[Federal Register Volume 65, Number 243 (Monday, December 18, 2000)]
[Notices]
[Pages 79145-79147]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32091]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43689; File No. SR-NYSE-98-25]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the New York Stock Exchange, Inc. Relating to the Creation of 
a Floor Audit Trail

December 7, 2000.

I. Introduction

    On August 4, 1998, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 \2\ 
thereunder, a proposed rule change. In its proposal, the NYSE seeks to 
adopt new provisions in NYSE Rule 123, to provide for the capturing of 
details of an order systemically on the Floor of the Exchange. The 
proposed provisions require that the details of all orders be recorded 
in an electronic system prior to being represented or executed on the 
Floor. On December 21, 1998, and June 8, 1999, respectively, the 
Exchange filed Amendment Nos. 1 and 2 to the proposed rule change.\3\ 
The proposed rule change, including Amendment Nos. 1 and 2, was 
published for comment in the Federal Register on August 12, 1999.\4\ 
The Commission received no comments on the proposed rule change and 
this order approves it.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letters from James E. Buck, Senior Vice President, NYSE, 
to Richard Strasser, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated December 18, 1998; and 
from Daniel P. Odell, Assistant Secretary, NYSE, to Richard 
Strasser, Division, Commission, dated June 7, 1999.
    \4\ See Securities Exchange Act Release No. 41706 (August 4, 
1999), 64 FR 44069.
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II. Description of the Proposal

    The Exchange has proposed a series of initiatives to strengthen the 
regulation of activities of members on the Floor. In this filing, the 
Exchange proposes to adopt new provisions in NYSE Rule 123 for 
recording the details of an order, as well as any modification or 
cancellation of such order, in an electronic system prior to 
representing or executing an order on the Floor.
    The proposed amendment to NYSE Rule 123 defines an order as any 
written, oral or electronic instruction to effect a transaction. 
Paragraph (e) of the proposed rule requires that, prior to being 
represented, an order, including any changes in its terms and any 
cancellations, must be entered into an electronic system that records 
the order details and records the time the order details were entered 
into the system and the time of any modification or cancellation. 
Nevertheless, the proposed rule excludes transactions initiated on the 
Floor and executed by a registered competitive market maker, a 
competitive trader or a specialist for their own account, as such 
trades may be initiated on the Floor and are already reported to the 
Exchange. In addition, the proposed rule provides that members may use 
either a proprietary or an Exchange system to comply with the rule, and 
if a proprietary system is used, order details must be sent to a 
designated NYSE database.
    The proposal requires that, other than as noted above, before 
representing or executing an order on the Floor, a member, whether 
acting as agent for another member on the Floor or otherwise, is 
obligated to make sure that the details of such order have been entered 
in an electronic system in accordance with the requirements of the 
rule. The Exchange represents that the details of the order may be 
entered into the system by an individual or organization other than the 
member who is representing or executing the order, but if this were to 
occur, the member with the order could not represent or execute the 
order until the details of the order were recorded in an electronic 
system.
    According to the NYSE, this proposed rule change does not replace 
existing requirements for recording orders contained in Exchange or 
Commission rules. For example, NYSE Rule 123, under the heading 
``Receipt of Orders,'' requires each member to preserve for three years 
a record of every order received by that member on the Floor from off 
the Floor, including the time when such order was received. NYSE Rule 
410 requires each member or member organization to preserve for three 
years a record of every order transmitted to the Floor or received and 
carried to the Floor by such member or member organization, including 
the name and amount of security, the terms of the order, the time it 
was transmitted or received, and the time an execution report was 
received.
    The proposal requires that members enter the following order 
details: symbol; clearing member organization; order identifier (as 
assigned by the member or member organization recording the order 
details) \5\ that uniquely identifies the order; identification of 
member or member organization recording order details; quantity; side 
of market (e.g., buy, sell long, sell short, sell short exempt); 
designation as market, limit, stop or stop limit; limit price, stop 
price and stop limit price (if applicable); time in force (e.g., day, 
GTC, GTX); \6\ designation as held or not held,\7\special conditions 
(e.g., Rule 10b-18, ``G'' order and any request by a customer that an 
order not be displayed); and, a system-generated timestamp. The 
proposed rule would also require the systematic entry of such other 
details as the Exchange may require from time to time.
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    \5\ According to the Exchange, its Broker Booth Support System 
(``BBSS'') automatically assigns a unique order identifier to the 
order, but a member or member organization can choose instead to 
override this feature and assign its own unique identifier.
    \6\ The Exchange represents that an order designated as good 
until a specific time will be recorded in a separate memo field 
(rather than in the time in force field) as a special condition or 
special instruction.
    \7\ The Exchange represents that this designation will also be 
recorded in a separate memo field (or fields) that will allow other 
special instructions and special conditions to be entered in a free 
format.
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    Along with this rule change, the Exchange proposes to design a 
database

