[Federal Register Volume 59, Number 137 (Tuesday, July 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17430]


[[Page Unknown]]

[Federal Register: July 19, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34363; File No. SR-NYSE-93-40]

 

Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Approving Proposing Rule Change To Amend Exchange Rule 95 to Add 
New Intra-Day Trading Provisions

July 13, 1994.

I. Introduction

    On October 28, 1993, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Rule 95 (``Discretionary 
Transactions'') to add new intra-day trading provisions.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
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    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 33372 (December 23, 1993), 58 FR 69430 
(December 30, 1993). Two comment letters were received on the 
proposal.\3\ This order approves the proposed rule change.
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    \3\See letter from Daniel P. Barry to Diana Luka-Hopson, Branch 
Chief, Division of Market Regulation, SEC, dated November 10, 1993 
(``Barry comment letter''); and anonymous letter to Diana Luka-
Hopson, Branch Chief, Division of Market Regulation, SEC, received 
on November 18, 1993 (``anonymous comment letter'').
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II. Description of the Proposal

    Under Exchange Rule 95, and NYSE Floor broker cannot effect a 
transaction if that broker has discretion regarding the choice of 
security to be bought or sold; the total amount of the security to be 
bought or sold; or whether the transaction shall be a purchase or a 
sale. Currently, there are no provisions, in Rule 95 or otherwise, 
specifically governing the practice of intra-day trading. The term 
``intra-day trading'' refers to the practice whereby a market 
participant places orders on both sides of the market and attempts to 
garner the spread by buying at the bid and selling at the offer.
    The NYSE proposes to amend Rule 95 to add new intra-day trading 
provisions. These provisions, as discussed below, will apply only when 
a Floor broker simultaneously represents, for the same account,\4\ 
market or limit orders on both sides (i.e., a buy order and a sell 
order) of a minimum variation market.\5\
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    \4\For purposes of Rule 95, the NYSE will define the term 
``account'' to include any account in which the same person or 
persons is directly or indirectly interested. The NYSE has indicated 
that the Rule 95 amendments will not apply to a Floor broker who 
simultaneously represents an agency order on one side of a minimum 
variation market and a principal order (or an agency order for a 
different ``account,'' as defined above) on the other side of the 
market. Telephone conversation between Donald Siemer, Director, 
Market Surveillance, NYSE, and Beth Stekler, Attorney, Division of 
Market Regulation, SEC, on March 9, 1994.
    \5\NYSE Rule 62 sets forth the minimum variation permitted for 
securities traded on the Exchange.
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    Under the NYSE proposal, if a Floor broker acquires a position on 
behalf of an intra-day trader's account, Rule 95(c) will place certain 
restrictions on how the broker can liquidate or cover that position 
during the same trading session. Specifically, the broker will be 
required to obtain a new liquidating order (i.e., one entered 
subsequent to the acquisition of the contra-side position) from his or 
her customer.\6\ Thereafter, proposed Rule 95(d) will require that the 
Floor broker must execute the liquidating order entered pursuant to 
Rule 95(c) before he or she can execute any other order for the same 
account on the same side of the market as that liquidating order.\7\ 
Neither provision of Rule 95, however, will apply to the execution of 
an order to liquidate or cover a position carried over from a previous 
trading session; a position assumed as part of a strategy relating to 
bona fide arbitrage; or a position assumed in reliance on the exemption 
for block positioners.\8\
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    \6\To obtain a new order, the Floor broker must leave the 
trading Crowd. The new liquidating order must be time-recorded 
upstairs (if initially received there) and upon receipt on the 
trading Floor. Telephone conversation between Donald Seimer, 
Director, Market Surveillance, NYSE, and Beth Stekler, Attorney, 
Division of Market Regulation, SEC, on March 9, 1994. The new order 
must be marked ``BC'' for a buy order to cover a short position, or 
``SLQ'' for a sell order to liquidate a long position.
    \7\Paragraph 95.20 contains the following example:
    In a minimum variation market, a Floor broker simultaneously 
represents a 5,000 share buy order and a 5,000 share sell short 
order for the same account. If the broker sells 2,000 shares short, 
he or she must obtain a 2,000 share ``BC'' order to cover that 
position that day. Until the ``BC'' order has been executed, and the 
short position has been unwound, the broker cannot execute any part 
of the original 5,000 share buy order.
    For discussion of exceptions to the above requirements, see 
infra, note 8 and accompanying text.
    \8\Under the circumstances described above, see supra note 7, 
the broker has carried a 2,000 share short position over from a 
previous trading session. If the broker sells 3,000 shares short, he 
or she still must obtain a 3,000 share ``BC'' order to cover that 
position that day. However, in this case, 2,000 shares of the 
original 5,000 share buy order may be executed to cover the carry-
over position. Thereafter, the ``BC'' order must be executed, and 
the short position unwound, before the broker can execute the 
balance of the original buy order.
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    Finally, the Exchange proposes to clarify its existing rule 
prohibiting members from handling discretionary transactions.\9\ In 
particular, Paragraph 95.30 provides examples of what types of orders a 
broker can handle simultaneously, without violating Rule 95's 
prohibition against a broker choosing whether a transaction will be a 
purchase or a sale.
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    \9\Telephone conversation between Brian McNamara, Managing 
Director, Market Surveillance, NYSE, and Beth Stekler, Attorney, 
Division of Market Regulation, SEC, on November 19, 1993.
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    The NYSE states that the amendments to Rule 95 are intended to 
address trading situations where a Floor broker may be perceived as 
having an advantage over other market participants in that he or she 
may be able to trade for the same customer without leaving the Crowd. 
According to the NYSE, by requiring the entry of a new liquidating 
order, these amendments can be expected to minimize any such perceived 
advantage. The Exchange states that the basis under the Act for the 
proposed rule change is the requirement under Section 6(b)(5) that an 
Exchange have rules that are designed to promote just and equitable 
principles of trade, to remove impediments to, and perfect the 
mechanism of, a free and open market and, in general, to protect 
investors and the public interest.

