Barron's

2 June 2003, Mailbag: To the Penny.

To the Editor:
Erin E. Arvedlund's examination of the impact of decimalization on mutual-fund trading costs ("Revisiting Decimals," May 19) raises important concerns, but may be putting the cart before the horse. As a representative of an agency-only brokerage firm that never "shops" orders or trades for its own account in order to avoid conflicts of interests with its customers, I can assure you that we are having no difficulties finding liquidity for our customers on either the floor or, for OTC stocks, on the ECNs. While it's wise for SEC Chairman William T. Donaldson and academics to examine the effects of decimalization, we must be careful not to jump to conclusions. The connection between decimalization and rising trading costs seems tenuous at best. Reducing the tick size to a penny actually makes it less risky for principals (whether market makers or specialists) to commit capital, since only one cent a share is at risk in an adverse move, rather than more than six cents in the case of sixteenths.

There are many more plausible reasons than decimalization that could account for increased trading costs or the decreased appetite for capital commitment (if any) experienced in the post-decimalization period. For instance, broker-dealers may now be less willing to risk losses on behalf of clients who are no longer producing extraordinary profits from IPO purchases. Also, they may be less willing to hold inventory because of the volatility of individual stocks in a market that has brutally punished any company experiencing an earnings miss or corporate scandal. Alternatively, the significant up-tick in volumes that followed decimalization (which ironically may have been caused by decreased per-share trading costs resulting from the well-documented tighter spreads that accompanied decimalization) may have been made up in part by fund managers who as a class increased their overall trading activity. Perhaps such managers traded around core positions as the market traded sideways and thus incurred frequent roundtrip trading costs. Above all, as we reexamine and reinvent our capital markets to keep them the most efficient in the world, let's not forget that correlation does not equal causation.

Joe Gawronski Rosenblatt Securities New York City

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