[Federal Register Volume 60, Number 194 (Friday, October 6, 1995)]
[Notices]
[Pages 52436-52438]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24908]



-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36324; File No. SR-CSE-95-07]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Cincinnati 
Stock Exchange, Inc., Relating to the Preferencing of Public Agency 
Market and Marketable Limit Orders by Approved Dealers and Other 
Proprietary Members

September 29, 1995.

I. Introduction

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 22, 1995, the Cincinnati Stock Exchange, Inc. (``CSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change, and on September 28, 1995, 
Amendment No. 1 thereto,\3\ as described in Items II and III below, 
which Items have been prepared by the self-regulatory organization. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ See letter from Robert Ackerman, Vice President, CSE, to 
Sharon Lawson, Senior Special Counsel, SEC, dated September 28, 
1995. Amendment No. 1 amended the request for an extension through 
June 28, 1996, to an extension through March 29, 1996.
---------------------------------------------------------------------------

II. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CSE hereby proposes to extend the CSE's pilot program regarding 
preferencing until March 29, 1996. The pilot was initially approved by 
the Commission on February 7, 1991, and is currently extended until 
October 2, 1995.

III. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the rule filing is to extend the existing pilot 
program of the Exchange relating to the preferencing of public agency 
market and marketable limit orders by approved dealers and other 
proprietary members. The Commission originally approved the pilot on 
February 7, 1991.\4\ The Commission has subsequently extended the pilot 
several times.\5\ The Exchange now seeks an extension of the program 
until March 29, 1996.

    \4\ See Securities Exchange Act Release No. 28866 (February 7, 
1991), 56 FR 5854 (February 13, 1991).
    \5\ See Securities Exchange Act Release Nos. 29524 (August 5, 
1991), 56 FR 38160 (August 5, 1991); 30353 (February 7, 1992), 57 FR 
5918 (February 18, 1992); 31011 (Aug. 7, 1992), 57 FR 38704 (August 
26, 1992); 32280 (May 7, 1993), 58 FR 28422 (May 13, 1993); 33975 
(April 28, 1994), 59 FR 23243 (May 5, 1994); 34493 (August 5, 1994), 
59 FR 41531 (August 12, 1994); 35717 (May 15, 1995), 60 FR 26909 
(May 19, 1995).
---------------------------------------------------------------------------

2. Statutory Basis
    The exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act in general and furthers the objectives of 
Section 6(b)(5) in particular in that it will promote just and 
equitable principles of trade and remove impediments to and perfect the 
mechanisms of a free and open market and a national market system.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The CSE does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The CSE informed the other Intermarket Trading System (``ITS'') 
participants of its intention to file this proposal to extend the 
preferencing pilot through March 29, 1996. The CSE previously solicited 
comments from other participants on its request for permanent 
approval.\6\ The proposed extension would continue the program under 
the same terms and conditions as the existing pilot that was previously 
commented upon.

    \6\  See infra note 14.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 

[[Page 52437]]
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying at 
the Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the CSE. All 
submissions should refer to File No. SR-CSE-95-07 and should be 
submitted by [insert date 21 days from date of publication].

V. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

A. Description

    The CSE is an electronic exchange that uses multiple competing 
dealers rather than a single specialist. CSE members transmit orders, 
make markets, and receive executions and reports through remote 
terminals or computer interfaces from around the country. The 
preferencing program permits CSE dealers to retain and execute their 
internal order flow at the prevailing ITS best bid or offer (``ITS/
BBO''), provided that there are no public agency limit orders on the 
CSE's National Securities Trading System (``NSTS'') limit order book at 
that price or better. To this end, the preferencing program permits CSE 
dealers to internalize order flow by eliminating price and time 
priority between CSE dealers, thereby enabling preferencing dealers to 
interact with public market and marketable limit orders they represent 
as agent
    Specifically, the preferencing program gives preferencing dealers 
priority over same-priced (or superior-priced) professional agency or 
principal orders entered prior in time when interacting with a public 
order it represents as agent.\7\ The dealer may interact with such 
orders either by (1) taking the contra-side position on the trade as 
principal (``paired order trade''), or (2) crossing the order with 
another customer order it represents as agent (``agency cross'').\8\

    \7\ See CSE Rule 11.9(u).
    \8\ The majority of agency crosses are the result of a limit 
order resident in the dealer's proprietary system at the ITS/BBO, 
which is matched with an incoming contra-side market order. For 
example, it the market is 20 bid--20\1/8\ asked, and a dealer has a 
limit order to buy at 20, an incoming market sell order will be 
matched with that limit order because the dealer may not trade for 
its own account ahead of its own customer limit order. See CSE Rule 
12.6(b).
---------------------------------------------------------------------------

    By way of example, if dealer A on the CSE is quoting at the ITS/
BBO, dealer B can still internalize its order flow (even if he is not 
quoting at the ITS/BBO so long as dealer B executes the order at the 
ITS/BBO (or better) and there is no contra-side public agency order in 
NSTS at that price. If there is a public agency limit order in NSTS 
with priority, however, NSTS will automatically break the cross and 
match the incoming public agency order with the public limit order on 
the CSE book. The system rejects the CSE dealer's principal side of the 
attempted cross or, in the case of an attempted public agency cross, 
rejects the agency order required to yield priority to the order that 
was on the NSTS book.
    In approving the initial preferencing program pilot, and subsequent 
extensions and expansions, the Commission imposed certain limitations 
and requirements on its operation. These conditions limit the number of 
issues in which a preferencing dealer may be registered to 350; require 
the Exchange to provide certain information to the Commission; prohibit 
preferenced trading for index arbitrage purposes when certain ``circuit 
breakers'' are in effect;\9\ and prohibit a dealer from making cash 
payments for order flow that it preferences to itself.