[[Page 79146]]

system that it believes will enable compliance with this rule and 
enhance the ability of its BBSS to support various trading floor 
business models, while minimizing the impact on the timely execution of 
orders. According to the NYSE, these systems are being developed in 
consultation with various member committees as well as the individuals 
on the Upstairs Traders Advisory Committee and the Exchange Traders 
Advisory Committee. In addition, the Exchange represents that it has 
interviewed individual brokers, member firm technology departments, and 
service bureaus.
    In addition to recording the data elements required by NYSE Rule 
123, the Exchange represents that its database system will be able to 
record optional order data elements, including special instructions 
(e.g., go along, percent of volume), account type identifier (this is 
optional on order entry but mandatory on submission to trade comparison 
for audit trail), account number and any other information the firm 
chooses to include in the record, provided it is consistent with the 
format(s) accepted by the Exchange.
    The Exchange also plans to modify the existing BBSS to enable 
compliance at trading floor booths for firms that choose an NYSE 
(versus a proprietary) system to comply with the proposed rule. 
According to the Exchange, the BBSS enables firms to enter orders that 
are phoned to the Floor to receive orders delivered to the booth 
systemically via a proprietary system/NYSE system interface; and to 
enter orders from off-floor using an NYSE system. The Exchange 
represents that the planned enhancements to BBSS are designed to 
support entry of all order types and all required information as well 
as to speed data entry by providing quick entry templates and other 
data entry enhancements. The Exchange believes that the BBSS upgrade 
would also improve order and information management features resulting 
in operational efficiencies for the firms.
    According to the Exchange, BBSS currently is capable of accepting 
orders with prices per share as low as $.01 and as high as $99,999.\8\ 
However, in the event that BBSS cannot accommodate an order at the time 
NYSE Rule 123 becomes effective, the Exchange represents that brokers 
relying on BBSS to comply with the Rule would be exempt for orders that 
could not be entered through BBSS until such time as BBSS is compatible 
with the entry of such orders. According to the Supplementary Material 
of the proposed rule, orders that by their terms are incompatible for 
entry in an Exchange system relied on by a Floor member to record the 
details of the order in compliance with the proposed rule shall be 
exempt from the order entry requirements of the proposed rule. However, 
if a proprietary system is used, the proposed rule requires that the 
system must be capable of transmitting details of all orders to the 
Exchange database.
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    \8\ Previously, BBSS could not accept orders with orders 
fractional prices less than 1/64th or integer prices greater than 
$99,999. The Exchange has updated the BBSS capacity to accommodate 
decimal pricing. The Exchange represents that under the new 
parameters, all orders should be compatible for entry into BBSS. 
Telephone conversation between Donald Siemer, Director, Market 
Surveillance, NYSE, and Florence Harmon, Senior Special Counsel, 
Division, Commission, on November 20, 2000.
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    With regards to system specifications, the NYSE represents that its 
systems development plan includes building a new database to collect 
and consolidate records of orders in NYSE systems and orders that are 
sent to the Exchange Floor for execution through a member firm's 
proprietary system. Further, the NYSE represents that its systems will 
be designed to provide for members firms' proprietary systems interface 
to the NYSE database in Common Message Switch (``CMS''), Financial 
Information Exchange Protocol (``FIX''), or other NYSE-approved 
industry standard format. According to the NYSE, such systems must 
submit a copy of the order details to the NYSE database upon receipt of 
the order by the member firm's proprietary system on the Floor.\9\ In 
addition, the NYSE requires an ``as of'' time indicator for orders 
entered late due to system problems, and if this occurs, member firms 
would have to notify the Exchange by the end of the following day and 
provide documentation of the system problem that necessitated the use 
of an ``as of'' time indicator.
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    \9\ According to the Exchange, ``upon receipt'' means as soon as 
practicable, but no later than 60 seconds after receipt. This 60 
seconds is intended to provide flexibility in implementation and is 
not intended to be incorporated into proprietary systems; e.g., a 
system that was programmed to routinely transmit a copy to the 
Exchange database system 60 seconds after receipt of an order would 
not comply with the system requirement.
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    The Exchange represents that it intends to communicate its system 
plan to member firms, then finalize NYSE system specifications, and 
issue interface specifications to member firms. The effective date of 
the proposed rule will be based on the implementation of enhancements 
to NYSE systems as well as the state of readiness of the member firm 
community. The Exchange represents that the NYSE systems have been 
tested; however, the implementation date is still subject to the 
completion of specification and design work, as well as the 
finalization of development, and cutover schedules.\10\
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    \10\ Telephone conversation between Donald Siemer, Director, 
Market Surveillance, NYSE, and Jennifer Colihan, Attorney, Division, 
Commission, on November 21, 2000. The Commission notes, however, 
that pursuant to the SEC Order, Phase I of the Floor Audit Trail 
must be implemented within nine months after the date of this 
approval order. See In the Matter of New York Stock Exchange, Inc., 
SEC Release No. 34-41574, June 29, 1999; Administrative Proceeding 
File No. 3-9925 (``SEC Order'').
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    The Exchange believes that the implementation of this system will 
allow the NYSE to track more accurately via systemic records whether an 
order has been received on the Floor prior to its execution. The 
Exchange also believes it would address the issue of falsification of 
order entry times. Therefore, the Exchange believes that its ability to 
surveil for anomalous trading situations--such as on-floor trading and 
the creation of inaccurate records, frontrunning of orders, and 
improper execution of customers' orders--will be enhanced.
    With regards to the enforcement of violations of the proposed rule, 
the NYSE represents that if it determines that a particular violation 
of this proposed rule is minor in nature, it could issue a cautionary 
letter. Moreover, the NYSE represents that it would consider seeking 
approval to add the proposed provisions of NYSE Rule 123 to the list of 
rules contained in NYSE Rule 476A, which provides for the imposition of 
fines for minor violations of rules. In those instances where the 
investigation reveals a more serious violation or repetitive violations 
of NYSE Rule 123, the Exchange represents that it would commence 
disciplinary procedures under NYSE Rule 476.\11\
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    \11\ The Exchange represents that it does not include specific 
reference to disciplinary matters in each rule because it believes 
the language in NYSE Rules 476 and 476A is all-encompassing.
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III. 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\ Specifically, 
the Commission believes that by strengthening the Exchange's ability to 
examine and surveil activities on the Exchange Floor, the proposal is 
consistent with the Section 6(b)(5) \13\

