Money manager Fidelity Investments has commented on the pilot program to widen tick size for smaller companies.
Traders has learned that Scott Goebel, Fidelity Investments deputy general counsel, filed a comment letter on behalf of the manager with the Securities and Exchange Commission regarding the recommendations made by its Investor Advisory Committee on undertaking a wider tick pilot. The letter hasnt yet been posted on the Commissions website, but Fidelity shared the letter with Traders.
In brief, Fidelity agrees with the Market Structure Subcommittees recommendation that the Commission should not reverse its decimal pricing policy, including not engaging in tests or pilot programs to widen the tick size for smaller companies.
Because of decimal pricing in the equity markets, retail investors currently receive more favorable trade executions, with tighter spreads and lower costs. Wider tick sizes will increase trading costs for retail investors without improving smaller company access to the public capital markets or the liquidity of their securities. We do not believe that retail investors and smaller companies should bear the burden of market participants desire for change.
The firm said in its letter that it has always been difficult to trade small and middle-capitalization stocks, and that decimalization is not the reason. Widening the tick size will not help smaller companies because other factors outside of decimalization influence smaller companies decisions to go public and impact liquidity in their securities.
Below is the full comment letter:
February 21, 2014
Ms. Elizabeth Murphy
Secretary
U.S. Securities and Exchange Commission
100 F Street NE
Washington DC 20549-1090
Re: Securities and Exchange Commission Dodd-Frank Investor Advisory Committee;
File Number 265-28
Dear Ms. Murphy,
Fidelity Investments (Fidelity)1 appreciates the opportunity to comment on a recent
recommendation made by the Securities and Exchange Commission’s (the SEC or
“Commission”) Investor Advisory Committee, Market Structure Subcommittee with respect to
decimalization and tick sizes.2,3 We agree with the Market Structure Subcommittees
recommendation that the Commission should not reverse its decimal pricing policy, including
not engaging in tests or pilot programs to widen the tick size for smaller companies (the
“Subcommittees Recommendation”).
The Jumpstart Our Business Startups Act4 (the JOBS Act) and related SEC rulemaking
have created new opportunities for smaller companies to raise capital in the public and private
markets. For example, by easing certain requirements in the securities registration process for
smaller companies, the JOBS Act seeks to encourage smaller companies to pursue an IPO.
Fidelity supports many of the provisions in the JOBS Act designed to improve access to the
capital markets for smaller companies.
The JOBS Act also asked the Commission to explore the impact of decimalization on
smaller companies and permits, but does not require, the Commission to change the tick size for
these securities.5 We believe that wider tick sizes will increase trading costs for retail investors
without improving smaller company access to the public capital markets or the liquidity of their
securities.
Fidelity expressed this view at the SECs 2013 Decimalization Roundtable
Since the Roundtable, Fidelity has observed the continued discussion on tick
sizes. Among other items, legislative proposals have been introduced that would establish a five year pilot program administered by the SEC to permit Emerging Growth Companies to increase
the tick size at which their securities would be quoted to increments of five or ten cents7 and SEC
Commissioners have discussed the possibility of a pilot program.
We have also observed frequent calls from market participants for a pilot program to
widen tick sizes for securities of smaller companies. We attribute this increased interest to
market participants frustrations with recent technology glitches and perceived inefficiencies in
the equities markets. In our discussions with other market participants, many concede that a
pilot program to widen tick sizes is not likely to increase capital formation for smaller
companies. Instead, many are in favor of a tick size pilot program simply as a way to experiment
with change in equity market structure. We support a comprehensive SEC review of the current
equity market structure, but we do not believe that retail investors and smaller companies should
bear the burden of market participants desire for change.
The Subcommittees Recommendation has added to a potential tick size pilot program.
