- The Washington Times - Wednesday, May 28, 2003

When decimal trading was introduced in the stock market two years ago, it was touted widely as a benefit to mutual fund investors, who would gain from the smaller price increments. Now the chief of the Securities and Exchange Commission is questioning whether the system might be raising trading costs unduly.

SEC Chairman William Donaldson said in a recent CNBC interview that he believes decimalization, implemented in 2001 from a system of trading in fractions of one-sixteenths (6.25 cents), should be re-examined because of potential harm to small as well as institutional investors.

Mr. Donaldson’s remarks have stirred debate on Wall Street, particularly from traders and exchanges that would stand to profit from fractional trading because of its larger price increments. But many opponents of decimalization conceded it was doubtful that the system would be abolished.

“We do fully support and appreciate the re-examination of the impact of decimal trading,” said John Giesea, chief executive of the Security Traders Association, which sent a letter to the SEC this month endorsing a prompt review.

“We want to understand the impact and suggest remedies,” he said. “But there’s no expectation of a return to fractions. I don’t think that’s a practical answer.”

When the markets converted to decimal trading in 2001, it was considered a boon to small investors who could more easily understand and get better deals under the new system. That’s because if a stock wasn’t available at a given price, investors could buy at a penny higher rather than an increment of 6.25 cents.

But while investors who buy shares in small blocks might be saving money, a recent study by professors Nicolas Bollen of Vanderbilt University and Jeffrey Busse of Emory University suggests penny trading could be hurting mutual fund investors.

The study found that investors of actively managed funds were losing returns of about 1 percent annually owing to higher trading costs. Mr. Bollen explained that smaller price spreads decrease the amount of shares available at any given price; that means big block trades from fund firms are more likely to exceed the number of shares offered, forcing firms to conduct several block trades at different prices. The additional transactions raise fund firm costs, which lower the return.

“For mutual fund investors, it appears that decimalization has hurt market quality,” Mr. Bollen said.

A review of decimalization is supported by New York Stock Exchange Chairman Dick Grasso, who has suggested trading in nickel increments instead, but is opposed by the Investment Company Institute, the trade group for mutual fund firms, which believes the system has helped small investors.

Peggy Peterson, a spokeswoman for House Financial Services Committee Chairman Michael G. Oxley, Ohio Republican, a strong supporter of decimalization, agreed with the ICI, and said other academic studies have indicated that mutual fund investors do benefit from the system.

She suggested that much of the recent criticism has come from Wall Street firms seeking to boost profits in an economic downturn.

“When people complain about decimals, sometimes they’re talking about liquidity. Sometimes they’re talking about decreased profits,” the spokeswoman said. “Retail investors are not going to be happy, particularly in this difficult environment, if spreads are artificially widened and they have to pay more for trades.”

A spokesman for the SEC, meanwhile, said Mr. Donaldson’s comments represented his personal views and that decimalization would be examined as part of a broader review of the market’s structure. No time frame has been set for that review.

“The commission has not formulated a view on decimalization,” said spokesman Herb Perone. “Anything he said about the pros and cons are entirely his own.”


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