Securities Markets: Preliminary Observations on the Use of	 
Subpenny Pricing (22-JUL-04, GAO-04-968T).			 
                                                                 
In 2001, U.S. stock and options markets, which had previously	 
quoted prices in fractions, began quoting in decimals. Since	 
then, various positive and negative effects have been attributed 
to the transition to decimal pricing. As part of this transition,
the major stock markets chose one penny ($.01) as the minimum	 
price variation for quoting prices for orders to buy or sell.	 
However, some electronic trading systems allowed their customers 
to quote in increments of less than a penny (such as $.001). The 
use of subpenny prices for securities trades has proved 	 
controversial and the Securities and Exchange Commission (SEC)	 
has proposed a ban against subpenny quoting for stocks priced	 
above one dollar across all U.S. markets. As part of ongoing work
that examines a range of issues relating to decimal pricing, GAO 
reviewed (1) how widely subpenny prices are used and by whom, (2)
the advantages and disadvantages of subpenny pricing cited by	 
market participants, and (3) market participants' reactions to	 
SEC's proposed ban.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-968T					        
    ACCNO:   A11095						        
  TITLE:     Securities Markets: Preliminary Observations on the Use  
of Subpenny Pricing						 
     DATE:   07/22/2004 
  SUBJECT:   Brokerage industry 				 
	     Competitive advantage				 
	     Electronic data interchange			 
	     Price regulation					 
	     Prices and pricing 				 
	     Stock exchanges					 
	     Stocks (securities)				 
	     Banned practices					 

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GAO-04-968T

United States Government Accountability Office

GAO Testimony

Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs

For Release on Delivery

Expected at 10:00 a.m. EDT SECURITIES MARKETS

Thursday, July 22, 2004

            Preliminary Observations on the Use of Subpenny Pricing

Statement of Davi M. D'Agostino, Director Financial Markets and Community
Investment

GAO-04-968T

Highlights of GAO-04-968T, a report to Committee on Banking, Housing, and
Urban Affairs

In 2001, U.S. stock and options markets, which had previously quoted
prices in fractions, began quoting in decimals. Since then, various
positive and negative effects have been attributed to the transition to
decimal pricing. As part of this transition, the major stock markets chose
one penny ($.01) as the minimum price variation for quoting prices for
orders to buy or sell. However, some electronic trading systems allowed
their customers to quote in increments of less than a penny (such as
$.001). The use of subpenny prices for securities trades has proved
controversial and the Securities and Exchange Commission (SEC) has
proposed a ban against subpenny quoting for stocks priced above one dollar
across all U.S. markets.

As part of ongoing work that examines a range of issues relating to
decimal pricing, GAO reviewed (1) how widely subpenny prices are used and
by whom, (2) the advantages and disadvantages of subpenny pricing cited by
market participants, and (3) market participants' reactions to SEC's
proposed ban.

www.gao.gov/cgi-bin/getrpt?GAO-04-968T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Davi D'Agostino at (202)
512-8678 or [email protected].

July 22, 2004

SECURITIES MARKETS

Preliminary Observations on Subpenny Pricing

Data on the extent to which market participants are quoting in subpenny
increments across all U.S. equity markets are not routinely reported or
readily available. However, studies of limited scope conducted by
regulators and one market found that subpenny prices were not widely used.
For example, a study done by the Nasdaq Stock Market in 2001 of Nasdaq
stocks found that subpenny increments were used in less than 15 percent of
the orders that specified a price (limit orders). Currently, the major
markets do not allow subpenny quoting but a few electronic trading systems
that match customer orders do.

