©2005 Investment Company Institute. All rights reserved. Information may be abridged and therefore incomplete.
Communications from the Institute do not constitute, and should not be considered a substitute for, legal advice.
[19043]
July 27, 2005
TO: EQUITY MARKETS ADVISORY COMMITTEE No. 27-05
RE: GAO REPORT ON DECIMALIZATION
The U.S. Government Accountability Office has released a report on the impact of
decimal pricing in the U.S. securities markets on retail and institutional investors, market
intermediaries, and options market investors and intermediaries.1 The report notes that since
the move from the use of fractions to decimal pricing, concerns have been raised that the
smaller tick size has made trading more challenging and costly for large institutional investors,
including mutual funds and pension plans, that trade large blocks of shares. The report
analyzes these issues and, as summarized below, concludes that decimal pricing has resulted in
lowered trading costs and reduced market transparency.2
The report found that since the move to decimal pricing, trading costs, a key measure of
market quality, have declined significantly for retail and institutional investors. For
institutional investors in particular, the report suggests that additional factors may have
contributed to reduced trading costs, including for example, the multiyear downturn in stock
prices that began in 2000.
The report also found, however, that while decimalization has lowered trading costs, it
also has reduced market transparency, as the number of shares that are generally displayed as
available for purchase or sale on U.S. stock markets declined significantly. The report explains
that institutional investors became less willing to display large orders in the markets following
the switch to decimalization for fear that competing traders would improve the best quoted
prices by as little as one penny, thereby driving up prices to execute large orders.3 In response,
1 GAO Report: Securities Markets – Decimal Pricing Has Contributed to Lower Trading Costs and a More Challenging Trading
Environment, GAO Report to Congressional Requesters (May 2005). The report can be found at
http://www.gao.gov/new.items/d05535.pdf.
2 The GAO’s conclusion was based on an analysis of trades conducted and related trading costs, a review of
academic, industry and regulatory studies, and interviews of numerous market participants, including pension and
mutual fund investment managers. In support of the GAO Report, the staff from the Securities and Exchange
Commission’s Division of Market Regulation and Office of Economic Analysis said that, overall, the GAO Report
accurately depicted conditions in the markets after the implementation of decimal pricing.
3 This trading strategy, called “penny jumping” or “stepping ahead,” harms institutional investors that display large
orders and can increase their trading costs. The report adds that the potential for stepping ahead has increased in a
2
the report found that institutional investors have adopted new trading strategies and
technologies, such as breaking up large orders into smaller lots and using electronic trading
technologies to submit a larger volume of smaller orders, and making greater use of alternative
trading venues, such as ECNs and crossing networks that anonymously match large
institutional investor orders. The report adds that through these adaptations, institutional
investors have been able to continue executing large orders at reduced costs.
Barry E. Simmons
Associate Counsel
decimal environment as the financial risk to traders stepping ahead of larger displayed orders has been greatly
reduced.