III. Comments Received and NYSE Response

    The Commission received two comment letters on the proposed rule 
change, one from a public customer who trades stocks on the NYSE and 
another from an anonymous NYSE employee.\10\ These letters raise 
various issues and concerns with respect to the NYSE proposal.
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    \10\See supra, note 3.
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    In his letter, Mr. Barry, the public customer, recommends that the 
proposed rule change be disapproved and argues that the amendments to 
Rule 95 are anti-competitive. The commenter provides two examples in 
support of his position. In the first scenario, an individual investor 
places buy and sell orders at the minimum variation with a ``two-dollar 
broker;'' there are no orders on the specialist's limit order book at 
the best bid or offer. The Barry comment letter asserts that, under the 
NYSE proposal, the specialist could freely buy and sell at the minimum 
variation for his own account, but the individual investor could not do 
so. According to the commenter, this is equivalent to allowing the 
specialist to trade ahead of public orders on the book.
    In the second scenario, the commenter begins from the premise that 
NYSE limit order books (particularly for bond funds, which he contends 
are the focus of the proposed amendments to Rule 95) are dominated by 
large orders of other specialists. His letter states that, as a result, 
the public must wait behind the professionals or use two-dollar 
brokers. From the commenter's perspective, the NYSE proposal will allow 
those market participants with the most resources to continue to engage 
in minimum variation trading, but will force two-dollar brokers and 
their retail customers out of the ``game'' through regulation.
    The Barry comment letter also argues that, if there is a problem 
with minimum variation trading, the practice should be restricted not 
only for the NYSE, but also for the third market (i.e., over-the-
counter trading of listed stocks) and broker-dealers who internalize 
their order flow. Above all, the commenter recommends that whatever 
restriction is imposed not single out small public investors.
    Finally, the commenter questions whether the NYSE has the authority 
to prohibit him from entering buy and sell orders at the minimum 
variation, or to dictate that such orders can be placed on the 
specialist's book but not given to a two-dollar broker. In his opinion, 
the NYSE's actions create the impression that the Exchange has been 
influenced by political pressure from the specialist community. The 
commenter predicts that approval of the proposed rule change will grant 
specialists a monopoly on commission dollars from trades in their 
specialty stocks, and will allow them to dominate the limit order book 
in their non-specialty stocks.
    The second commenter, an anonymous NYSE employee, states that the 
purpose of his letter is to inform the Commission of the ``real story'' 
leading up to the proposed amendments to Rule 95. According to the 
commenter, this story casts doubt on the effectiveness of self-
regulation and Commission oversight of the self-regulatory 
organizations. In brief, the letter alleges that certain Exchange 
constituencies (e.g., specialists) pressured NYSE staff and a committee 
of the Exchange's Board of Directors (``Board'') to find a way to stop 
intra-day trading. The commenter suggests, among other things, that 
this practice has become so controversial because the specialist 
community is losing trading opportunities to public customers who 
participate when there is a market disparity, and losing commission 
dollars to the two-dollar brokers who execute their orders.
    The anonymous comment letter notes that the Exchange staff 
initially drafted rules similar to the proposal before the Commission 
which, in the commenter's opinion, would have eliminated the two-dollar 
broker's (and thus the small public customer's) ability to engage in 
minimum variation trading, allegedly to protect the specialists' 
business. According to the anonymous comment letter, membership outrage 
forced the Exchange to withdraw its initial proposal; thereafter, NYSE 
staff drafted these amendments to Rule 95 and submitted them to the 
Commission without seeking comment from the Floor.
    The NYSE responded to the issues raised by the two comment 
letters.\11\ First, in response to Mr. Barry's concerns about the 
proposal's effect on public customers, the NYSE contends that the 
amendments to Rule 95 are not intended to preclude individual 
investors, or anyone else, from engaging in the practice of minimum 
variation trading. In this regard, the NYSE notes that no distinction 
is made between orders entered by individuals and those entered by so-
called professionals.
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    \11\See letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Sandra Sciole, Special Counsel, Division of 
Market Regulation, SEC, dated March 16, 1994 (``NYSE response 
letter'').
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    According to the NYSE response letter, the proposed amendments are 
intended to address the perception that a Floor broker, who 
simultaneously represents buy and sell orders at the minimum variation 
for the same customer, may have an advantage over other market 
participants, such as individual investors, because that broker can 
trade on both sides of the market without leaving the Crowd. The NYSE 
argues that, by requiring the broker to obtain a new liquidating order, 
the proposed rule change should minimize any such possible advantage 
from the intra-day trading strategy, and thus should enhance investors' 
confidence in the fairness and orderliness of the Exchange market.
    The NYSE letter also responds to the anonymous commentator's 
concerns about its internal rule development process. The NYSE states 
that the amendments to Rule 95 were developed by an advisory committee 
to the Exchange Board that included representatives from all major 
constituent groups. That panel's recommendations were reviewed by the 
Floor trading community and the appropriate constituent committees, 
before being approved by the Board and authorized for filing with the 
Commission. In the NYSE's opinion, all major constituent groups had the 
opportunity to contribute to the rule development process, and the 
proposal that was submitted to the Commission reflects a consensus 
among their views.

IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Section 6(b).\12\ In particular, 
the Commission believes the proposal is consistent with the Section 
6(b)(5) requirements that the rules of an exchange be designed to 
promote just and equitable principles of trade, to prevent fraudulent 
and manipulative acts, and, in general, to protect investors and the 
public interest.
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    \12\15 U.S.C. Sec. 78f(b) (1988).
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    The Commission previously has recognized that it is not 
inconsistent with the Act for a self-regulatory organization (``SRO'') 
to limit certain types of trading activity in order to minimize 
interference with the execution of public customer orders and preserve 
the quality of its market.\13\ The NYSE believes that intra-day trading 
constitutes activity that can interfere with public customer orders and 
present the perception of an unfairness trading advantage to larger 
market participants. Under current NYSE rules, orders for the account 
of intra-day traders can compete, often on equal footing, with orders 
for the account of retail investors.\14\ To the extent that the public 
may have to share incoming order flow with intra-day traders, customer 
orders may, on the whole, be allotted fewer shares than they otherwise 
would receive.
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    \13\See, e.g., Securities Exchange Act Releases Nos. 33678 
(February 24, 1994), 59 FR 10192 (March 3, 1994) (File No. SR-NYSE-
92-13) (approving NYSE proposal to identify and preclude the use of 
certain odd-lot trading practices, including intra-day trading, that 
the NYSE believes are inconsistent with the purpose of its odd-lot 
order execution system); and 25842 (June 23, 1988), 53 FR 24539 
(June 29, 1988) (File No. SR-NYSE-87-18) (approving NYSE telephone 
policy which, among other things, prohibits members from using 
portable telephones on the Exchange floor, on the grounds that such 
a large time and place advantage for relatively few large investors 
could create a perception of unfairness or inequality).
    \14\NYSE Rule 72 provides for the manner in which bids and 
offers at the same price will be sequenced for execution. A member 
who makes the first bid or offer at a particular price has 
``priority'' at that price, which means that the member is the first 
one in the market entitled to receive an execution at that price. If 
no member can claim priority, all members who are bidding or 
offering at a particular price are deemed to be on ``parity'' with 
each other, or equivalent in status. When members are on parity, a 
member whose bid or offer is larger than other bids or offers may 
claim ``precedence based on size'' and thereby be entitled to the 
next execution at that price.
    Accordingly, if size precedence is not invoked, orders for the 
account of intra-day traders (except for those orders required to 
yield pursuant to Section 11(a)(1)(G) of the Act and the rules 
thereunder) may be on parity with public customer orders.
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    The Commission believes that it is not unreasonable for the NYSE to 
be concerned about the impact of such trading on public participation 
in its market. Intra-day traders place orders on both sides of the 
market; by executing one order immediately after the other, their floor 
broker can garner the spread for them without ever leaving the trading 
crowd. The NYSE argues, and the Commission agrees, that such 
``instantaneous representation'' may create a perception that intra-day 
traders have a time and place advantage over other market participants. 
Such a time and place advantage has, in the past, led the Commission to 
place restrictions on members' floor trading.\15\
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    \15\See, e.g., SEC Rule 11a1-1(T).
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    After careful review, the Commission has concluded that the NYSE 
proposal could minimize intra-day traders' perceived time and place 
advantage, thereby enhancing investors' confidence in the fairness and 
orderliness of the Exchange market. Under the proposed amendments to 
Rule 95, market participants whose conduct reasonably suggests that 
they are engaged in intra-day trading activity will be subject to 
certain new requirements. Specifically, a floor broker who acquires a 
position for an account, while simultaneously representing orders at 
the minimum variation for that same account, will be required to obtain 
a new order to liquidate or cover that position during that trading 
session. This, in effect, forces the broker to leave the trading Crowd 
and re-establish contact with the customer, thus ending the broker's 