On electronic trading systems, professional traders (such as those
employed by hedge funds) use subpenny quotes to gain a competitive price
advantage over other orders. However, many market participants GAO
interviewed cited numerous disadvantages to the use of subpenny quoting.
They argued that subpenny quotes primarily benefit the professional
traders who subscribe to market data systems displaying subpenny prices
and who use fast systems to transmit their orders to take advantage of
such prices. As a result, most investors do not benefit from subpenny
quotes because they do not use these systems and because many
broker-dealers do not accept orders from their customers in subpenny
increments. In addition, participants said that subpenny quotes allow some
traders to step ahead of others' orders for an economically insignificant
amount. They said this discourages other traders from submitting limit
orders and reduces overall transparency and liquidity in the markets.

Based on the work GAO has conducted to date, including a limited review of
comments on SEC's proposal to ban subpenny quoting, most market
participants support SEC's proposed action. However, some organizations
opposed to the ban said that it could reduce the ability of traders to
offer better prices and stifle technological innovation and reduce market
participants' incentive to invest in better systems. Although some
electronic trading systems supported the ban, others indicated that the
decision to use subpenny quotes should be left to market participants who,
as technology advances, may increasingly find subpenny quotes more useful
than they do today.

In addition to reviewing subpenny pricing, GAO continues to review the
broader impacts of decimal pricing on markets, securities firms, and
investors. As part of this work, we plan to conduct original analysis
using a comprehensive database of trades and quotes from U.S. markets to
identify trends in quoted spreads, clustering of quotes and trades across
certain prices, and other potential changes since decimal pricing was
introduced.

Mr. Chairman and Members of the Committee:

It is a pleasure to be here today to participate in this important hearing
on market structure issues. As you requested, my statement today will
focus on the use of subpenny quotes in the securities markets. I also will
describe the work we are conducting for this Committee's Subcommittee on
Securities and Investment as part of our ongoing broader study of the
impact of decimal pricing on the securities markets, firms, and investors.

Many changes have occurred since the U.S. markets transitioned from
pricing stocks and options in fractions of a dollar to using decimal
prices. Many participants cite decimal pricing as providing benefits to
small investors, but others argue that it has contributed to lower
liquidity and reduced the willingness and ability of securities firms to
execute their customers' orders. As part of the transition to decimal
prices, the major stock markets chose one penny as the minimum price
variation (MPV), which is the minimum increment in which the prices of
stocks on these markets are allowed to be quoted. However, some electronic
trading systems allow their customers to quote in increments of less than
a penny. The use of subpenny prices for stock trades has proven
controversial, and the Securities and Exchange Commission (SEC) has
proposed a ban against subpenny quoting for stocks priced above one dollar
across all U.S. markets.1

Today, I will discuss the preliminary results of our review of subpenny
pricing issues, including:

o  how widely subpenny pricing is used and who uses it,

o  	the advantages and disadvantages of subpenny pricing, as reported by
market participants, and

o  	the reactions of market participants to SEC's proposed ban on subpenny
quoting.

To address these issues, we interviewed a variety of market participants,
including regulators, markets, electronic trading systems, broker-dealers,
industry associations, trade analysis firms, and institutional investors.
We

1Securities Exchange Act Release No. 49325 (February 26, 2004), 69 FR
11126 (March 9, 2004).

also reviewed relevant studies, testimonies, and comment letters on SEC's
regulatory proposal. Our work is ongoing, and we expect to report on the
broader range of decimal pricing issues later this year.

In summary:

Although data on the extent to which market participants are quoting in
subpenny increments are not routinely reported or readily available, the
use of subpenny quotes in U.S. equity markets appears to be limited.
Currently, the major markets do not allow subpenny quoting but a few
electronic trading systems that match customer orders do. Professional
traders using those electronic trading systems have used subpenny quotes
to gain a competitive price advantage over other orders. The general
investing public does not use such systems and can usually see prices only
in penny increments.

