(Reuters) - U.S. regulators are considering whether stocks of small companies should be priced in increments of more than a penny, a change that could affect more than two-thirds of listed companies.
The Securities and Exchange Commission thought it settled this debate in 2001, when it ruled that stock prices should move in penny increments, ending a practice of quoting stocks in fractions.
But under the JOBS Act passed earlier this year, regulators must reexamine whether bigger increments make sense for smaller companies, as a way to spur more capital formation and trading, which could help employment.
For dealers, who profit from buying shares at one price and selling them at a price that is often one notch higher, increasing the trading increment could bring millions of dollars of additional revenue.
But consumer advocates say dealers' gains are investors' losses, and that trading increments should therefore remain at a penny.
This month, the SEC is expected to publish a report on whether penny ticks have harmed small cap companies. Regulators are likely to study the issue at length, so a decision could be months away, according to people familiar with the SEC's thinking.
A shift in trading increments could affect 70 percent of listed companies, depending on how small company stocks are defined, according to Russell Investments, the Seattle-based fund research and consulting firm. Companies with less than $2 billion in market value are typically considered small capitalization companies.
Brokers say bigger trading increments would allow them to regularly trade shares of companies that they ignore now.
Under the current system of quoting in pennies, if 200,000 shares of a stock trade in a day, and they trade in increments of a penny, dealers could end up sharing $2,000 of profit a day from buying the shares at one price and selling them a penny higher. With such a small pool of potential profits, many dealers will not bother.
If, instead, shares traded in 10-cent increments, that daily profit could be $20,000, big enough for dealers to be interested.
Brokers say higher trading profits would allow them to offer research on small cap companies, which could attract more investors into the market and beef up trading volume.
"We would invest more money in trading and research if and our returns would justify those investments," said Gregory Wright, CEO of ThinkEquity, a San Francisco-based boutique investment bank.
And some investors are sympathetic to that notion.
For some midsize fund managers looking to sell big blocks of shares quickly, having active dealers is crucial.
"We run a small cap portfolio and when you make trades you have to be careful and put out trades at 100 shares a time so that it won't move the markets," said Joseph Doyle, chief investment officer at Morris Capital Advisors LLC in Malvern, Pennsylvania. "A big part of our decision about when to make trades is to get a sense of what the market will bear and how long it will take us to do a given order."
But for retail investors, it's a different story.
Decimal pricing "makes it fairer for retail investors so that they can get a competitively set spread when they buy and sell, instead of an artificially wide spread," said Steven Wallman, a former SEC commissioner from 1994 to 1997 who fought for decimal pricing of stocks. "This saves them money."
Before the SEC ordered the adoption of decimalization in 2001, stocks were quoted in eighths or sixteenths of a dollar. A shift to penny increments allowed investors to more easily compare prices at which securities are quoted, as well as reduce trading costs by narrowing bid-ask spreads.
Under decimalization, "the markets will be easier to understand for the average investor, who is used to dealing in dollars and cents for every-day transactions," then-SEC Chairman Arthur Levitt said at the time, testifying before Congress.
The move was also designed to crack down on spread-related scandals on the floor of the New York Stock Exchange, in which traders would quote a very wide spread between what they offered to pay for a small-capital stock and what they would charge for selling it, pocketing the difference.
But more than 10 years after the change was phased in, the impact of trading in penny increments remains unclear.
Market depth - or the ability of the market to sustain market orders without moving the price of securities - "declined significantly following the switch to decimal pricing, suggesting that large institutional orders from pension funds, mutual funds, and hedge funds may actually suffer from reductions in tick size," Nicolas Bollen, an associate professor of finance at Vanderbilt University, found in a 2003 study.
While wider spreads would encourage brokers to trade small cap stocks as well as devote analyst research to smaller companies, bulge-bracket banks have less of an incentive to push for the change.
These big players typically focus their trading on large cap stocks with substantial volume and liquidity. A company such as Apple Inc trades more than 16 million shares a day, compared with a small-cap company such as Bridgeline Digital Inc, which trades about 112,000 shares daily.
Executives at small-cap companies say wider spreads will hopefully lead to increased after market support, which could encourage emerging growth companies to pursue initial public offerings. But it isn't the only solution.
"Increasing the spreads isn't just the only answer though it's a step in the right direction," said Bridgeline Digital CEO Thomas Massie.
Editing by Alwyn Scott and Bernadette Baum