[Federal Register Volume 60, Number 116 (Friday, June 16, 1995)]
[Notices]
[Pages 31749-31751]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-14795]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35837; File No. SR-NYSE-94-45]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to Member 
Organization Facilitation of a Customer Stock or Program Orders

June 12, 1995.

I. Introduction

    On December 6, 1995, the New 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 regarding member organization 
facilitation of customer stock or program orders.\3\ On January 11, 
1995, the Exchange submitted Amendment No. 1 to the proposed rule 
change.\4\

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1994).
    \3\NYSE Rule 80A defines the term ``program trading'' as (1) 
index arbitrage or (2) any trading strategy involving the related 
purchase or sale of a ``basket'' or group of 15 or more stocks 
having a total market value of $1 million or more.
    \4\See fax from Donald Siemer, NYSE, to Beth Stekler, SEC, dated 
January 11, 1995 (consisting of a revised Memorandum). The amendment 
made certain technical corrections to the text of the Memorandum.
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    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 35230 (January 13, 1995), 69 FR 4453 (January 
23, 1995). One comment letter was received on the proposal.\5\

    \5\See infra note 10 and accompanying discussion.
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II. Description of Proposal

    The NYSE proposal consists of an Information Memorandum to advise 
Exchange members of certain activities that the Exchange will consider 
inconsistent with just and equitable principles of trade. Specifically, 
the Memorandum discusses facilitation of customer block orders at the 
close, trading based upon information of imminent customer 
transactions, and procedures to review facilitation activities for 
compliance with Exchange rules and federal securities laws.
    First, the Memorandum discusses a member's responsibilities when 
positioning itself to facilitate a customer transaction to be executed 
after the close at the closing price.\6\ The Memorandum states that a 
member should not trade for its own account ``near the close'' if it 
intends to execute an ``at the close'' order\7\ that reasonably can be 
expected to affect the closing price of the security. Whether or not 
the purchase will be deemed near the close will depend upon the degree 
of risk that reasonably 

[[Page 31750]]
could be attributed to the position established by the trade versus the 
reasonably anticipated impact the trade at the close will have on the 
closing price. Generally, however, trades after 3:40 p.m. will be 
considered executed ``near the close.''\8\

    \6\Although the Memorandum uses an example where the member has 
agreed to sell to a customer at the closing price, and therefore is 
purchasing stock before and at the close, the principles discussed 
in the Memorandum would apply equally to the situation where the 
member agrees to purchase stock from the customer at the closing 
price and therefore sells the security before and at the close. See 
letter from James Buck, Senior Vice President and Secretary, NYSE, 
to Brandon Becker, Director, Division of Market Regulation, SEC, 
dated April 19, 1995 (``NYSE Letter'').
    \7\An ``at the close order'' is a market order which is to be 
executed in its entirety at the closing price on the Exchange. If 
the order is not executed at the closing price, it is treated as 
cancelled. See NYSE Rule 13.
    \8\The Memorandum notes that members will not be precluded from 
executing customer orders on an agency basis at any time, including 
at or near the close. The Memorandum, however, cautions that this 
does not preclude the Exchange from determining that such activity 
might be a violation of the anti-manipulation provisions of the Act 
or Exchange rules. See 15 U.S.C. 78i(a) and j(b) (1988); NYSE Rule 
476.
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    Second, the Memorandum states that if a member has knowledge of an 
imminent block order, the member should not effect any transactions in 
that stock with the intention of reversing the position subsequently by 
participating on the contra-side of the block transaction. The 
Memorandum further provides that a person should not disclose to any 
other person trading strategies or customers' orders so that the person 
may take advantage of the information for his or her personal benefit 
or for the benefit of the member organization.\9\

    \9\The Memorandum notes, however, that this would not preclude a 
member organization from soliciting interest to trade with the 
contra-side of a block in the normal course of engaging in block 
facilitation activities.
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    Finally, the Memorandum reminds members that they are required to 
establish and maintain procedures reasonably designed to review 
facilitation activities for compliance with Exchange rules and federal 
securities laws. It also states that members must ensure that trading 
strategies engaged in by their proprietary traders to facilitate 
customers' orders have an economic basis and are not engaged in to mark 
the close or to mark the value of a position, and that before any at 
the close customer orders are transmitted to the Floor of the Exchange, 
members accepting such orders must exercise due diligence to learn the 
essential facts relative to these orders.

