Have you ever traded penny stocks with a small account only to have your frustration come out when it’s time to make another trade? The Pattern Day Trade rule has become an issue for many who choose to buy small-cap stocks.
This rule requires traders to have at least $25,000 in their trading account to buy and sell penny stocks or higher-priced stocks within a single day and do it more than three times within a rolling 5-day period. You can get around this in many cases (depending on your broker) by choosing to use a cash account. You can make as many day trades (buy & sell within the same session) as your heart desires. But you’re limited to using the amount of settled funds in your account.
If you’re trading penny stocks, you have to be aware of settlement times. In most cases, your cash will settle two business days after the trade date (T+2). That means you’re going to have to wait a few days after you sell out of your trade to have those funds available to trade again. The “upside” is that you are “forced” to not over-trade.
But the downside is that you can’t take advantage of market volatility as quickly as you might like. For those who’ve day traded with smaller accounts before, you know this issue all too well. But the U.S. Securities & Exchange Commission might be trying to help out retail traders after all.
SEC Proposes Rules To Shorten Settlement Cycle
This month the Securities & Exchange Commission filed a paper outlining a proposed change to this settlement rule. The paper itself is nearly 250 pages long, but we’ll break down some of the high points in this article.
The SEC voted to propose rule changes that would reduce risks in clearing and settling securities. One way to do this is to shorten the standard settlement cycle for “most broker-dealer transitions” in securities. The shorter settlement entails shifting from a T+2 or two business day settlement period to a T+1 or one business day settlement.
According to the Commission, the changes are designed to decrease the “credit, market, and liquidity” risks in transactions.
SEC Chair Gary Gensler expanded on this, saying:
“These proposed amendments to the securities clearing and settling process, if adopted, could lower risk to the financial system and drive greater efficiencies in the markets…First, these amendments would shorten the standard settlement cycle. As the old saying goes, time is money. Shortening the settlement cycle should reduce the margin that counterparties would need to post with clearinghouses. Second, these changes would require affirmations, confirmations, and allocations to take place as soon as technologically practicable on trade date (“T+0”). Finally, the release would require clearing agencies that provide central matching services to have policies and procedures to facilitate straight-through processing — i.e., fully automated transactions processing.”
A Big Win For Penny Stocks Traders
This could present a big win for day traders, especially those with smaller accounts not meeting “day trader” status. One of the few ways to achieve a T+1 settlement is by trading options. But options are higher volatility and have many other factors, including time decay, to weigh against the trade. With a proposed T+1 settlement for securities trades, this could open up a much faster route for those looking to gain exposure to the market.
The SEC’s paper outlines what this would mean for retail or “self-directed” traders. In particular, the white paper pointed out recent events that prompted these decisions:
“Accelerating Time to Settlement” and “Settlement Optimization.”59 Among other things, the DTCC-owned clearing agencies have been exploring steps to modify their settlement process to be more efficient, such as by introducing new algorithms to position more transactions for settlement during the “night cycle” process (which currently begins in the evening of T+1) to reduce the need for activity on the day of settlement. Portions of these two initiatives have been submitted to the Commission and approved as proposed rule changes.”
Speedy Settlement & Lower Volailtity
The SEC’s paper also discussed “More recently, periods of the increased market volatility—first in March 2020 following the outbreak of the COVID-19 pandemic, and again in January 2021 following heightened interest in certain “meme” stocks—highlighted the significance of the settlement cycle to the calculation of financial exposures and exposed potential risks to the stability of the U.S. securities market.”
This discussion played off of the DTCC’s February 2021 paper discussing that speeding up settlement beyond T+2 could “bring significant benefits” to market participants. The DTCC suggested that a T+1 approach to settlement could happen in the second half of 2023 and estimated that this type of settlement cycle could lessen the volatility aspect of specific margin requirements by “up to” 41%.
When it comes to trading penny stocks, the daily trends shift quickly. As a result, having a shorter time to clear could offer up ways to market participants to be more methodical in their approach. Late last year, the DTCC and the Securities Industry and Financial Markets Association, and an Industry Steering Committee issued a T+1 Report outlining the proposed transition to a T+1 standard by the second quarter of 2024. In addition to this, an Industry Working Group also considered the potential of a T+0 settlement. While this might be far down the list of next steps, it is in the discussion. Could traders have a 0 settlement timeframe for trades someday?
Next Steps
Now traders and the securities industry look for the next steps. Whether you’re trading penny stocks or higher-priced stocks, the rules seem to have broad application. Next on the docket is public comments and review. The Commission is asking for feedback on its proposed amendments and submission of data or analysis on myriad questions, including:
- Should the Commission amend Rule 15c6-1 to shorten the standard settlement cycle to T+1 as proposed? Why or why not?
- Are efforts to shorten the standard settlement cycle to T+1 a logical step on the path to T+0 settlement, or would shortening to T+1 require investments or processes that would be outdated or unnecessary in a T+0 environment?
- What are the circumstances that motivate earlier settlements?
- Should the Commission provide exemptive relief under Rule 15c6-1(b) for any other securities or types of transactions?
- How would retail investors be impacted by new processes that broker-dealers may implement in support of a T+1 standard settlement cycle?
- How would institutional investors be impacted by new processes that broker-dealers may implement in support of a T+1 standard settlement cycle?
- What impact, if any, would the proposal have on trading involving derivatives and exchange-traded products?
According to the SEC, comments are due 30 days after publication in the Federal Register or April 11, 2022 (which is 60 days after issuance), whichever is later.
Quick Summary
- The Securities and Exchange Commission (SEC) is proposing rules to shorten the standard settlement cycle for most broker-dealer transactions from two business days after the trade date (T+2) to one business day after the trade date (T+1).
- The SEC also proposes new requirements for the processing of institutional trades by broker-dealers, investment advisers, and certain clearing agencies in order to protect investors, reduce risk, and increase operational efficiency.
- If adopted, compliance with a T+1 standard settlement cycle would be required by March 31, 2024. However, the SEC is also assessing whether or not to require a same-day standard settlement cycle (i.e., settlement no later than the end of trade date, or T+0).
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