The U.S. Securities and Exchange Commission (SEC) terminated its small-cap stock pilot program on September 28, 2018. The program, which commenced on October 3, 2016, mandated minimum quotations and trading increments for stocks of certain smaller companies. It was started after the House of Representatives passed bipartisan legislation requiring wider stock quote increments on smaller companies with the intent of boosting job growth by emerging companies.

As explained in the June 2015 AAII Journal (Briefly Noted, “SEC Approves Pilot Program for Small-Cap Stocks”), selected stocks were placed into one of four groups. Group 1 had mandated five-cent quotation spreads, but stocks in this group could trade at different price increments. Group 2 could trade in the midpoint of the five-cent bid/ask spread. Group 3 stocks had to trade at the quoted price. Control group stocks were not subject to the pilot’s rules.

In its report about the program, the Financial Industry Regulatory Authority (FINRA) wrote: “Test-Group stocks generally saw less volume, executed in fewer, larger transactions with less message traffic, short-term order cancellations and quote volatility … Price improvement increased, but not by a large-enough margin to counteract the wider tick, resulting in higher effective spreads.”

Trading shifted away from the major exchanges to other platforms where traders and institutional firms could get better execution prices. This reduced the number of cancelled orders, but left individual investors—who lacked the ability to control where their orders are filled—paying the wider bid/ask spreads. At the same time, growth in volume for the test group securities “lagged that of the Control Group.”

One goal of wider spreads was to attract more market makers and greater analyst coverage. This did not happen. The pilot program “did not appear to increase the number of market makers, on average, in Test-Group securities,” wrote FINRA.

Citadel Securities was more critical in its assessment of the pilot program. Citing data in the FINRA report, the market-making firm opined, “Unfortunately for investors, any changes in price-improvement fell far short of countering the increase in quoted spreads. So where did the money go? It appears to have gone to the market makers.”

Sources: “Assessment of the Plan to Implement a Tick Size Pilot Program,” FINRA, July 3, 2018; and “Market Lens,” Citadel Securities, August 2018.