SEC Calls for "Innovative" Proposals for Thinly Traded Securities

Steven Lofchie Commentary by Steven Lofchie

The SEC called on exchanges and market participants to submit "innovative" proposals aimed at improving the secondary market structure for exchange-listed equity securities traded in lower volumes (a/k/a "thinly traded securities").

The SEC stated that it was seeking proposals concerning thinly traded securities that address (i) instances where the suspension or termination of unlisted trading privileges (or "UTPs") may be applied and (ii) whether exemptive relief from Regulation NMS and other rules under the Securities Exchange Act would enhance trading and liquidity.

Commentary

If the SEC is trying to improve the public willingness to invest in smaller companies, it should focus less on how the securities trade and more on the availability of information about these issuers; e.g., investment research. The outcome of the early 2000s enforcement actions over broker-dealers producing research reports tainted by conflicts of interest were that the regulators adopted rules that significantly raised the costs of producing research and simultaneously deprived firms of a significant amount of the potential benefits of producing research. See generally the Research Chapter of the Broker-Dealer Guide.

The first step that the SEC should take is to conduct a study on whether investment firms find it profitable to produce research regarding small issuers. Assuming that they do not find this activity profitable, the SEC should figure out how it can be made profitable (which may involve living with the existence of some conflicts of interest).

No firm is going to produce research unless there is money to be made from it. If the government determines to kill the possibility of profits so as to avoid conflicts of interest, the side effect of the cure is to stop the product of investment research (i.e., to kill the patient). If there is no research, investors are going to be reluctant to invest, regardless of how "innovative" the markets may be. See also SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies (with Lofchie Comment).

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