Thursday, June 28, 2012

Congress Looks at Minimum Tick Sizes to Help the IPO Market


On June 20, 2012, the House Committee on Financial Services held a hearing to review issues affecting the performance and utility of the securities markets.   A major item on the agenda included a review of what additional steps could be taken to improve the quiet state of the Initial Public Offering, or IPO, market.  The Committee had earlier this year exercised a leadership role in the passing of one of the only bipartisan bills in recent memory - the JOBS (“Jumpstart Our Business Startups”) Act.   The JOBS Act represents a significant rethinking of securities laws to create a new path for nascent  pre-IPO companies to raise seed capital from public investors without meeting many of the reporting and other requirements previously in place. 

The Financial Services Committee is now considering the role that minimum trading increments, or price ticks, have in building a new public company’s ability to enjoy a liquid secondary market.  A price tick is the minimum difference between the price for which a stock can be bid to be purchased and the price at which it can be offered for sale.  Certainly, the confidence that a would-be reporting company has in being able to attract investors - not only though its business plan and financial performance – but, also in the efficiency of entering and exiting an investment in the company’s stock, is a critical consideration for a corporation making the decision to “go public” or not.   Thus, it is an important issue for the Committee’s consideration.

New public companies face a daunting road. [1]  How important is it for the pendulum to start swinging back to encourage more companies to use the public markets?  In the House Committee’s recent hearing, Jeffrey M. Solomon, Chief Executive Officer of Cowen & Co., cited in his prepared testimony statistics that showed a 28 percent decline in the number of U.S. public companies from 1991 to 2011, a drop-off from 6,943 to 4,988.[2]

For the United States to lose more than a quarter of its public companies in the span of a generation is eye-popping.  However, based on Congress passing the JOBS Act legislation and showing an ongoing interest in additional positive steps like modifying tick sizes for some companies, Congress is showing meaningful concern about the role of securities regulation on capital formation.  These actions are a very welcome step in beginning to address the problem. 

The focus on tick sizes for smaller and new public companies may seem like a small matter, but having Congress examine how the market structure of securities trading can be either a catalyst or a drag on capital formation is extremely worthwhile.  For select stocks, whether new or thinly traded, the goal of wider ticks is to attract market makers to provide greater liquidity by allowing them to make a profit on the bid/ask spread of a security.  New issues of securities that are developing a following, or stocks that have been listed for some time but “trade by appointment” – a polite way to say they are illiquid – can benefit by drawing the participation of liquidity providers who would otherwise not make markets in that stock because of a lack of trading opportunity. 

Whether the tick difference is a nickel, a dime or a quarter can be left to the exchanges or to the issuers, but Congress must assure that there is a mechanism to make tick sizes for affected stocks consistent across trading venues.  In addition, sub-penny pricing should not be allowed to infiltrate the trading in stocks with wider tick sizes as has been the case with securities listed in the broader market.  Sub-penny pricing, once thought to be a means to bring price improvement to investors who place market orders, namely retail investors, has become too often a means of confusing and disadvantaging the retail client rather than helping him. 

Appropriate changes in regulation to foster capital formation can have a profoundly positive effect on the confidence business has in the government’s economic stewardship of the economy.  Hopefully, the current focus on the state of capital formation will continue.




 


[1] See my opinion pieces e.g. “Sarbanes-Oxley Is a Curse for Small Cap Companies,” Wall Street Journal, August 15, 2005,  http://online.wsj.com/article/0,,SB112406088194912851,00.html, and “America’s Regulations Are Scaring the Sox off Small Caps,” Financial Times, August 1, 2006, http://www.ft.com/intl/cms/s/0/26a51a40-20fa-11db-8b3e-0000779e2340.html#axzz1ypU7Yo4N

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