III. Summary of Comments

    The Commission received one comment letter on the proposed rule 
change on behalf of six NYSE-member firms (the ``Comment Letter'').\10\ 
The issues raised therein and the NYSE response are discussed 
below.\11\

    \10\See letter from Roger Blanc, Willkie Farr & Gallagher, dated 
March 2, 1995 (representing Bear, Stearns & Co. Inc.; CS First 
Boston Corporation; Goldman, Sachs & Co.; Morgan Stanley & Co. 
Incorporated; PaineWebber Incorporated; and Saloman Brothers Inc.) 
(``Comment Letter'').
    \11\See NYSE Letter, supra note 6. According to the NYSE, the 
proposed rule change was reviewed and approved by the Exchange's 
Upstairs Traders Advisory Committee, Institutional Trading Advisory 
Committee, Market Performance Committee, and Quality of Markets 
Committee prior to filing with the Commission.
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    The Comment Letter noted that, because the rule change would 
preclude NYSE members from effecting proprietary transactions for the 
20 minutes prior to the close, the proposal would result in additional 
risk for such members when facilitating customer block transactions at 
the closing price. As a result of this added risk exposure, it was 
argued that the costs to customers in executing such transactions would 
increase. In its response, the NYSE recognized that the proposal could 
produce additional risk for proprietary facilitation, but stated that 
the transactions after 3:40 p.m. bear de minimis risk because they are 
made in close proximity to a trade at the close that most likely would 
have a profitable impact on the prior transactions. In addition, the 
Exchange asserted that the rule change is consistent with the existing 
prohibitions against frontrunning, and that the 3:40 p.m. cut-off time 
was included to avoid confusion over what transactions generally would 
be considered ``near the close.''
    The Comment Letter stated that the proposed rule appears to remove 
the Exchange's burden of proving manipulative intent on the part of a 
member that entered an order after 3:40 p.m., without ``immunizing'' 
transactions executed before that time. The Comment Letter asserted 
that because transactions occurring before 3:40 p.m. could still be 
deemed ``near the close,'' the proposed rule change provides the 
Exchange with a high degree of prosecutorial discretion, making the 
proposal inconsistent with Section 6(b) (6) and (7) of the Act.\12\ 
Additionally, the Comment Letter stated that predicating the 
prohibition against proprietary orders upon whether a member entered a 
market at the close order that `'can reasonably be expected to impact 
the closing price'' would require firms to predict the impact of future 
trades. The NYSE responded that it believes it is appropriate to use 
the proposed standard because it provides flexibility for judgmental 
errors. The NYSE also noted that this is the same standard used in 
frontrunning cases to assess compliance with just and equitable 
principles of trade.

    \12\15 U.S.C. 78f(b) (6) and (7) (1988).
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    Finally, the Comment Letter pointed out that the NYSE has not 
provided empirical support for restricting proprietary trading near the 
close. It also asserted that the transactions that would be prohibited 
represent actual customer demand, as opposed to orders by firms 
intended to take advantage of customer orders. The Comment Letter 
suggested that instead of the proposed interpretation, the Exchange 
should impose a requirement that members make full disclosure to their 
customers before undertaking transactions of this kind. In response, 
the Exchange stated that the empirical basis for its belief is 
demonstrated in patterns of trading that the Exchange has reviewed. The 
Exchange also asserted that disclosure to customers, even when the 
proprietary trade has a minimal impact, would be ineffective. According 
to the NYSE, the transactions in question may be effected due to the 
probability of immediate profitability, and they would, in any event, 
be based on an unfair informational advantage over other market 
participants. In addition, the NYSE asserted that, while the 
proprietary orders are initiated because of customer interest, those 
proprietary orders also would not be entered but for the knowledge of 
customer orders.

IV. Discussion

    After careful consideration of the Comment Letter and the NYSE 
response thereto, the Commission has decided to approve the proposed 
rule change. For the reasons discussed below, 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 
Sections 6(b) (5), (6), and (7).\13\

    \13\15 U.S.C. 78f(b) (5), (6), and (7).
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    The Commission notes that two of the topics discussed in the 
Memorandum are restatements of current Exchange policy. Specifically, 
The Memorandum's discussion of trading based upon information of an 
imminent customer transaction and the requirement that members maintain 
procedures reasonably designed to review facilitation activities for 
compliance with Exchange rules and federal securities laws are 
consistent with Exchange Rule 476 and previous NYSE interpretations 
issued pursuant to that Rule.\14\ The Commission continues to believe 
that these policies are consistent with the Section 6(b)(5) requirement 
that the rules of an exchange be designed to promote just and equitable 
principles of trade, to prevent fraudulent and manipulative 

[[Page 31751]]
acts, and, in general, to protect investors and the public.