Although some market participants saw benefits to subpenny pricing, most
cited various disadvantages to the use of subpenny quotes. The advantages
market participants cited included gaining order priority, price
improvement, and more competitive and efficient markets. However, other
market participants cited disadvantages. For example, subpenny quotes
primarily benefit professional traders who subscribe to market data
systems displaying subpenny prices and who use fast order routing systems
to access prices. These prices are usually not available to the general
investing public. In addition, market participants noted subpenny quotes
allow some traders to step ahead of others' orders for an economically
insignificant amount. Finally, they argued that this stepping ahead
discourages other traders from submitting limit orders, which reduces
overall transparency and liquidity in the markets.2

Based on the work we have conducted to date and a limited review of some
of the comments on SEC's proposal to ban subpenny quoting, most market
participants appear to support SEC's proposed action. However, some
organizations opposed to the ban said that it could reduce the ability of
traders to offer better prices and stifle technological innovation and
reduce market participants' incentive to invest in better systems.
Although some electronic trading systems supported the ban, other

2A limit order is a request to buy or sell stock at a specific price. In
contrast, a market order does not set a specific price but is executed at
the best price quoted at the time the order is received by the executing
market.

electronic trading systems indicated that the decision to use subpenny
quotes should be left to market participants who, as technology advances,
may increasingly find subpenny quotes more useful than they do today. We
are also continuing to review the broader impacts of decimal pricing on
markets, securities firms, and investors. As part of this work, we also
plan to conduct original analysis using a database of trades and quotes
occurring on U.S. markets to identify trends in quoted spreads, clustering
of quotes and trades across certain prices, and other potential changes
since decimal pricing was introduced.

Background 	In 2000, in response to calls from Congress, SEC directed U.S.
stock and options markets to change from quoting equity securities and
options in fractions of a dollar, such as 1/16th, to quoting in decimals.
Proponents of this change believed decimal pricing would make stock prices
easier for investors to understand, align U.S. markets with other major
stock markets of the world, and lower investors' trading costs by
narrowing spreads to as little as one penny.3 At the time of SEC's order,
U.S. markets were the only major securities markets in the world still
trading in fractions. After a phase-in period of several months, the major
exchanges and Nasdaq began using decimal pricing for all quotes on equity
securities and options on April 9, 2001. The national securities markets,
including the New York Stock Exchange (NYSE) and Nasdaq, chose to allow
quoting on their markets with an MPV, or tick size, of one penny. The MPV
is the minimum increment in which stock prices on these markets are
allowed to be quoted.4 However, even before the transition to decimal
pricing, some stocks were trading in increments of less than the MPV, such
as 1/256th of a dollar.

3The spread is the difference between the lowest price at which an
investor is willing to sell stock and the highest price another investor
will pay for it. This spread represents a trading cost to investors, since
in a hypothetical round-trip trade in which an investor buys the stock and
then immediately sells it, the price paid exceeds the price received.
Narrowing the spread can lower purchase prices and raise sale prices,
reducing trading costs.

4Securities Exchange Act Release No. 46280 (July 29, 2002), 67 FR 50739
(August 5, 2002).

  Professional Traders on Electronic Markets Are the Primary Users of Subpenny
  Quotations

Since U.S. markets converted to decimal pricing, professional traders
trading outside the national securities markets have been the primary
users of subpenny prices. Although the national securities markets set
their MPVs at one penny, several electronic trading systemsknown
as electronic communication networks (ECNs)display quotes and
execute orders entered by their customers in subpennies and allow traders
to quote prices and trade in subpenny increments.5 When quotes from these
proprietary systems are displayed to traders outside the proprietary
systems, the quotes are rounded to the nearest full penny increment-
specifically, down for buy orders and up for sell orders-to comply with
the required one-penny MPV of the national securities markets. In such
instances, orders executed against these quotes receive the subpenny
price. According to SEC staff and others, although several ECNs initially
allowed quoting in subpennies, some have curtailed the use of such quotes.
At the time we prepared this statement, we were aware of only two ECNs
that allowed quoting in subpennies-Instinet's INET and Brut ECN-for a few
selected stocks.

