SEC Concerned over Decimalization Impact

May 24, 2001 ( - Regulators voiced concern about complaints that decimalization has brought an increase in market specialists undercutting investors and possibly hurting smaller investors.

Laura Unger, Securities and Exchange Commission (SEC), told the Senate Banking subcommittee on securities and investment, that research by SEC economists shows that the average bid/ask spread has narrowed with decimal trading on the New York Stock Exchange and the Nasdaq Stock Market by 37% and 50% respectively.

She noted that the narrowing of spreads makes it likely that investors, entering small orders that are executed at or within the price quoted, have experienced reduced trading costs.

Prior to the move to decimals earlier this year, which now sees shares trading in smaller increments, spreads typically varied between 12.5 cents and 50 cents, translating into larger profit for brokers, who base their cut on the size of the spread.

The saving of an estimated $3 million a day in transaction costs was one of the major reasons behind the SEC’s move to require all stocks traded on US bourses be quoted in dollars and cents rather than in fractions by April this year.

Stepping Ahead

Unger voiced concern over the alleged “stepping ahead’ of investors by market makers, noting that new smaller increments make it easier and cheaper for these major players to profit from trades by “stepping ahead’ of investors with offers just slightly higher, 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 the order by at least the minimum increment, which was much higher before decimalization.

This practice can lead to higher transaction costs and reduced transparency of prices in the market as other traders try to hide their orders from market makers, which could be detrimental to the small investor, Unger noted.