[[Page 79147]]

requirements that the rules of an exchange be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest.\14\
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
    \14\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    The proposed rule change is intended to fulfill some of the 
undertakings contained in the order issued by the Commission relating 
to the settlement of an enforcement action against the NYSE for failure 
to enforce compliance with Section 11(a) and Rule 11a-1 of the Act and 
NYSE rules 90, 95, and 111.\15\ The SEC Order found that the NYSE's 
floor broker regulatory program suffered from two major deficiencies: 
(1) The NYSE failed to take appropriate action to police for profit-
sharing or other performance-based compensation of independent floor 
brokers; and (2) the NYSE suspended its routine independent floor 
broker surveillance for extensive periods of time.\16\ In addition, 
although not part of the findings in the SEC Order, the Commission's 
initial and amended complaints and the Office of the United States 
Attorney for the Southern District of New York's indictment charged, 
among other things, that independent floor brokers profited from the 
information they acquired on the NYSE floor by trading ahead of 
customer orders and, in some instances, engaging in frontrunning in 
violation of Section 17(a) of the Securities Act of 1933, Section 10(b) 
of the Act and rule 10b-5 thereunder.
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    \15\ See note 10, supra.
    \16\ Id.
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    As part of the SEC Order, the NYSE agreed and was ordered to 
continue the development and implementation of an electronic floor 
system (``Phase I Floor Audit Trail'') that will be used to enter 
details related to orders before these orders can be represented on the 
trading floor. To accomplish this undertaking, the NYSE was ordered to 
submit a proposed rule change setting forth the complete details and 
specifications of the Phase I Floor Audit Trail, and to fully implement 
the Phase I Floor Audit Trail nine months after Commission approval of 
the proposal. This proposed rule change addresses this undertaking. The 
Commission believes that, by strengthening the Exchange's ability to 
examine and surveil members' activities on the Exchange Floor, the 
proposed rule change is consistent with and is an important step toward 
satisfying certain of the undertakings relating to oversight of the 
trading floor.
    The proposal requires that members and member organizations enter 
the details of an order before they can represent or execute the order 
on the floor of the Exchange. Among other things, the member must 
electronically time stamp the order before representing or executing it 
on the floor and must record any changes in the terms of the order or 
cancellations of the order.\17\ The Commission finds that requiring 
members and member organizations to electronically record the details 
of an order before representing or executing the order on the floor 
will enhance the Exchange's ability to deter and detect violations of 
the securities laws and the Exchange's rules, such as trading ahead of 
customer orders or frontrunning. Specifically, the rule enhances the 
NYSE's ability to track the handling of an order from receipt until 
execution. For example, this information can be used to reconstruct 
markets to determine whether an independent floor broker traded ahead 
of a customer order. The Commission also finds that enhancing the 
surveillance of members' activities on the floor is consistent with the 
Exchange's responsibility, under Section 6(b)(5) of the Act, to prevent 
fraudulent and manipulative acts and practices.
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    \17\ The Commission notes that in a pending proposed rule 
change, the NYSE is proposing to require that members synchronize 
business clocks to record the date and time of any event that the 
Exchange requires to be recorded. See SR-NYSE-99-51 (proposal to 
implement Phase II of the Floor Audit Trail System).
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IV. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-NYSE-98-25) is approved.
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    \18\ 15 U.S.C. 78s(b)(2).

    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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-32091 Filed 12-15-00; 8:45 am]
BILLING CODE 8010-01-M