The extent to which stocks are quoted in subpenny increments appears to be
limited. According to SEC staff, data on the extent to which subpenny
increments are used to quote securities across all U.S. equity markets are
not routinely reported or readily available. However, a 2001 Nasdaq report
to SEC that reviewed trading in stocks listed on its market showed that
less than 15 percent of limit orders were submitted in subpennies after
decimals were introduced.6 A vast majority of the subpenny limit orders
cited in the 2001 Nasdaq report were handled by a single ECN. SEC staff
also conducted a study of the use of subpennies in trading that took place
between April 21 and 25, 2003, and found that subpenny trades accounted
for about 13 percent of trades in Nasdaq stocks, 10 percent of trades in
American Stock Exchange stocks, and 1 percent of the trades in NYSE
stocks. These trade execution data, however, do not directly demonstrate
the extent of subpenny quoting, because trades may be executed using the
subpenny increment for other reasons. For example, some institutional
investors may ask their broker-dealers to execute orders at the weighted

5ECNs are a type of alternative trading system that use electronic systems
to match their customers' orders to buy or sell securities at specified
prices. ECNs register with SEC as broker-dealers.

6The Nasdaq Stock Market, Inc., Final Report to the SEC, The Impact of
Decimalization on the Nasdaq Stock Market (New York, New York: June 11,
2001).

  Market Participants Cited Advantages and Disadvantages to Subpenny Pricing

average price at which a stock traded on a particular day. This weighted
average price can be carried out to several decimal places.

Representatives of one ECN told us that it allowed traders to quote
certain stocks in subpennies because its customers wanted to be able to
quote in these increments. They also said that this use of subpenny quotes
was a way to differentiate their business from that of their competitors.
In addition, these ECN representatives said that subpenny quoting enhanced
the efficiency of trading in certain actively traded securities, such as
the Nasdaq 100 Index Tracking Stock (QQQ). According to SEC staff and
market participants with whom we spoke, subpenny quotes are used primarily
by professional traders, such as day traders or traders for hedge funds,
to gain a competitive price advantage over other traders.7 However, some
ECNs that were allowing their customers to use subpenny quoting more
widely have significantly curtailed the number of stocks that could be
quoted in subpennies. According to a representative at one ECN, its share
of the total trading volumes of these stocks increased rather than
declined after it stopped quoting in subpennies.

Although some market participants saw benefits to subpenny pricing, most
cited various disadvantages to the use of subpenny quotes. Some market
participants said subpenny quoting allowed traders to raise the priority
of their orders. For example, a representative of one ECN told us that
when a large number of traders were all quoting the same full penny price,
one trader could increase the chances of executing a trade by improving
the price by a subpenny increment. This representative also said that the
customers on the other side of the trade also benefited from the subpenny
increment, as their orders were executed at slightly better prices. ECNs
we contacted also told us that subpenny pricing allowed for more efficient
and competitive markets. For example, a one-cent MPV could act as an
artificial constraint on pricing for stocks that trade actively. According
to representatives of one ECN, allowing such actively traded stocks to
trade in increments of less than a penny allows buyers and sellers to
discover a stock's true market price.

7Day traders use a trading strategy that involves making multiple
purchases and sales of the same securities throughout the day in an
attempt to profit from short-term price movements via direct access to
securities markets. Although there is no statutory definition of hedge
funds, it is the term commonly used to describe private investment
vehicles that often engage in active trading of various types of
securities and commodities.

However, most of the market participants we contacted mainly cited
disadvantages to subpenny quoting. First, many participants told us that
the benefits of subpenny pricing accrue to professional traders but not to
the general investing public. Representatives of one firm with whom we
spoke told us that quotes in subpenny increments were available to
professional traders who pay to access proprietary trading systems the
ECNs operate. Through these proprietary systems, professional traders can
use fast order routing systems to obtain the subpenny prices, which may be
better than those that are publicly displayed on other markets that use
one-cent MPVs. According to market participants, many brokerdealers do not
accept orders from their customers in subpenny increments, and so the
average investor generally cannot access the subpenny quotes. A
representative of a large broker-dealer stated at an April 2004 SEC
hearing that his firm had stopped allowing clients to submit orders priced
in subpenny increments for this reason. Further, representatives at one
securities market argued that the integrity of the securities markets was
reduced when some traders have advantages over others.

