February 10, 2025
Stock Brokers

Meaning, Rules and Regulations, FAQs


What Is Sub-Penny Trading?

Sub-penny trading is a practice where brokers and dealers trade in unseen, unregulated markets in increments of less than a penny. They trade through wholesalers, dark pools, and lit exchanges.

The Sub-Penny Rule (SEC Rule 612) of 2005 prevents exchanges governed by the U.S. Securities and Exchange Commission (SEC) from quoting trades in increments of less than a penny. This limitation can result in an artificially wide National Best Bid and Offer (NBBO) which is the pricing benchmark used by off-exchange market-makers.

Key Takeaways

  • Sub-penny trading is completed in an undisplayed market center such as a dark pool.
  • Retail brokers accept sub-pennying orders because they’re permitted to secure the best possible prices for their clients even if the trades aren’t on an exchange.
  • The SEC introduced Rule 612 in 2005 to prevent exchanges from quoting in increments of less than a penny.
  • The access fee is often included in a broker’s commission so they’re incentivized to find orders that don’t necessarily pay these fees.

Understanding Sub-Penny Trading

Exchanges and electronic communication networks (ECNs) charge access fees to any market participant who takes a displayed offer or hits a displayed bid in exchange for providing liquidity. Participants who display the bid or offer are provided with a rebate in exchange for providing liquidity. The resulting fee is capped at $0.003 per share by the SEC. It can’t exceed 0.3% if the protected quotation is less than $1.

Sub-penny trading occurs when a market participant in an undisplayed market center such as a dark pool steps ahead of a displayed limit order by a fraction of a cent and captures the spread. The buyer receives a better deal but the seller misses out on the opportunity to fill the order and the liquidity provider doesn’t receive any rebates.

Retail brokers accept sub-pennying orders because they’re allowed to secure the best possible price for their clients even if the trade isn’t on an exchange or ECN. The access fee is often included in a broker’s commission so they’re incentivized to find orders that don’t necessarily pay these fees.

New Rules and Regulations

The SEC introduced Rule 612, the Sub-Penny Rule, in 2005 to address the increment issue. The rule states that the minimum price increments for stocks over $1 must be $0.01. Stocks under $1 can increment by $0.0001.

The rule banned sub-penny quoting but not sub-penny trading so the practice of sub-penny trading persisted in the off-exchange markets following the rule.

The consensus stood that price increments of $0.0001 were economically insignificant when Rule 612 was adopted in 2005 and that only sophisticated investors would use these smaller increments to step ahead of retail investors. Others argued that technology hadn’t advanced enough to properly handle an increase in on-exchange quoting for sub-penny trading.

SEC Chair Gary Gensler directed SEC staff in June 2022 to potentially allow stock exchanges to quote shares in increments of less than $.01. This enabled venues such as Nasdaq or the New York Stock Exchange to better compete with wholesalers and they often beat the publicly displayed prices on exchanges by adding or subtracting hundredths of a penny to the price of a stock.

The SEC introduced a study in 2015 that called for the widening of increments or ticks but changes didn’t occur until June 2022 when SEC Chair Gary Gensler addressed the future of sub-penny trading on exchanges including standardizing tick size across different market centers.

How Does a Sub-Penny Trade Work?

Assume a stock is quoted at .75 x .76 when a retail investor is looking to sell 1,000 shares. A competing market maker has a hidden bid of .7510 for 1,000 shares when putting in a sell limit order at .75. The hidden bid buys the 1,000 shares and the customer is filled at .7510 on the 1,000 shares when they submit the sell order rather than .75 as shown in a regulated exchange market.

Where Can I Buy Sub-Penny Stocks?

Changes were being considered in 2022 by the SEC to trade sub-penny stocks on the regulated exchanges but sub-penny trading only occurs on dark pool markets as of 2024. These are private exchanges for trading securities that aren’t accessible by the investing public.

Is Sub-Penny Trading Regulated?

Sub-penny trading is unregulated and completed in an undisplayed market. “Sub-pennying” refers to bids floated by brokers, dealers, and high-frequency traders who often use a limit order with a hidden bid that’s a fraction of a penny better. They get their transactions executed first by doing this, giving bidders the best chance to capture the spread.

The Bottom Line

SEC Chair Gary Gensler introduced some changes to the practice of sub-penny trading in June 2022. One change involved allowing regulated exchanges to trade these stocks. They’re still only available on dark pool markets or through wholesalers or lit exchanges as of 2024, however.

Other SEC rules apply to sub-penny trading as well. Exchanges can’t quote in increments of less than a penny and access fees are often included in a broker’s commission. Speak with a knowledgeable professional to make sure you understand all the ropes before wading into any new trading option.



Source link

Leave a Reply

Your email address will not be published. Required fields are marked *