[Federal Register Volume 64, Number 150 (Thursday, August 5, 1999)]
[Notices]
[Pages 42734-42736]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-20176]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41668; File No. 4-208]


Intermarket Trading System; Order Approving Fourteenth Amendment 
to the Restated ITS Plan Linking the Pacific Exchange's Application of 
the OptiMark System to the Intermarket Trading System

July 29, 1999.

I. Introduction and Summary

    Pursuant to Section 11A of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule aaAa3-2 thereunder,\2\ on 
March 29, 1999, the Intermarket Trading System (``ITS'') submitted to 
the Securities and Exchange Commission (``Commission'') an amendment 
(``Fourteenth Amendment'') to the Restated ITS Plan (``Plan'') \3\ ITS 
is a communications and order routing network linking eight national 
securities exchanges and the electronic over-the-counter market 
operated by the NASD. ITS was designed to facilitate intermarket 
trading in exchange-listed equity securities based on current quotation 
information emanating from the linked markets. The purpose of the 
Fourteenth Amendment is to link the PCX Application of the OptiMark 
system (``PCX Application'') to ITS.
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    \1\ 15 U.S.C. 78k-1.
    \2\ 17 CFR 240.11Aa3-2.
    \3\ The ITS Plan is a National Market System plan approved by 
the Commission pursuant to Section 11A of the Act and Rule 11Aa3-2 
thereunder. See Exchange Act Release No. 19456 (January 27, 1983), 
48 FR 4938 (February 3, 1999).
    Participants to the Plan include the American Stock Exchange 
LLC, the Boston Stock Exchange, Inc., the Chicago Board Options 
Exchange, Inc., the Chicago Stock Exchange, Inc., the Cincinnati 
Stock Exchange, Inc., the National Association of Securities 
Dealers, Inc. (``NASD''), the New York Stock Exchange, Inc., the 
Pacific Exchange, Inc. (``PCX''), and the Philadelphia Stock 
Exchange, Inc.
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    On April 12, 1999, the proposed plan amendment was published for 
comment and made summarily effective on a temporary basis.\4\ No 
comments were received on the proposal. For the reasons discussed 
below, the Commission is approving the proposal on a permanent basis.
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    \4\ See Exchange Act Release No. 41246 (April 2, 1999), 64 FR 
17700 (April 12, 1999).
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II. Background to the Amendment

    On January 26, 1999, the Commission granted the ITS participants a 
temporary exemption from the ITS Plan provision requiring a Plan 
amendment to reflect the PCX Application's interface with ITS.\5\ The 
Commission granted this exemption to the participants, in part, because 
the PCX Application was scheduled to begin operating on January 29, and 
there was insufficient time to obtain authorization from each of the 
authorizing bodied of the participants before the date.\6\ The PCX 
Application began operating pursuant to the temporary exemption on 
January 29, 1999. The exemption expired on April 2, 1999, but was 
extended until publication of the notice.\7\ The Commission made the 
proposed amendment summarily effective on a temporary basis not to 
extend beyond August 10, 1999.\8\
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    \5\ The Commission has authority under Exchange Act Rule 11Aa3-
2(f) to exempt participants in a national market system plan from 
the requirements of that plan. Exchange Act Rule 11Aa3-2(f) 
provides:
    The Commission may exempt from the provisions of this section, 
either unconditionally or on specified terms and conditions, any 
self-regulatory organization, member thereof, or specified security, 
if the Commission determines that such exemption is consistent with 
the public interest, the protection of investors, the maintenance of 
fair and orderly markets and the removal of impediments to, and 
perfection of the mechanisms of, a national market system.
    The Division of Market Regulation has delegated authority to 
grant an exemption in this instance pursuant to 17 CFR 200.30-
3(a)(29). See Letter from Richard R. Lindsey, Director, Division of 
Market Regulation, Commission, to Allan A. Bretzer, Committee 
Chairman, ITS Operating Committee (``ITSOC''), dated January 27, 
1999.
    \6\ In general, to amend the ITS Plan, the ITS participants vote 
on a particular amendment and, assuming unanimous approval, each 
participant goes back to its respective authorizing body, such as 
its Board of Directors or executive Committee. Following 
ratification by each of the participants' authorizing bodies, the 
ITSOC submits a proposed amendment to the Commission, which 
publishes it for comment. An amendment to the ITS Plan is generally 
not effective until approved by the Commission. On January 21, 1999, 
the ITSOC unanimously voted to recommend to the participants' 
authorizing bodies an amendment to the Plan that would allow the PCX 
Application to link with ITS.
    \7\ See Letter from Belinda Blaine, Associate Director, Division 
of Market Regulation, Commission, to Allan A. Bretzer, Chairman, 
ITSOC, dated April 1, 1999.
    \8\ Pursuant to Exchange Act Rule 11Aa3-2(c)(4), the Commission 
may summarily put into effect on a temporary basis a Plan amendment.
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III. Description

