November 12, 2014

Sizing Ticks

Ticks are blood-sucking insects, about how regulators have viewed spreads between stock prices.

Country singer Brad Paisley sings that he’d like to walk you through a field of wildflowers and check you for ticks. As a kid in tick country on Oregon’s Snake River breaks, I pulled plasma-bloated fatsos off my skin and watched my grandmother touch match-reddened tweezers to protuberant tick buttocks on my grandfather’s scalp.

Now the Securities and Exchange Commission is studying ticks. It’s in regulatory parlance SEC Release No. 73511, File No. 4-657.  You can comment by email at, or on the website, here (include “File No. 4-657” in any case).

Fittingly, we’re in New York this week where ticks began, a timely escape from the season’s first deep freeze in Denver.  Your stock trades in penny increments, or ticks, thanks to rules created by the SEC in the 20th century.

The belief then was that brokers were charging too much with wide spreads in securities that jobbed small investors. Shrink ticks to desiccated carcasses and mom and pop would win went the reasoning. Fifteen years after slimming ticks, the SEC has ordered a study on widening them. The SEC didn’t say it made a mistake last century. It just told exchanges, “See if there’s a better way.”

I’ve read File No. 4-657 from introduction to footnotes and definitions.  We’ve summarized before but hitting highlights, the exchanges have proposed three clusters and a control group comprising effectively all the 1,750-ish small-caps in the market. Stocks will quote in five-cent spreads but trade anywhere between, or trade in five-cent spreads, or trade at five-cent spreads with a “trade-at” rule, this latter blasted by brokers because it prohibits undercutting prices at exchanges.

The small-caps will be further segmented into 27 subsets by clustering stocks into low, medium and high categories for price, market-cap and volume. Three, times three, times three, equals 27. If 5% of stocks have low prices, medium market-cap and high volume, then each group will have 5% with those features. And so on.  All stocks must have six months of trailing data. The test spans a year. Then there’s a six-month post-test data-collection period. Two years total and the test won’t start until six months after approval.

It’s a valiant effort and I’m not knocking it. But it reconstitutes the market we have today in a fashion so mathematically precise that you could get the same thing we have now, with a wider spread, which is not a market but a data network. I think we should create a whole separate market populated by volunteer companies and volunteer market-makers that set their own rules. Let it run alongside the old market. But everybody’s got an opinion.

Speaking of opinions, not once is yours sought, issuers. The exchanges earn hundreds of your millions in listing fees but don’t want your view on how your shares trade. The closest they come is this in the “General Questions” section:

Should companies whose securities are included in the Pilot be allowed to opt-out of participating in the Pilot? If so, how should such an opt-out work and what impact would it have on the ability of the Commission and others to analyze the Pilot?

In other words, “We could ask for volunteers but what might that do to our test?”

Also missing, criteria helping issuers understand success.  The measures in this plan are in an abstruse 35-point appendix on “market quality.” Measuring success should be done in a fashion besides one that benefits those construing the study.

Finally, there’s no “Abort Mission” command. Exchanges can withdraw. Issuers? I’m reminded of a great old Kevin Costner movie with a shocking conclusion, called “No Way Out.” Maybe that’s what you should title your comment letter.

We need the study, yes. Prices 19 of 20 trading days on average are set by something besides the investors you spend your time, money and energy proselytizing. So, read. Comment. The Securities Act explicitly prohibits discriminating in rule-making against any exchange constituency, including issuers.

And if we don’t, we can’t blame anyone else for what we get.  Remember Bell, California? There the people checked out. Then they and we both learned how that city of 30,000 was staffed by blood-sucking ticks paying themselves millions at taxpayer expense.  Blame the leaders, yes. But where were the citizens?

You’re citizens of the capital markets, issuers. Let’s be a vibrant constituency. If you need help weighing in, ask us. We’ll give pointers!

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