Many of the market participants we contacted told us that quoting in
subpenny increments also resulted in more instances of traders "stepping
ahead" of large limit orders. According to some market participants,
reduced MPVs that accompanied decimal pricing have negatively affected
traders displaying large orders at one price. These traders find that
their orders go unexecuted or have to be resubmitted when other traders
step ahead of them by quoting a better price in increasingly small
amounts. These participants argued that at higher MPVs, which were
previously 1/8th or 1/16th of a dollar per share, traders stepping ahead
of other orders were taking a greater financial risk if their orders were
executed and prices then moved against them. However, market participants
with whom we spoke said subpenny increments were generally an economically
insignificant amount and that traders using them faced much lower
financial risk. Recent SEC and Nasdaq studies of subpenny trading found
that most trades executed in subpenny increments clustered at prices
1/10th of a cent above and below the next full penny increment, suggesting
that subpenny quotes were primarily being used to gain priority over other
orders and were not otherwise the result of natural trading activities.
Market participants also told us that the more likely it is that a trader
can step ahead of other orders-as they can by using subpenny quotes-the
less likely traders are to enter their limit orders, which are an
important source of liquidity. This reduced incentive to enter limit
orders also reduces the number of shares displayed for sale and
potentially affects liquidity and market efficiency.

Furthermore, some market participants also saw subpenny quoting as
reducing market transparency for retail investors and depth for
institutional investors. When the MPV decreases, for example to
subpennies, the number of potential prices at which shares can be
quoted-called price points-increases, because displayed liquidity is
spread over more price points. For example, subpenny quotes using 1/10th
of a penny ($.001) increase the number of price points to 1,000 per
dollar. This affects retail investors, because fewer shares are generally
quoted at the only prices visible to them-the current best prices for
purchase or sale. This affects institutional investors, because the more
price points that must be considered, the more difficult it becomes to
determine whether sufficient shares are available to fill larger orders.
Market participants said that quotes in a subpenny pricing environment
change more rapidly (a phenomenon known as quote flickering) and make
determining the actual prices at which shares are available more
difficult. Quote flickering reduces broker-dealers' ability to determine
whether the trades they have conducted satisfy their regulatory
responsibility to obtain the best execution price for their clients.
Finally, some market participants told us that subpenny pricing has the
potential to greatly increase the processing and transmission capacity
requirements for the market data systems that transmit price and trade
information, causing firms to expend resources to redesign electronic
systems.

SEC's proposed rule to prohibit market participants from pricing stocks in
increments of less than one penny appears to be widely supported. As part
of its proposed rule changes to Regulation NMS, SEC has proposed
establishing a uniform pricing standard for stocks that trade in all
market centers, which SEC defines as exchanges, over-the-counter market
makers, specialists, and ECNs. Specifically, SEC proposes to prohibit
market participants from accepting, ranking, or displaying orders, quotes,
or indications of interest in a pricing increment finer than a penny in
any stock, unless the stock has a share price of less than one dollar. The
proposed rule would not prohibit executing trades in increments of less
than one penny, which most markets currently permit, because there are
instances when subpenny trading is appropriate-for example, when the
trade's price is based on some averaging mechanism. According to SEC
staff, this change would address differences in pricing that exist across
markets and that benefit some investors at the expense of the general
investing public. According to the staff, banning subpenny pricing should
also reduce the extent to which limit orders lose priority because of
subpenny pricing, thereby preserving incentives to display limit orders,
which are an important source of liquidity for the markets.

