[Federal Register Volume 66, Number 80 (Wednesday, April 25, 2001)]
[Notices]
[Pages 20844-20845]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-10232]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44194; File No. SR-NYSE-97-18]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Approving Proposed Rule Change Relating to Specialists' Entry of 
Bids and Offers in Electronic Communications Networks and Other Market 
Centers

April 18, 2001.

I. Introduction

    On June 2, 1997, 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 prohibit a specialist from 
entering bids and offers in electronic communications networks 
(``ECNs'') or other market centers at prices superior to the 
specialist's quote on the Exchange. On November 19, 1997, the Exchange 
submitted Amendment No. 1 to the proposed rule change.\3\ On February 
10, 1999, the Exchange submitted Amendment No. 2 to the proposed rule 
change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, NYSE modified references the Exchange 
had made to the Commission's Quote Rule.
    \4\ In Amendment No. 2, NYSE removed all references to the 
Commission's Quote Rule. NYSE also eliminated its proposed exemption 
for bids or offers relating to program trading orders entered into 
an ECN or other market centers by an upstairs trading operation 
conducted by a specialist member organization.
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    The proposed rule change, including Amendment Nos. 1 and 2, were 
published for comment in the Federal Register on May 20, 1999.\5\ The 
Commission received three comment letters on the proposal. This order 
approves the proposed rule change as amended.
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    \5\ Securities Exchange Act Release No. 41397 (May 13, 1999), 64 
FR 27610.
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II. Description of the Proposal

    The proposal would amend NYSE Rule 104.10 to explain that a 
specialist \6\ has a duty to quote his or her best bid and offer on the 
Exchange. Under the proposed rule, a specialist's bid or offer for a 
specialty stock on the Exchange could not be inferior to his or her bid 
or offer in an ECN or another market center.\7\ Thus, if a specialist 
placed a bid or offer in an ECN or on another market center at a price 
superior to the then disseminated best bid or offer on Exchange, the 
specialist would be required to communicate \8\ such price to the 
Exchange.
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    \6\ The Exchange defines ``specialist'' as an individual 
specialist on the floor.
    \7\ ``Another market center'' means a registered national 
securities exchange or registered national securities association.
    \8\ The Exchange views ``communicate'' in this context to 
require the specialist to make the price, whether the bid or the 
offer, available for execution on the Exchange. The specialist would 
then be liable for executions at this price on both the Exchange and 
on the ECN or other market center.
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    In addition, the proposed rule change would prohibit a specialist 
from entering a bid or offer for a specialty stock in an ECN or on 
another market center at a price variation in which the specialist 
would not be permitted to quote or trade under Exchange rules. The 
Exchange believes that if the specialist placed a superior priced bid 
or offer in an ECN \9\ or other market center at a variation that could 
not be quoted or traded on the Exchange, the specialist would be unable 
to satisfy his or her specialist obligations, i.e., the specialist 
could not trade at his or her best bid or offer with contra-side 
marketable orders received on the Exchange. Also, if the specialist 
placed in an ECN or other market center an inferior bid or offer at a 
variation not accepted by the Exchange and the order was subsequently 
executed on the ECN or other market center, the specialist could not 
satisfy any superior-priced orders on his or her book at the price of 
his or her trade off the Exchange, consistent with his or her 
responsibilities as agent.
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    \9\ The proposed rule applies only to specialists when they add 
liquidity to an ECN or another market center (i.e., enter a new bid 
or offer) and not when they remove liquidity (i.e., hit a pre-
existing bid or offer) or enter ``fill-or-kill'' orders.
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III. Summary of Comments

