Sub-Penny Rule

The sub-penny rule sets the minimum pricing increment for a national market system (NMS) stock. It is a quoting and order-handling rule. Which increment applies at or above $1.00 per share is a property of the stock rather than of the order, because the spread is measured per NMS stock. Below $1.00 per share the increment is $0.0001 whatever the stock.

The nickname is only half accurate. The rule does permit a sub-penny increment where a bid or offer, order or indication of interest is priced at or above $1.00 per share and the stock's Time Weighted Average Quoted Spread was $0.015 or less. So the flat statement that nothing finer than a penny is allowed at or above $1.00 covers one tier only.

Who Is Bound by the Sub-Penny Rule, and What Is Barred?

The prohibition binds five categories of person:

• A national securities exchange
• A national securities association
• An alternative trading system
• A vendor
• A broker or dealer

A vendor here is any securities information processor engaged in the business of disseminating transaction reports, last sale data, or quotations with respect to NMS securities to brokers, dealers, or investors on a real-time or other current and continuing basis, whether through an electronic communications network, moving ticker, or interrogation device.

None of those five may display, rank, or accept from any person any of three things in an NMS stock in a prohibited increment:

• A bid or offer
• An order
• An indication of interest (IOI)

An indication of interest has to be named separately because the definition of a bid or offer expressly excludes indications of interest.

Exam Tip: Gotchas

• The rule names three acts, and accepting is one of them. A firm that never displays or ranks a sub-penny price still breaches the rule by accepting one from any person.
• The rule does not name an execution price. It reaches a bid or offer, an order and an indication of interest, which is why a sub-penny execution can occur.
• A vendor is inside the prohibition. A securities information processor disseminating quotations is bound alongside the exchanges, associations, alternative trading systems and broker-dealers.

What Are the Permitted Increments?

The permitted increment turns first on the price of the bid, offer, order or indication of interest, and then, at or above a dollar, on the stock's own quoted spread:

The two upper tiers sit inside one paragraph that applies to anything priced equal to or greater than $1.00 per share. The bottom tier is a separate paragraph, binding the same five persons, for anything priced less than $1.00 per share.

Exam Tip: Gotchas

• A half-cent increment is permitted on a tight-spread stock. Where the Time Weighted Average Quoted Spread was $0.015 or less, the minimum increment at or above $1.00 is $0.005, so a sub-penny quotation can be entirely lawful.
• Which of the two upper tiers applies is a property of the stock, not of the order. Two orders at the same price at or above $1.00 in two different stocks can face different minimum increments, because the spread measurement is made per NMS stock.
• The $0.0001 tier is a separate prohibition with the same five persons. It is not an exception carved out of the dollar-and-above paragraph, and it applies to a bid or offer, an order or an indication of interest priced under $1.00.

How Is the Spread Measured, and When Does an Increment Take Effect?

Time Weighted Average Quoted Spread means the average dollar value difference between the national best bid and the national best offer during regular trading hours, where each instance of a unique national best bid and national best offer is weighted by the length of time that quote prevailed as the national best bid or national best offer.

The Evaluation Period for this rule means two windows: the three months from January through March of a calendar year, and the three months from July through September of a calendar year, during which the primary listing exchange measures a stock's Time Weighted Average Quoted Spread to determine the minimum pricing increment for each NMS stock.

Each measurement then becomes operative on a fixed date:

These definitions are set for the purposes of the sub-penny rule only. The Evaluation Period used to assign a stock's round lot is a different measurement on different months, and the two must not be merged.

Exam Tip: Gotchas

• The measurement months and the operative months are different. A spread measured over January through March does not govern anything until the first business day of May, and it then runs to the last business day of October.
• The November assignment crosses into the next calendar year. It runs from the first business day of November through the last business day of April of the following year, so a January quotation is governed by the prior July through September measurement.
• Two Evaluation Periods exist in Regulation NMS and they are not the same one. The round lot version looks at all trading days in March and in September, while this one looks at three-month quarters, and each is scoped to its own rule.

What Increment Does a New NMS Stock Get?

Any security that becomes an NMS stock during an operative period is assigned a minimum pricing increment of $0.01 for bids or offers, orders, or indications of interest priced equal to or greater than $1.00 per share.

That paragraph speaks only to that side of the dollar threshold. Anything priced below $1.00 is governed by the $0.0001 increment, because the under-a-dollar paragraph sets that increment for any NMS stock priced below $1.00, with no spread test at all.

Exam Tip: Gotchas

• A brand new NMS stock starts at a penny at or above $1.00, never at a half cent. The half-cent tier depends on a measured Time Weighted Average Quoted Spread, and a stock that has just become an NMS stock has none.
• The new-stock assignment covers only prices at or above $1.00. It says nothing about a sub-dollar price, which stays on the $0.0001 increment set by the separate paragraph.

What Should You Check on Exam Day?

• Read the price first: at or above $1.00 the increment is $0.01 or $0.005 depending on the stock's spread, and below $1.00 it is $0.0001.
• Check whether the stock's Time Weighted Average Quoted Spread was above $0.015 or at or below it, because that single test picks between the two upper tiers.
• Confirm the conduct is displaying, ranking or accepting a bid or offer, an order or an indication of interest; the rule does not set an execution price.
• Count the bound persons as five, including a vendor, and do not narrow the rule to broker-dealers.
• Assign a penny increment to a security that became an NMS stock during an operative period, for prices at or above $1.00.