  SEC's Proposal to Ban Subpenny Quoting Appears to Have Widespread Support

Most market participants we have contacted to date and most commenting on
SEC's proposal appear to support a ban on subpenny pricing for stocks
priced at more than one dollar. Of the over 500 comment letters available
on SEC's Web site as of July 16, 2004, we determined that about 50
provided comments on the proposed ban. Of these, 86 percent of the
commenters supported banning subpenny quoting. According to NYSE and
Nasdaq representatives with whom we spoke, the current existence of quotes
that not all investors can access is a significant reason for their
support of SEC's proposed subpenny prohibition. Nasdaq's support for
banning subpenny quoting comes despite filing for a proposed rule change
with SEC in 2003 that would permit Nasdaq to adopt an MPV of 1/10th of one
cent for its listed securities. According to the Nasdaq representatives,
if SEC does not prohibit subpenny quoting, Nasdaq would want SEC approval
to begin quoting in subpennies in order to compete with ECNs. Nasdaq
subsequently withdrew its propsed rule change, presumably because SEC is
proposing to ban subpennies in its proposed changes to Regulation NMS.
Representatives at several institutional investors and broker-dealer firms
also agreed that quoting in subpenny increments should be prohibited. In
its June 30, 2004, comment letter to SEC, the Investment Company Institute
(which represents the interests of the $7 trillion mutual fund industry)
stated that quoting in subpennies eliminates many of the benefits brought
by decimal pricing and exacerbates many of the unintended consequences
that have arisen in the securities markets since its implementation that
have proven harmful to mutual funds and their shareholders.

However, other market participants and other commenters opposed SEC's
proposal to ban subpenny quoting. Several of the organizations that
opposed a ban said that subpenny quotes allow traders more ability to
improve the prices they offer to others. A group of 10 academic
researchers that commented to SEC argued that the impacts of subpenny
quoting on market transparency could be resolved with technology. For
example, data vendors can choose to update quotes only when there are
meaningful changes. A letter from a university regulatory research center
noted that banning subpenny quoting could stifle innovation in the way
that quotes are displayed to investors. For example, graphical displays
could replace flickering quotes with fluid motion and use patterns and
shapes to help investors recognize changes. A ban could also reduce
incentives for other market participants to invest in innovative
technologies.

Opinions among some ECNs were mixed, with roughly an equal number
supporting and opposing SEC's proposal to ban subpenny quoting.

  GAO's Review of the Impacts of Decimal Pricing Is Ongoing

Representatives of two ECNs indicated that SEC should not enact a ban,
arguing that tick size is best determined by demand in the marketplace.
Furthermore, representatives of two ECNs noted that stocks that trade at a
spread of a penny benefit from the increased efficiency afforded by
subpenny increments; one representative noted that a penny MPV
artificially constrains price discovery for these stocks. In addition,
this representative said that stocks with low share prices should be
quoted in subpenny increments because subpennies become economically
significant when the share price is a few dollars or less. Finally, these
representatives said that as more traders and firms upgrade their trading
technology, they may find more advantages from quoting in subpennies and
that a regulatory ban enacted now might become an unpopular constraint in
the future. One of the ECNs is supporting SEC's proposal to ban subpenny
quoting because its customers preferred not to have subpennies used on
that ECN's system. At the time we prepared this statement, we had not yet
talked to entities that are reported to be key users of subpenny quotes
and who may be opposed to SEC's proposal, such as day traders, hedge
funds, or entities whose sole business is computer-enabled trading.

At the request of this Committee's Subcommittee on Securities and
Investment, we are conducting additional work to review the impact of
decimal pricing on the securities markets, securities firms, and retail
and institutional investors. To conduct this work, we are reviewing
relevant regulatory, academic, and industry studies that address decimal
pricing impacts. We are also interviewing and obtaining information from
market participants, including:

o  regulators;

o  securities markets, including stock and options markets;

o  ECNs;

o  	securities firms, including broker-dealers that conduct large-block
trading, market makers, and exchange specialists;

o  	industry associations, including those representing securities
traders, broker-dealers, and mutual funds;

o  trade analysis firms;

o  	institutional investors, including pension and mutual fund investment
managers; and

o  academic researchers who have studied trading and decimal pricing.