We agree with the Subcommittees Recommendation for three primary reasons: 1) other factors,
outside of decimalization, have prevented smaller companies from going public and have
impacted the liquidity of their securities; 2) imposing wider tick sizes on smaller companies will
increase trading costs for retail investors without a corresponding benefit; and 3) we do not
believe that widening tick sizes for smaller companies will lead to a greater research focus on
those companies. Each of these comments is discussed in further detail below.
Widening the tick size will not help smaller companies because factors outside of decimalization
influence smaller companies decisions to go public and impact liquidity in their securities
In our experience, macroeconomic and regulatory factors influence a companys decision
to go public, not tick size. The CEOs and CFOs of private companies consider many factors
when determining whether or not to engage in an IPO. Generally, these considerations include
disclosure and other regulatory requirements, the need for primary capital, acquisition strategy,
employee retention, sector sentiment, market sentiment and valuations — but not tick size.
Moreover, the past decade has witnessed a number of additional factors that have had an impact
on a smaller companys decision to go public, such as the Sarbanes Oxley Act of 2002, the
proliferation of private securities litigation, the credit crisis of 2008-2009, the availability of
private equity capital, bank recapitalizations and the TARP program, low valuations and
declining overall market liquidity. Given this variety of factors, we do not believe that tick size
is relevant to a companys decision to conduct an IPO.
Similarly, we believe that float and position concentration, not decimalization, cause
lower liquidity in the securities of smaller companies. Institutional investors are significant
participants in the U.S. equity markets. An important factor in the decision of an institutional
investor to invest in a company is the availability of enough outstanding shares of a given
companys stock, or float, to permit the institutional investor to make trades in and out of the
market without significantly affecting the price of the security. If an institutional investor cannot
trade a small companys stock without moving its price substantially, it will often decide not to
invest in the security.
A smaller company typically has fewer shareholders than a larger company has.9
Company insiders often hold the majority of a smaller companys outstanding shares, which
means that there is less stock left for the public to own. The ability to match buyers and sellers is
more difficult when only a few sophisticated investors own the stock, and a Commission
decision to widen the tick size of securities of smaller companies will not increase the float at
these companies. Moreover, in our experience, holders of securities in smaller companies
normally hold their stock with a high level of conviction, which means that a decision to sell the
stock is based more on the fundamentals of the company, and less on any premium to last sale.
As a result, we do not believe that wider tick sizes will improve liquidity in these securities.
A change in tick size for smaller companies will increase trading costs for retail investors
without a corresponding benefit.
Several participants at the Roundtable, and recent comment letters to the Commission,
observed that because securities analysts depend on revenue from trading commissions, they
have an incentive to cover only high volume stocks. Conversely, because many securities of
small and middle capitalization companies do not have such trading volume, they have less
analyst coverage, which has led to a decline in investor awareness and interest in these securities.
If the SEC were to increase the minimum tick size for the securities of smaller companies, then,
so the argument goes, market intermediaries would realize greater profits from trading costs,
which would in turn lead them to promote the securities of smaller companies, thereby spurring
investor demand.
We question the assertion that greater promotion of smaller company securities by market
makers will spur retail investor interest. Our retail investor data indicates that retail investors
typically shun securities, in all capitalization categories, with wider spreads, and smaller
capitalization securities already have wider spreads relative to the securities of companies with
middle or larger capitalizations.10 Given this data, we believe that any increased promotional
activities will be more than offset by the negative impact of wider spreads.
Moreover, those retail investors that continue to buy securities of smaller companies will
also be harmed. Instead of placing orders in penny increments, retail investors will be required
to place orders in higher increments, such as nickel and dime increments. Over time, we believe
that these increased trading costs will detract from retail investors savings goals. Moreover, in
our experience, retail customers have grown accustomed to placing orders in a penny increment
and find it intuitive to do so.
Eliminating decimalization will not improve the economics of research on smaller companies
Many who argue for wider tick sizes for smaller companies assert that an increase in tick
size will provide increased profits to market makers that will spur research coverage for and
interest in, smaller companies. We believe these claims are unfounded and that ample research
on securities of smaller companies currently exists.