    The purpose of the Fourteenth Amendment is to link the PCX 
Application to ITS.\9\ The PCX Application is a facility of the PCX 
that receives orders generated by the OptiMark System--an electronic 
matching system that, on a periodic ``call'' basis, processes certain 
qualifying expressions of trading interest (called ``profiles''). 
Profiles may include those created from the published quotations 
disseminated by the other participants in ITS at the commencement of 
the

[[Page 42735]]

OptiMark System call reflecting the best bid and offer prices and 
associated sizes (``CQS profiles'').\10\ The orders received by the PCX 
Application are processed by the PCX to permit: (a) in the case of 
those orders reflecting a match between non-CQS profiles, appropriate 
execution on the PCX and reporting thereafter in accordance with the 
applicable PCX rules; and (b) in the case of those orders reflecting a 
match between an non-CQS profile and a CQS profile: (i) processing 
pursuant to Section 6(a)(ii)(A), or (ii) transmission to ITS pursuant 
to Section 6(a)(ii)(B) of the ITS Plan,\11\ whichever is applicable.
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    \9\ The Fourteenth Amendment is identical to the amendment 
approved by the ITSOC on January 21, 1999.
    \10\ For further discussion of the PCX Application, see Exchange 
Act Release No. 39086 (September 17, 1997), 62 FR 50036 (September 
24, 1997) (order approving the PCX Application).
    \11\ Section 6 of the ITS Plan describes various interfaces 
between ITS and the participants.
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    The Fourteenth Amendment adds subsections (33(A)) and (33(B)) to 
Section 1 of the ITS Plan to define and include the terms ``PCX 
Application'' and ``PCX application Module.'' The proposal also amends 
existing definitions set forth in subsections (11), (23), (34(A)) and 
(34(B)) to recognize the use of the PCX Application and the PCX 
Application Module.
    The proposed amendment adds to Section 6(a)(ii) a description of 
the operation of the PCX Application and how PCX accesses other 
participants' markets through ITS. The amendment also authorizes PCX to 
computer-generate ITS commitments.
    In addition, the proposed amendment adds Section 8(h), which sets 
forth the parameters of the PCX Application's automated linkage to ITS. 
This section establishes the ``PCX Application Formula'' (``Formula''), 
which sets a ceiling on the volume of trade-at commitments \12\ 
generated by the PCX Application, relative to the total volume of 
transactions resulting from the PCX Application. Specifically, the 
Formula has as it numerator the number of shares computer-generated by 
the PCX Application as ITS trade-at commitments that are executed in 
other ITS participant markets, and as its denominator the same shares 
as in the numerator plus all shares executed on the PCX received from 
the PCX Application and reported to the Consolidated Tape Association. 
The Formula results in the PCX Application Percentage. Section (h) 
provides that PCX may computer-generate trade-at commitments if the PCX 
Application Percentage does not exceed the agreed upon ceiling as 
calculated over rolling calendar quarters, as defined in the Plan.\13\ 
The ceiling starts at 15% and will be reduced to 10% when the NYSE and 
PCX jointly request that the percentage be reduced. Section (h) 
provides that if the PCX Application Percentage exceeds the ceiling, 
then PCX must cease computer-generating trade-at commitments for a 
three-month period. During the first 24 calendar months following 
implementation of the PCX Application, however, the PCX retains the 
right to notify the ITSOC in writing, as specified in the new Section 
(h)(iv), that it will implement system adjustments to the PCX 
Application in an effort to ensure furture compliance with the PCX 
Application ceiling. In the event of such notification, the PCX has, at 
a minimum, nine calendar months from the date of such notice (or such 
longer period as may be approved by all members of the ITSOC upon a 
showing of reasonable cause), to implement its proposed system 
adjustments. During this nine month period, the restrictions do not 
apply. Notwithstanding other provisions, if, for any rolling calendar 
quarter, the PCX Application Percentage exceeds 30%, the PCX must cease 
computer-generating trade-at commitments for three calendar months 
beginning the first business day of the second month following the end 
of such rolling calendar quarter.
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    \12\ ``Trade-at'' commitments are those commitments sent from 
the PCX Application when there is no match of non-CQS profiles, or a 
partial execution of a non-CQS profile, with the balance filled by 
another participant market.
    \13\ ``Rolling Calendar Quarter'' means any three consecutive 
calendar months, with the first Rolling Calendar Quarter ending on 
the last business day of the first three full calendar months 
following the month in which the PCX Application commences 
operation, i.e., April 30, 1999.
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    Finally, Section 8(h)(vi) provides that the PCX will furnish the 
ITSOC with a report each month showing the number of shares for each 
component of the PCX Application Formula, as well as the number of 
executed shares resulting from ``trade-through'' commitments.\14\
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    \14\ A trade-through occurs when a transaction is effected at a 
price below the best prevailing bid, or above the best prevailing 
offer. The ITS Plan requires price continuity among the various 
markets by ensuring that the best national bids and offers are 
provided opportunities to trade with other markets effecting trades 
outside the best national quote.
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IV. Discussion