To identify trends and changes since decimal pricing was introduced, we
are also attempting to collect and analyze data on the characteristics of
markets, firms, and investors and the impact of decimalization on these
entities (table 1).

Table 1: Data Being Collected on Decimal Impact Review

Area affected Examples of data

Markets  o  spreads

o  market liquidity

o  trading volumes

o  price volatility

Securities firms  o  number of active market makers

o  number of market makers per stock

o  firm profitability

Investors  o  trading costs

Source: GAO.

In addition, we plan to conduct research and analysis using a
comprehensive electronic database of quotes and trades that have occurred
on U.S. stock markets. The Trade and Quote (TAQ) database offered by NYSE
consolidates all quotes and trades that have occurred on NYSE, Nasdaq, the
American Stock Exchange, and the regional exchanges. As part of this
research, we plan to expand and extend analysis done for a recently
published study on the impact of decimal pricing on trade execution costs
and market quality, including volatility and liquidity.8

8Hendrik Bessembinder, "Trade Execution Costs and Market Quality after
Decimalization," Journal of Financial and Quantitative Analysis, vol. 38,
no. 4 (December 2003), pp. 747

77. This study looks at 300 NYSE and 300 Nasdaq stocks from the second
week of January 2001 through August 2001. The TAQ database is a collection
of intraday trades and quotes for all securities listed on NYSE, the
American Stock Exchange and Nasdaq. TAQ data do not contain information on
orders.

Among the types of information we plan to analyze using this database are:

o  quoted spreads,

o  quotation sizes (i.e., number of shares being quoted),

o  	the percentage of trades and shares executed at prices less or greater
than the best quoted price prevailing at the time of executions, and

o  the volatility of returns from investing.

Observations

We plan to use this analysis to shed light on how trade execution costs
and market quality may have changed in transitioning from a fractional to
a decimal pricing environment. In addition to the variables considered in
the published study, we plan to gather data on trade size and the numbers
of trades and quotes that may provide evidence on changes in trading
behavior. We also plan to analyze the TAQ data to identify whether and to
what extent clustering occurs when quotes or trade executions occur more
frequently than would be expected at particular price points (e.g.,
multiples of 5 cents and 10 cents) despite the existence of the one-cent
tick.

Because we are continuing to review issues relating to decimal pricing, we
do not have definitive conclusions on subpenny pricing at this time. Our
work to date has shown that subpenny quoting can provide advantages to
some traders but can also create disadvantages to others and potentially
impair incentives to display liquidity. A significant majority of market
participants appear to support SEC's proposed ban on quoting in
subpennies, but little information is available on the impact of using
these quotes. On the one hand, given that such quotes are currently used
only in a few trading venues and for a limited range of stocks, SEC's
proposed ban would probably not result in a significant change for the
overall markets or most investors. On the other hand, if SEC did not ban
subpenny quotes, it is possible that exchanges and more markets would want
to quote in subpennies-a change that could have a significant impact on
U.S. equity markets. Still, a ban would take away the ability of
individual markets and investors to choose whether to use subpenny quotes
if they decide their use would be advantageous. Subsequent changes in
market structure, technology, and investor needs could require SEC to
reconsider whether the use of subpenny quotes would be appropriate at some
future date.

  GAO Contacts and Staff Acknowledgement

(250208)

Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions that you or Members of the Committee may have.

For questions concerning this testimony, please contact Cody Goebel at
(202) 512-8678 or [email protected]. Other key contributors to this
statement were Jordan Corey, Emily Chalmers, Joe Hunter, Kathryn Supinski,
and Richard Vagnoni.

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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