Bloomberg News

Fidelity Joins D.E. Shaw Opposing Wider Ticks as Small-Cap Fix

February 07, 2014

President of Fidelity Capital Markets Brian Conroy

President of Fidelity Capital Markets Brian Conroy said, “There’s no one piece we can point to as the defining factor in the decline of IPOs. The fact that a stock can be quoted in pennies is good for the retail investor.” Photographer: Andrew Harrer/Bloomberg

Lawmakers who say moribund trading in smaller companies limits access to capital have proposed rolling back penny pricing in some U.S. equities. Executives and some of the biggest money managers say it’s not the answer.

Legislation in Congress would require securities regulators to test widening the minimum price increment at which shares of smaller stocks change hands from 1 cent. The aim is to boost earnings opportunities for market makers that facilitate trading, spurring them to buy and sell more shares and create conditions that would persuade more startups to go public.

The proposal is off the mark and ignores bigger barriers to small-cap initial public offerings, among them paperwork burdens and greater private financing options, says Rajat Bhargava, an entrepreneur who took firms public in 1999 and 2000. The view is echoed by companies including Fidelity Capital Markets, Pershing Square Capital Management LP, Travelers Cos., D.E. Shaw & Co. and TD Ameritrade (AMTD:US) Holding Corp., who advise against meddling with a stock market where two decades of reform have lowered costs to investors.

“Going public for a company these days compared to the 1990s is a fundamentally different thing,” said Bhargava, who decided against taking five other startups public and is now chief executive officer of Boulder, Colorado-based JumpCloud Inc. “If you look at the environment today, companies can gain the level of liquidity and financing that they need” by staying private, he said.

While IPOs are picking up, they’re below levels in the 1990s. Offerings by newly public companies on U.S. exchanges peaked at 933 in 1996 before sliding to 93 in 2003, according to data compiled by Bloomberg. Last year’s total was more than 200, the most since 245 in 2007, the data show.

Squeezing Spreads

The bottom came two years after the U.S. Securities and Exchange Commission narrowed the minimum price increment for stocks to 1 cent from eighths or sixteenths of a dollar. To Sean Duffy, a Wisconsin Republican in the House, the shift hurt small businesses: it limited potential profits for market makers, who in turn did less to promote companies with research, eliminating a benefit of being public.

While the shift to decimalization and automation of trading has been “great for a lot of companies and investors, it has created a unique set of pressures for small businesses that are trying to go public and trying to get investors familiar with their business,” Duffy said during an interview. “We can alleviate some of that pressure with our tick-size bill.”

Volume for smaller companies has lagged behind larger ones since the shift to pricing stocks in penny increments, according to data compiled by Bloomberg. For companies valued between $100 million and $500 million, about 229,000 shares traded daily in 2013, up 8.2 percent since 2000. For companies exceeding $1 billion, volume increased 20 percent to 2.1 million a day.

Funding Research

Duffy co-sponsored legislation to widen the difference between bids and asks for some stocks to a minimum of five cents. The extra pennies available to market makers would be enough to increase trading, justify more Wall Street research in small companies and spur investor interest, he says.

The Jumpstart Our Business Startups Act, signed into law in 2012, instructed the regulator to examine the issue. The position of supporters was summed up by the Equity Capital Formation Task Force’s report sent to the Treasury in November.

“The new market economics have put significant strain on the after-market support system for small-cap stocks,” according to the task force, whose members include IntercontinentalExchange Group Inc. (ICE:US)’s New York Stock Exchange and Nasdaq OMX Group Inc. (NDAQ:US), whose markets could make more money should volume in small companies increase. “With less support for life after their IPOs, fewer startups may see the public markets as offering the best option in their quest to evolve into large, enduring institutions.”

Alternate Explanation

A panel of SEC advisers drawn mostly from the money management industry disagrees. The Investor Advisory Committee voted 13-3 on Jan. 31 to encourage the SEC to drop plans to test wider ticks. Members backing the recommendation included Roy Katzovicz, a partner at Pershing Square; Alan Schnitzer, vice chairman at Travelers; and Darcy Bradbury, managing director at D.E. Shaw.

