The Securities and Exchange Commission (“SEC”) is considering implementation of regulatory changes in order to improve secondary market structures for thinly traded securities. It has announced a request for exchanges, issuers, investors, or other market participants to submit proposals that will facilitate market structure innovations that would meaningfully enhance trading.
Data collected by the SEC’s Division of Trading and Market’s Office of Analytics and Research (“OAR”) in a 2018 market analysis, the Department of Treasury’s 2017 Capital Markets Report, and an SEC Staff Roundtable revealed that the current “one-size-fits-all” approach to market structure is not working well for thinly-traded securities.
The following challenges for both investors and issuers are present for thinly-traded securities under the current market structure:
● Higher transaction costs for investors due to wider spreads and less displayed size relative to securities traded at higher volumes.
● Challenges for investors to establish and/or unwind meaningful positions due to a lack of readily available liquidity.
● Negative impacts for the issuer’s cost of capital due to the less liquid securities1
Potential innovations may require partial of full suspension of unlisted trading privileges (“UTP”) for less liquid stocks or exemptive relief from Regulation National Market System (NMS) and other rules under the Securities and Exchange Act of 1934.
Potential Market Innovations
One potential approach suggests the creation of an exchange specifically for thinly traded securities. Such an exchange could provide market makers with incentives to assume heightened market making obligations for thinly traded securities, perhaps leading them to quote them more frequently and in greater size.2 Additionally, it is expected that an exchange may also explore ways to incentivize market makers to provide additional liquidity during times of both normal market conditions as well as periods of market stress.
Periodic intraday auctions could also be implemented on an exchange, concentrating liquidity at distinct time intervals throughout the trading day. This innovation could help liquidity efficiently coalesce to help market participants to find contra-side liquidity for large orders.3
Another structural change that may be considered to improve liquidity is the introduction of non-automated markets or indicative quoting for thinly traded securities. These approaches could enable an exchange to offer a negotiated market that would potentially address liquidity challenges and facilitate trade negotiation and incentivize market maker participation.
Expectations from Proposals
Effective proposals should include a specific definition of “thinly traded security,” including how the factors below help to define term, and how its thresholds were set, including relevant data and analysis:
● Average daily trading volume
● Number of trades
● Share volume
● Dollar volume
● Market capitalization
● Number of shareholders
● Public float
Proposals are also expected to address whether companies may opt in or out of the exchange, how the benefits outweigh the operational complexity it would create, and potential effects to the broader market structure.
If you or your firm have questions about requests for proposals or the SEC’s strategies to modernize secondary markets, Jacko Law Group and its team of attorneys may be able to help. Contact our team of attorneys today.
 See Commission Statement on Market Structure Innovation for Thinly Traded Securities, Release No. 34-8732 (Oct. 17, 2019), available at https://www.sec.gov/rules/policy/2019/34-87327.pdf.
Robert D. Conca is a Partner at Jacko Law Group, PC. His practice includes representation of investment advisers, broker-dealers, private funds, and non-financial industry companies, and their personnel, in a variety of ...
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