    \14\See, e.g., NYSE Information Memo Number 89-53 (November 27, 
1989).
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    Similarly, the proposed Memorandum's description of the types of 
proprietary trading near the close that may, in certain circumstances, 
constitute a violation of just and equitable principles of trade is 
reasonably designed to address potential trading abuses that might 
occur when members are facilitating customer block or program orders. 
The Commission agrees with the NYSE that the conduct addressed in the 
Memorandum--trading with knowledge of impending large at the close 
orders--could prove detrimental to market integrity. The proposed 
guidelines for such trading near the close are consistent with long 
standing prohibitions against frontrunning. Moreover, the NYSE 
restrictions on block facilitation activities near the close are very 
limited in scope and should provide helpful guidance to members.
    For the reasons discussed below, the Commission also believes the 
Comment Letter's criticisms of the proposal are adequately addressed. 
First, it is unnecessary for the NYSE to conduct further empirical 
studies before adopting this proposal. The NYSE represents that it has 
observed instances of block facilitation trading by its members that 
results in closing prices that disadvantage customers.\15\ In addition, 
as previously mentioned, the Memorandum is an elaboration of existing 
prohibitions against frontrunning. Thus, the NYSE is merely providing 
guidance on the types of conduct that already constitute a violation of 
just and equitable principles of trade under its rules.

    \15\See NYSE Letter, supra note 6.
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    Second, the Commission does not believe that simply requiring 
disclosure to customers sufficiently will protect customers or preserve 
market integrity. As the NYSE has indicated, the conduct addressed in 
this proposal affects not only the facilitation member's customer, but 
also all other market participants. The NYSE member still would have an 
informational advantage over the rest of the market even after full 
disclosure to its customer.
    Third, the Comment Letter considers the Memorandum's guidance as a 
blanket prohibition against certain proprietary trading after 3:40 
p.m., the designated cut-off time.\16\ The Memorandum, however, only 
restricts post-3:40 p.m. trading in limited circumstances. The 
Memorandum states that a member, when positioning itself to facilitate 
a customer transaction to be made after the close at the closing price, 
should not trade for its own account ``near the close'' (after 3:40 
p.m.) if it intends to execute an at the close order that reasonably 
can be expected to impact the closing price of the security. The 
Memorandum does not prohibit proprietary trading after 3:40 p.m., only 
a limited type of proprietary trading when in possession of a form of 
non-public, material market information.

    \16\See Comment Letter, supra note 10.
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    Fourth, the Commission does not agree with the Comment Letter's 
assertion that the proposed regulation of proprietary trading near the 
close, defined generally as after 3:40 p.m., provides the Exchange with 
excessive prosecutorial discretion. The 3:40 p.m. cut-off is intended 
to provide members with more guidance as to prohibited conduct under 
the NYSE rules. At the same time, the 3:40 p.m. cut-off is not intended 
to operate as a ``safe-harbor.'' The cut-off guideline provided in the 
Memorandum does not preclude the Exchange from determining that certain 
transactions before 3:40 p.m. were executed ``near the close.'' The 
Commission agrees with the NYSE that the standard for determining which 
transactions are executed ``near the close'' must be flexible and take 
into consideration factors unique to the market for a particular 
security. The Commission therefore believes the proposed standard for 
determining when an execution is ``near the close'' is appropriate and 
even though it may cover transactions effected before the designated 
cut-off time.
    Fifth, the Comment Letter suggests that the proposed standard would 
relieve the Exchange from proving manipulative intent for transactions 
executed after 3:40 p.m. The NYSE, however, seeks to address conduct 
that could enable block positioners to benefit from an unreasonable 
informational advantage over other market participants. The Commission 
believes that it is reasonable for the NYSE to adopt a position to 
reduce the likelihood of members trading to their own advantage based 
on customer information. This position still requires proof that the at 
the close order reasonably could be expected to affect the closing 
price.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-NYSE-94-45) is approved.

    \17\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\

    \18\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-14795 Filed 6-15-95; 8:45 am]
BILLING CODE 8010-01-M