“Other exogenous factors, rather than decimalization, are the primary causes of the decline in small company IPOs over the past couple of decades,” according to the document the panel voted to approved. “There is no persuasive evidence that an increase in tick size would result in beneficial activities to support capital formation -- and current market structure would suggest compellingly to the contrary.”

The group blamed the dwindling number of IPOs on the end of the 1990s technology boom, costs to comply with stricter compliance standards stemming from the 2002 Sarbanes-Oxley Act, and the impact from two recessions.

Demand Side

These factors have “resulted in a period of extreme market stress and markets that are inhospitable to IPOs,” according to their report.

Brian Conroy of Fidelity Capital Markets contends that in the absence of evidence linking the narrow price increment with a drop in IPOs, widening the difference between bids and asks will only make buying stocks more expensive for investors.

“We don’t understand how this connection was made between IPOs and small-cap liquidity,” said Conroy, the president of Boston-based Fidelity Capital Markets. “There’s no one piece we can point to as the defining factor in the decline of IPOs,” he said. “The fact that a stock can be quoted in pennies is good for the retail investor.”

Technology Bubble

Conroy said that the early 2000s saw several changes, all of which “had a tangible influence” on IPOs. As well as decimalization and the rise of automated high-speed trading, there was the collapse in share prices for technology companies that had driven IPO activity, and greater corporate regulation such as the Sarbanes-Oxley Act.

“We are not in favor of a pilot,” he said during an interview.

Paul Jiganti of TD Ameritrade, a brokerage for small investors, also isn’t persuaded that Congress is on the right track. He attributes the drop to increased regulation, a weak economy, investor fear caused by stock market plunges beginning in 2000 and 2007, and an abundance of private financing.

“There’s an array of reasons for why there’s been a dearth of IPOs,” Jiganti, managing director for market structure and client advocacy at Omaha, Nebraska-based Ameritrade, said in an interview. While tick sizes may be a factor, “it would tough to convince me it’s a major factor.”

Venture Capital

Venture capitalists invested $8.37 billion into U.S. startups during the final three months of 2013, the highest quarterly total since 2007, according to the National Venture Capital Association. At least 20 private North American technology companies have raised investment rounds of more than $100 million since the beginning of 2013, according to data compiled by Bloomberg.

Suresh Vasudevan, chief executive officer of Nimble Storage Inc. (NMBL:US), which went public in December, suggested there has been a rise of pre-IPO acquisitions partly because the rate of change in the technology industry cuts the time companies can stay on top.

“As an entrepreneur you ask, should you sell now and cash in or bet that you have the longevity to last for the next five or seven years?” he said.

Larger technology companies are also buying businesses and growing faster than they used to, Vasudevan said. Companies in the technology industry like Google Inc. and Yahoo! Inc. have been on a buying spree, providing alternatives to an IPO. Google last month announced a $3.2 billion deal for thermostat maker Nest Labs Inc. Yahoo has purchased a series of startups as CEO Marissa Mayer attempts to turn the Internet company around.

Strategic Buyers

Selling to another company also helps avoid the costs of going public, which increased after new regulations were introduced in the early 2000s. In a report published in 2012, PricewaterhouseCoopers LLP found that almost half of companies surveyed said complying with Sarbanes-Oxley Act ahead of an IPO cost from $100,000 to $500,000, with 13 percent of respondents saying it cost more than half a million dollars.

In a speech last week, SEC Commissioner Michael Piwowar said he welcomed a tick-size pilot even as he sounded a note of skepticism.

“Even if increasing the tick size does not produce the benefits that proponents suggest it will, a pilot program will provide useful information about the dynamics of liquidity in our equity markets,” he said.

Nimble’s Vasudevan said the pricing increment for his stock was never a consideration when deciding to go public. The $3 billion company’s shares have almost doubled (NMBL:US) since their debut, with volume averaging about 220,000 a day in 2014.

He said tick sizes weren’t an issue and that the success of the company would determine the stock’s popularity. Only if management failed “would it be such an illiquid stock that we’d be in a zombieland of not enough interest,” Vasudevan said.

To contact the reporter on this story: Sam Mamudi in New York at smamudi@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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