    The Commission finds that the proposed Fourteenth Amendment is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national market system plan, 
and, in particular, with the requirements of Section 11A.\15\ The 
Commission believes the proposal is consistent with the requirements of 
Sections 11A(a)(1)(C)(i), (ii) and (iv), and (D),\16\ which provide for 
the economically efficient execution of securities transactions and 
fair competition among the ITS participants and their markets. These 
sections also promote means to ensure that brokers execute investors' 
orders in the best market, and all markets for qualified securities are 
linked through communications and data processing facilities that 
foster efficiency, enhance competition, increase the information 
available to brokers, dealers, and investors, and contribute to the 
best execution of such orders. The Commission also finds that the 
amendment is consistent with Rule 11Aa3-2(c)(2),\17\ which requires the 
Commission to determine that the amendment is necessary and appropriate 
in the public interest, for the protection of investors and the 
maintenance of fair and orderly markets, to remove impediments to, and 
perfect the mechanisms of, a national market system or otherwise in 
furtherance of the purposes of the Act.
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    \15\ 15 U.S.C. 78k-1.
    \16\ 15 U.S.C. 78k-1(a)(1)(C)(i), (ii) and (iv) and (D).
    \17\ 17 CFR 240.11Aa3-2(c)(2).
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    The Commission notes that the PCX Application has been linked to 
ITS since January 29, 1999, under the same terms now being 
approved.\18\ The Commission further notes that the amendment now being 
approved was agreed to by the ITS participants after extensive 
discussions.\19\ Furthermore, no comments were received on the proposed 
amendment.
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    \18\ The Commission notes that the PCX and NYSE reached an 
agreement whereby, on or about June 1, 1999, the PCX Application 
began sending its trade-at volume to the NYSE through SuperDot, 
rather than through ITS. See Letter from John C. Katovich, Senior 
Vice President and General Counsel, OptiMark Technologies, Inc., to 
Allan A. Bretzer, Chairman, ITSOC, dated May 28, 1999.
    \19\ The participants agreed upon these amendments after the 
Commission published a proposal to amend the ITS Plan. See Exchange 
Act Release No. 40204 (July 15, 1998), 63 FR 39306 (July 22, 1998). 
The Commission received 30 comment letters on the Proposing Release, 
generally favoring linking the PCX Application to ITS.
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    Overall, the Commission believes that linking the PCX Application 
to ITS has provided, and potentially will continue to provide, a new 
and more efficient way to match and execute trading interest. Absent 
this linkage, the PCX would not be able to operate the PCX Application 
without major changes that would cripple the PCX Application, thereby 
reducing market innovation and competition.
    The ITS Plan states that ITS is not meant to be used to route 
routinely all or a substantial portion of a market's orders to another 
market. The Commission agrees that automated order routing of a 
substantial share of a

[[Page 42736]]

market's orders to ITS would violate the Plan and would be inconsistent 
with the Plan's intention.
    The adoption of a formula is reasonable in this instance to address 
the participants' concerns. The Fourteenth Amendment should prevent the 
PCX Application from being used as an automated order delivery device 
to obtain cost-free, non-member access to other market centers, while 
at the same time giving OptiMark an opportunity to offer an innovative 
new service to investors.

V. Conclusion

    It Is Therefore Ordered, pursuant to Section 11A(a)(3)(B) of the 
Act,\20\ that the amendment be approved.

    \20\ 15 U.S.C. 78k-1(a)(3)(B).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(29).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-20176 Filed 8-4-99; 8:45 am]
BILLING CODE 8010-01-M