them more and invest in hiring stock salesmen and analysts who would shine a spotlight on otherwise ignored and illiquid small public companies. A tick is the minimum pricing increment that can be used to trade securities.
All of this would kick some life into illiquid small capitalization companies and the generally lackluster IPO market for small-cap stocks, they contend.
However, the two investor advisory subcommittees opposed a pilot program, arguing that they "see little evidence" that an increase in tick size would increase research and market making activities. The investor subcommittees added that if tick sizes are increased "additional profits will simply be retained by trading centers or shared with firms that send them order flow, rather than being directed into increased research or other activities to benefit capital formation."
Indicating that they believe the SEC may launch a pilot program anyway, the subcommittees also issued a separate recommendation suggesting that if the commission goes forward with such a pilot program that it be "designed with a tight timeframe" and a guaranteed sunset unless benefits are proven to outweigh the costs. This suggestion is also expected to be approved by the committee, people familiar with the panel said.
The recommendations come as a wider tick pilot program has gained momentum. SEC Chairman Mary Jo White has said recently that the agency is considering a wider tick spread pilot program but has yet to announce the details of its length or how it would look. Also, the House Financial Services Committee in November unanimously, by an unusual bipartisan vote of 57-0, approved a wider-tick spread pilot program bill introduced by Rep. Sean Duffy, R-Wis.
The recommendations issued by the subcommittees also raised serious concerns with a small business group known as the Equity Capital Formation Task Force, which worries that a pilot program with a 'tight timeframe" would discourage boutique investment banks from spending money on new technology or the hiring of sales people that would inject liquidity in these securities because they would worry that the program would shut down too soon. The ECFTF, which is made up of officials who work for boutique investment banks, exchanges, trading firms and lobbying shops, sent a letter Wednesday to the advisory panel arguing that opposing any pilot program is a "do nothing approach" that is not a viable alternative to solve the core problem, which includes a "substantial decline in small company IPOs over the past decade and a half." This group has led the way in advocating for an SEC pilot program that would widen tick increments.
Jeff Solomon, the CEO of boutique investment bank Cowen & Co. and co-chief of ECFTF, said he actually believed that implementation recommendation could work if the advisory panel struck the term "tight timeframe" from the provision. He argued in an interview with The Deal that a pilot program with a tight timeframe, say one year, would limit its effectiveness.
"Lets not try to kill this before we see if it works," he said. "We need to make the investment and prove that we can bring about that liquidity otherwise, with a short pilot program, no one will change behavior."
Solomon said he supported an alternative dissenting recommendation issued by Stephen Holmes, the COO of venture capital firm InterWest Partners and a member of the advisory committee who is seeking multiple pilot programs including one over no less than three years. Solomon said three to five years is necessary to see if this approach works.
The investor advisory committee is also expected to vote on Holmes' dissenting proposal and people familiar with the group expect a substantial minority of the panel to back his approach.
Holmes said he worried also that the SEC would seek to find a middle ground between the small business and investor advisory committees by launching a short pilot program, where many of the concerns raised by those members opposed to a such a program would come true because not enough time would be given for the investment banks to invest in new capital formation activities.
"A short duration would doom the pilot programs to failure," said Holmes. "A duration of approximately three years is suggested. Their desire for a short-term test period is kind of like saying we really don't think you should do it but you should do it for a short time, knowing that it is a kiss of death, and it won't work."
However, Barbara Roper, director of investor protection at the Consumer Federation of America and a member of the SEC advisory panel, said that wider tick spreads will result in institutional and retail investors paying above-market costs. "Under the best circumstance, if the industry spends the money to increase research on these companies, there is nothing that guarantees the greater number of IPOs and more liquidity they are suggesting," Roper said. "Investors are being forced to pay for biased research, where our previous experience suggests that this research will hype stocks that the analyst themselves think are worthless."
She added that there is nothing that suggests that the "tight timeframe" means one year, noting that it would be up to the SEC to decide how short a timeframe is needed.
Steven Wallman, co-founder of Foliofn, chairs the market structure subcommittee, one of the groups issuing the recommendations. Wallman was also previously a commissioner at the SEC that voted to back a 2001 SEC rule known as "decimalization," where the spread size between bids and offers on stock exchanges was reduced from 25 cents to a one-cent minimum "tick size."
Written by Ronald Orol