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So far, so good in America's transition to pricing stocks in decimals -- instead of those awkward sixteenths of a dollar. As planned, investors are paying lower transaction costs. But could this effort at reform ultimately end up boosting costs? There's early reason for concern, according to participants in a Securities & Exchange Commission roundtable discussion on Dec. 11.
With decimals, the smallest pricing increment for most stocks drops from 6 1/4 cents to a penny. The idea is that the "spread" -- or the difference between prices at which trading firms buy shares from those wanting to sell them and sell them to those wanting to buy -- can shrink, too. For instance, instead of offering to buy shares at $20 and sell them for $20.0625, a trading firm might narrow the gap, buying at $20 and selling at $20.04. Wider spreads hurt investors because Wall Street pockets the difference as a fee for the cost of executing trades. And although the difference is measured only in pennies, it can add up to billions in trading profits for financial firms.
In a phase-in that began on Aug. 28, the New York Stock Exchange has begun trading 158 stocks in decimals, with the most recent batch of 94 issues added on Dec. 4. By the spring of 2001, the thousands of stocks on the NYSE and Nasdaq are due to begin trading in decimals.
POSITIVE EFFECT? A review of 63 stocks in the NYSE conversion shows that spreads, as quoted by trading firms, are down 19% on average, to 10 cents per share. A slightly different measure of spreads, reflecting not price quotes but actual trade prices, is down an average of 12%, to 6.8 cents per share. "The rollout to decimals to date has gone very well," says Annette L. Nazareth, director of the SEC's market regulation division.
But the outlook isn't completely rosy. Wall Street firms have gone on the defensive in reaction to decimalization. In an effort to protect the profits they earn from spreads, firms have taken to limiting the size of orders they're willing to execute at a particular price. As a result, it appears that some investors' orders aren't being filled in a single transaction. For instance, an investor might want to buy 2,000 shares at $20 per share, but only 1,000 shares might be offered at that price.
And that's where the concern about higher costs comes in. Although per-trade costs may be lower, it could take more trades to completely fill orders. Handling more trades will boost costs for Wall Street firms, participants said, which the investor might have to pick up. "Are those costs going to be passed along? It's too early to figure that out right now," says Matthew DeSalvo, managing director of Morgan Stanley Dean Witter in New York.
Participants cautioned about drawing conclusions too soon and predicted that the overall effect of decimals will be positive. It's possible that technological improvements will offset the added trading costs, and over time, competition could help narrow the spread even more.
By Christopher H. Schmitt in Washington Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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