On July 20, 2012, as required by Section 106 of the JOBS Act, the SEC released its study on the effects of decimalization (i.e., the trading and quoting of securities in increments of $.01) on initial public offerings and the liquidity of small-cap and middle-cap company securities.
In conducting its study, the SEC took a three-pronged approach consisting of (a) a review of empirical studies regarding tick size and decimalization, (b) participation in discussions held as part of a meeting of the SEC Advisory Committee on Small and Emerging Companies concerning the impact of market structure on small- and mid-cap companies and on IPOs, and (c) a survey of tick-size conventions in non-US markets.
The Staff concluded that while decimalization may have been one of the factors that led to a decline in the IPO markets and in the liquidity of small- and mid-cap companies, there was not sufficient empirical evidence to isolate the effect of decimalization from other relevant factors. The Staff thus recommended that the SEC “should not proceed with the specific rulemaking to increase tick sizes, as provided for in Section 106(b) of the JOBS Act, but should consider additional steps that may be needed to determine whether rulemaking should be undertaken in the future.” The suggested additional steps include soliciting the views of investors, companies, market professionals and academia on how to best study decimalization’s effects on IPOs, trading, and liquidity for small and middle cap companies.
Given the focus of the JOBS Act on liquidity for small-cap and middle-cap company, it will be interesting to see how quickly the SEC or Congress acts to perform the more detailed analysis.
Perhaps more interesting than the study’s focus on the impact of decimalization on the IPO market was its discussion of the effect on sell-side research.
Critics of the SEC Report point to the report entitled "Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth" (known as the “IPO Task Force Report”) presented in 2011 to the Treasury Department from an industry group formed as an outgrowth of a Treasury Department conference, which stated that “decimalization . . . put the economic sustainability of sell-side research departments under stress by reducing the spreads and trading commissions that formerly helped to fund research analyst coverage.”
The IPO Task Force Report indicated that independent equity analyst coverage has significantly shifted away from smaller capitalization stocks towards highly liquid, larger capitalization stocks, and suggested that analyst coverage of smaller public companies has become unprofitable both because of the Global Analyst Research Settlement in 2003, which prohibited direct compensation of analysts through investment banking revenue, and decimalization, which reduced spreads that formerly helped fund analyst coverage. The report concluded that less analyst coverage of smaller capitalization companies means that less information on these stocks is generated, which, in turn, reduces market interest in these stocks.
A Grant Thornton report issued in June 2010 as well as recent academic literature have generally come to the same conclusion, and it remains clear that the consolidation of staff and reduction of coverage at the sell-side research departments of securities firms, especially for smaller capitalized companies, continues and that these firms are blaming decimalization at least in part. What remains unclear is whether decimalization is the root cause or just one of many factors.