    \9\ Specifically, the index arbitrage restriction permits 
preferencing dealers to preference their customer order flow that is 
related to index arbitrage only on plus or zero plus ticks when the 
Dow Jones Industrial Average (``DJIA'') declines by fifty points or 
more from the previous day's closing value. See Securities Exchange 
Act Release No. 28866, supra note 4.
---------------------------------------------------------------------------

    The CSE proposes to extend the preferencing program pilot through 
March 29, 1996.

B. Discussion

    After considering carefully the data and comments received on the 
CSE's preferencing program, the Commission finds that the CSE's 
proposal to extend its preferencing pilot program to March 29, 1996, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange. 
Specifically, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\10\ which requires that the 
rules of an exchange be designed to promote just and equitable 
principles of trade, prevent fraudulent and manipulative acts, remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system (``NMS''), and in general, to protect 
investors and the public interest.

    \10\ 15 U.S.C. Sec. 78f(b)(5) (1988).
---------------------------------------------------------------------------

    In its August 1994 order extending the preferencing program,\11\ 
the commission expressed concerns regarding what impact preferencing 
might have on the quality of the CSE market and the national market 
system. The Commission enumerated six reporting requirements to be 
submitted quarterly in order to facilitate evaluation of the CSE's 
preferencing program. In addition, the Commission required the CSE to 
submit an analysis detailing how the preferencing program has affected 
the quality of the CSE's market, including its effect on quote 
competition, market transparency, depth and liquidity, and improved 
quotations.\12\ Specifically, the Commission instructed the CSE to 
analyze the effects of the preferencing program on the quality of 
market making by CSE preferencing dealers, and demonstrate that the 
preferencing program has resulted in added depth and liquidity to its 
market and improved quotations. The CSE subsequently filed interim 
reports with the Commission and submitted its pilot analysis.\13\

    \11\ See Securities Exchange Act Release No. 34493, supra note 
5.
    \12\ See id.
    \13\ See letters from David Colker, Executive Vice President and 
Chief Operating Officer, CSE, to Arthur Levitt, Chairman, SEC, dated 
January 18, 1995 (``January Report''), and to Jonathan Katz, SEC, 
dated June 14, 1995 (``June Report'') (available to the public in 
File No. SR-CSE-95-03).
---------------------------------------------------------------------------

    The data provided by the CSE attempts to prove that the Exchange's 
preferencing dealers add to the national market system because, among 
other things, (1) the average spread of CSE quotes in issues that have 
only preferencing dealers is \1/4\ point, which is narrower than any 
other regional exchange for these securities; (2) preferencing dealers 
are responsible for generating 4% of all quotes that establish a new 
ITS/BBO, more than twice the percentage of CSE's market share in NYSE-
listed stocks; (3) preferencing dealers account for 46% of all ITS 
inbound orders in those issues that have both preferencing dealers and 
non-preferencing dealers; and (4) preferencing dealers execute 
approximately 62% of their orders between the ITS/BBO when the spread 
is greater the \1/8\ point.
    The Commission received several comment letters on the CSE proposal 
to adopt permanently the preferencing 

[[Page 52438]]
pilot, many of which challenged the CSE's statistics.\14\ Some of the 
commenters proffered statistics to support their contention that the 
CSE merely serves as a means for firms to internalize order flow. Among 
other things, commenters alleged that (1) over 94% of preferencing 
dealers' executions are paired order trades; (2) only 4.8% of CSE 
trades can be characterized as trades between CSE dealers; and (3) CSE 
quotes are inaccessible to other ITS participants.

    \14\ The Commission received negative comment letters from, 
among others, the New York Stock Exchange, American Stock Exchange, 
and Boston Stock Exchange. These and other correspondence received 
regarding the CSE's request for permanent approval of the pilot 
program are available to the public in File No. SR-CSE-95-03.
---------------------------------------------------------------------------

    The Commission has examined the data provided by the CSE and 
commenters and believes it would be useful to analyze additional data 
before making a definitive determination on the pilot. To allow further 
evaluation of the market structure implications of permanently 
approving the CSE's preferencing program, the Commission requests that 
the CSE continue to submit the quarterly reports described in the 
Commission's previous orders approving extensions of the pilot. The 
Commission also will collect relevant data on its own to evaluate the 
pilot.
    More importantly, the Commission is interested in exploring whether 
broader market structure initiatives can address the commenters' 
concerns regarding order interaction and the effects of preferencing on 
the NMS in general, and on order execution quality in particular. In 
this regard, the Commission recently proposed rules that attempt to 
address, among other things, the order interaction and best execution 
issues presented by preferencing of order flow.\15\ Extension of the 
CSE pilot will allow the Commission an opportunity to study the 
implications of the proposals for the CSE's preferencing pilot during 
the pendency of the rulemaking process.

    \15\ See Securities Exchange Act Release No. 36310 (September 
29, 1995).
---------------------------------------------------------------------------

    The Commission finds good cause for approving the proposed rule 
change, as amended, prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. The 
Commission believes that accelerated approval of the proposal is 
appropriate in order to avoid an interruption to the existing pilot 
while the Commission continues to collect data and consider broader 
market structure rules to address internalization.

VI. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2)\16\ that the 
proposed rule change, as amended, is hereby approved on an accelerated 
basis, and the preferencing pilot is extended through March 29, 1996.

    \16\ 15 U.S.C. Sec. 78s(b)(2) (1988).
---------------------------------------------------------------------------

    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 95-24908 Filed 10-5-95; 8:45 am]
BILLING CODE 8010-01-M