The institutions have complained that the changeover from trading in fractional increments, or increments of 6.25 cents, to one-cent increments has opened the door for specialists to undercut their trades.
Specialists, Market Makers
The function of specialists, or market makers is to maintain the order flow of certain listed stocks by way of their positions on the floor of the exchange, however they are also able to trade for their own proprietary accounts.
The smaller increments make it easier and cheaper for these specialists to profit from trades by “stepping ahead” of investors with offers just slightly higher than the last bid price, when they have a big institutional investor lined up to buy the stock.
Exchange regulations demand that a market maker, who wants to step ahead of a customer order, pay a price that is greater than that customers order by at least the minimum increment, which was much higher before decimalization.
The NYSE, concerned that a worsening of the situation could lead to institutions trading elsewhere, plans to change its regulations to forbid specialist firms from “stepping ahead” for their own proprietary trading accounts, but would allow them to do so on behalf of their clients.