continuous representation of orders at the trading post. This extra 
responsibility will dampen the ability of floor brokers to represent 
two-sided orders of intra-day traders.
    The Commission agrees with the NYSE that this restriction will 
lessen the perception that professionals or institutional participants 
have a large time and place advantage over small public customers. 
Intra-day trading in a strategy employed by professionals or 
sophisticared traders. Intra-day orders can crowd-out small customer 
limit orders and delay or prevent their execution. This provides the 
perception that public customer orders are being disadvantaged by the 
time and place advantage of intra-day traders. By lessening this 
advantage, the NYSE proposal should increase public confidence in the 
market.
    The Commission also notes that the NYSE proposal is very limited in 
scope. It does not prohibit any market participant from engaging in 
minimum variation trading. Rather, the amendments to Rule 95 are 
narrowly drafted to ensure that market participants are not receiving 
an undue advantage from the method in which they engage in such trading 
activity.
    Moreover, in the Commission's opinion, the NYSE proposal contains 
sufficient safeguards to ensure that the new requirements will not 
impinge upon bona fide short-term trading strategies. In this regard, 
the Commission notes that these provisions of Rule 95 will not apply in 
certain situation where orders have been placed on both sides of a 
minimum variation market for purposes unrelated to intra-day 
trading.\16\
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    \16\See, e.g., note 8 and accompanying test.
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    Similarly, the Commission believes that Paragraph 95.30, by 
providing specific examples of the types of orders a Floor broker may, 
and may not, represent simultaneously, will clarify the NYSE's policy 
regarding discretionary transactions. In the Commission's opinion, this 
should facilitate the Exchange's efforts to detect and deter violations 
of Rule 95.
    Finally, the Commission does not agree with the commenters' 
arguments in opposition to the proposed rule change. As part of its 
review of the NYSE proposal, the Commission specifically evaluated the 
possible effects on small public customer orders. The Commission is not 
persuaded that the amendments to Rule 95 were intended to disadvantage 
public customers. In fact, the opposite is the case. As a practical 
matter, public customers will be a main beneficiary if the Rule 95 
amendments successfully enhances the perception of fairness of the 
Exchange market and the ability of public customer limit orders to be 
executed.
    In regard to the comment letters' allegations about the influence 
certain Exchange constituencies may have exerted on the rule 
development process, the Commission is satisfied with the NYSE's 
response.\17\ In light of the Exchange's representations and all 
available facts, the Commission has no basis to conclude that the NYSE 
did not follow proper procedures in the development, approval and 
submission of the proposed rule change.
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    \17\In particular, the Commission has not been persuaded by the 
commenters' allegations regarding the NYSE's motives for allowing 
specialists to continue to garner the bid-ask spread. Specialists 
differ from intra-day traders in two respects. First, specialists 
are under a continuous obligation to maintain fair and orderly 
markets and are subject to affirmative and negative market making 
responsibilities. Their ability to quote a two-sided market is 
integral to their market making function. Second, they are required 
to yield to public customer orders in all circumstances.
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    In sum, although the Commission recognizes that there may be a 
variety of approaches to address the concerns raised by intraday 
trading, the Commission believes that the proposed rule change 
adequately balances the needs of market participants to effectuate 
their trading strategies unhampered, with concerns about the potential 
for certain market participants to have unfair time and place 
advantages by using Floor brokers to garner the spread in minimum 
variation markets. For these reasons, as discussed more fully above, 
the Commission finds that the new intra-day trading provisions of Rule 
95 are consistent with the Act in that they will further the protection 
of investors and the public interest and will remove impediments to and 
perfect the mechanism of a free and open market.

V. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-NYSE-93-40) is approved.

    \18\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17430 Filed 7-18-94; 8:45 am]
BILLING CODE 8010-01-M