Today, retail investors have a significant amount of research available to them on smaller
company securities. For example, Fidelity currently offers its retail customers, through its
website, an Equity Summary Score on over two thousand issuers with total annual gross
revenues of less than $1 billion. The Equity Summary Score, provided by Starmine, provides a
consolidated view of the ratings from a number of independent research providers. Only stocks
that have four or more analyst opinions qualify for an Equity Summary Score. The availability
of the Equity Summary Score for a large number of smaller companies demonstrates that equity
research on smaller companies is available to retail investors today, but the source of this
research is not sell-side analyst research.
We also note that since decimalization was implemented in the U.S. securities markets,
there has been a paradigm shift in research coverage. For a variety of factors, there are fewer
publishing analysts at sell-side firms and a steady growth of in-house research staff at many buyside firms. As a result, many buy-side firms no longer rely on sell-side firms for research
coverage to the same extent they did twenty years ago. We believe that if the Commission
increases the tick size of smaller securities to incent increased analyst coverage of these
securities, the resulting research will not be helpful to buy-side firms and will not improve on the
level of research information already available to retail shareholders.
We also question the assumption that wider tick sizes will actually drive the economics
of market maker firms sufficiently to create research on smaller companies. We have yet to hear
a proponent of wider tick sizes commit to provide research on smaller companies if tick sizes are
widened or suggest the presence of research as a measurement of success in a potential tick size
pilot program. We believe that a Commission decision to widen tick sizes will serve to subsidize
less-efficient market makers, who may not ultimately produce more research on smaller
companies involved in the pilot, at the expense of retail investors and fund shareholders.
Recommendations concerning the structure of a pilot program
Although we do not agree that the Commission should widen tick sizes of smaller
company securities, we acknowledge that the Commission may nevertheless pursue a tick size
pilot program to generate data prior to making a final decision on this topic. Accordingly, we
offer our views on effective ways to structure a pilot program, should the Commission decide to
pursue this approach.
We strongly oppose the pilot program including a Trade-At rule under which trading
venues and brokerage firms would only be allowed to execute orders away from an exchange if
the venue or brokerage firm could provide price improvement in the trade by a specified amount
over the market’s best price. We believe that non-traditional and non-displayed liquidity pools
are an integral part of market structure that provide increased liquidity and anonymity as well as
pricing conducive to seeking best execution for our mutual funds and retail customers. We
believe that a Trade-At rule will harm investors by adversely impacting competition, reducing
the quality of trade executions and significantly increasing trading costs.
Moreover, we believe that imposing a Trade-At rule in a pilot program will decrease
liquidity in smaller securities. Our experience shows that smaller capitalization securities are
more often traded in venues other than exchanges. Under a Trade-At rule, there is a
disincentive for non-exchange participants to provide liquidity to the market, because small price
improvements (i.e., prices that do not exceed the specified amount) would not be sufficient to
allow orders to be executed away. For these reasons, we urge the Commission to not include a
Trade-At rule in a potential pilot program.
At a minimum we believe that any pilot program should be limited in scope and time
with clearly established parameters that define what a successful pilot means. The pilot
program should include periodic reviews, with the ability to immediately terminate the program
if it presents negative effects on the included securities. We believe that the primary goal of the
pilot program should be to determine whether liquidity was enhanced in the pilot programs
securities as a result of a wider tick size. We believe that improved liquidity should be measured
by the pre- and post-pilot depth and duration of the quote in the order book.
Lastly, we oppose any pilot program that would prohibit trading at increments smaller
than the pilot programs wider quoting increments and market center trading at the midpoint of
the wider spread. Such a prohibition would go against current market practices and prevent
broker-dealers from providing price improvement to retail customers. Moreover, any potential
pilot program should also permit the ability to quote in wider increments.
Fidelity thanks the Commission for considering our comments. We would be pleased to
provide any further information or respond to any questions that you may have.
Sincerely,
Scott C. Goebel
