Institute Comments on the Effects of Decimal Trading in Subpennies

Washington, DC, November 21, 2001 - The Institute has filed a comment letter with the Securities and Exchange Commission on the SEC's concept release requesting comment on the impact of trading and potentially quoting securities in increments of less than a penny.

The comment letter states that the Institute supports the move from fractional pricing to decimal pricing in the U.S. securities markets, but strongly opposes the entry of orders and the quoting of securities in subpennies. In particular, the letter states that permitting the entry of orders and the quoting of securities in subpennies would eliminate many of the benefits brought by decimalization and would exacerbate many of the unintended consequences that have arisen in the securities markets since its implementation, which have proven harmful to mutual funds and their shareholders.

The comment letter also states that the Institute is concerned about the effect of quoting securities in subpennies on market transparency and depth. The letter notes that preliminary data has shown that the implementation of decimalization has already had an adverse impact on transparency and depth of book and that displaying consolidated quotes in subpenny increments would further reduce the displayed quote size and overall depth of the markets. The letter also notes that the reduction in market transparency and depth that would occur in a subpenny environment also would adversely affect liquidity, especially for mutual funds and other institutional investors that need to execute relatively large-sized orders.

In addition, the comment letter states that many of the difficulties that institutional investors have faced trading large orders since the implementation of decimalization have been caused by increased instances of stepping-ahead of limit orders. The letter notes that permitting the entry of orders and the quoting of securities in subpennies would allow a trader to gain priority over another trader by bidding as little as $.001 more for the same security with almost no risk of loss. This potential for the increased stepping-ahead of limit orders would therefore create a significant disincentive for market participants to enter any sizeable volume into the markets and would result in the reduction in the value of displaying limit orders.

Finally, the comment letter states that it would be especially inappropriate to permit the entry of orders and the quotation of securities in subpennies before addressing several unresolved market structure issues. In particular, the letter notes that it has become more important than ever to ensure that all markets display a meaningful depth of book and establish appropriate priority rules for orders entered into the market and that it would be nothing more than folly to permit the entry of orders and the quoting of securities in subpennies before we have established an appropriate regime for trading in pennies.