    The Commission received comment letters from American Century 
Investment Management (``ACIM'') and Archipelago, LLC, opposing the 
proposed rule change.\10\ The Exchange responded to these letters but 
did not amend the proposed rule change.\11\
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    \10\ See letter from Mike Cormack, Manager, Equity Trading, 
ACIM, to Jonathan G. Katz, Secretary, SEC, dated July 28, 1999. The 
Commission received two substantially similar comment letters from 
Archipelago. See letters from Gerald D. Putnam, CEO, Archipelago, to 
Jonathan G. Katz, Secretary, SEC, dated July 20 and July 21, 1999.
    \11\ See Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Jonathan G. Katz, Secretary, SEC, dated 
September 23, 1999.
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    In its letter, ACIM suggested that the proposal was an attempt by 
the NYSE to control the trading of its own member firms to protect the 
NYSE's monopoly of listed equity trading in the U.S. ACIM urged the 
Commission to reject the proposal because it limits the competitiveness 
of the U.S. equity markets, raises the costs for investors, and 
conflicts with the Order Handling Rules (``OHR'') \12\ by limiting the 
choices of specialists in the display and routing of orders. ACIM also 
questioned how the proposal would be implemented after decimalization, 
asking: (1) Will the specialist be forced to follow the increment 
selected by the NYSE, and (2) what happens to orders routed to the NYSE 
that do not meet the increment guidelines of the NYSE? In addition, 
ACIM argued that when a specialist faces the possibility of double 
liability because the specialist has used an ECN to post an order, the 
NYSE should not be able to mandate procedures for the specialist's 
behavior; the specialist should be able to make his own investment 
decisions.
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    \12\ Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996).
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    Archipelago also challenged the proposal as anti-competitive. 
Specifically, Archipelago charged that the proposal violates the 1975 
Amendments to the Act \13\ and Rule 19c-1 \14\ because it undermines 
the concept of the National Market System (``NMS'') by severely 
limiting the ability of specialists to use ECNs in an agency capacity, 
which in turn prevent specialists from meeting their best execution 
obligations to customers.\15\ In addition, the proposal deprives 
investors of pricing efficiency and flexibility; specifically the 
ability to enter competitively priced limit orders in sub-$1/16 
increments. Archipelago further commented that the proposal, by 
limiting the ability of specialists to use ECNs competitively, is an 
attempt to circumvent the OHR, which require full integration of ECNs 
into the marketplace. Lastly, Archipelago stated that the NYSE has not 
provided any meaningful analysis concerning the competitive effects of 
the proposal as required by Rule 19b-4,\16\ offering only perfunctory 
boilerplate.
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    \13\ 15 U.S.C. 78k-1.
    \14\ Rule 19c-1 precludes exchanges from prohibiting exchange 
members from routing customer orders to off-exchange trading venues. 
17 CFR 240.19c-1.
    \15\ Archipelago also noted that off-exchange restrictions on 
proprietary specialist trading are inconsistent with the NMS as 
well.
    \16\ 17 CFR 240.19b-4.
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    In response, the Exchange argued that Archipelago and a ACIM's 
letters mischaracterized the NYSE's proposal and raised broad policy 
questions regarding the future evolution of the NMS that are not 
relevant to the

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proposed rule change. Specifically, the NYSE responded that the 
proposal does not undermine the NMS or Rule 19c-1 because the proposal 
does not impose any restrictions on the routing of customer orders. The 
proposal only sets standards for a specialist's market maker bid or 
offer on the exchange. The NYSE also stated that the proposal is 
consistent with the OHR because it does not impose any restrictions on 
a specialist's responsibility to display customer orders.
    Further, the NYSE wrote that the proposal does not impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Act with respect to the routing of customer limit 
orders to ECNs or other market centers. The NYSE opined that the 
restriction on specialists is appropriate because it is designed to 
ensure that specialists' dealer capital is committed to meeting their 
affirmative obligation to maintain fair and orderly markets in the 
primary market in which they are registered as dealers. Finally, the 
NYSE argued that each market center would determine its own decimal 
trading variation. If these variations are the same, then the 
restriction against bidding or offering at a variation not permitted on 
the Exchange will not apply. In any event, the NYSE suggested that 
contra side order flow would seek to trade at whatever variation it 
chooses.

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)(5) and 6(b)(8).\17\ 
Section 6(b)(5) requires that the rules of an exchange be designated to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest.\18\ Section 6(b)(8) requires 
that the rules of an exchange do not impose any burden on competition 
not necessary or appropriate in furtherance of the purposes of the Act. 
Further, the Commission finds that the proposal is consistent with 
section 11(b) of the Act \19\ and Rule 11b-1 thereunder,\20\ which 
allow exchanges to promulgate rules relating to specialists to ensure 
orderly markets.
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    \17\ 15 U.S.C. 78f(b)(5) and 78f(b)(8).
    \18\ 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).
    \19\ 15 U.S.C. 78k(b).
    \20\ 17 CFR 240.11b-1.
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    Specialists play a crucial role in providing stability, liquidity, 
and continuity to the trading of securities on the Exchange. In return 
for the privilege of serving as the only specialist in stocks traded on 
the NYSE, which as the primary market for listed stocks continues to 
receive a significant percentage of the order flow, the NYSE improves 
conditions designed to improve the quality of its market. Among the 
obligations imposed upon specialists by the Exchange, and by the Act 
and rules thereunder, is the maintenance of an orderly market in 
designated securities.\21\ To ensure that specialists fulfill these 
obligations, it is important that the Exchange have the ability to 
implement rules and develop measures to guide and improve specialists' 
performance. The Commission believes that the proposal is consistent 
with the Exchange's objective to promote the maintenance of orderly 
markets because it enhances the Exchange's ability to encourage 
improved specialist performance and market quality by clarifying 
specialists' duty at the NYSE--to quote his or her best bid and offer 
on the Exchange.
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    \21\ See, e.g., 17 CFF 240.11b-1; NYSE Rule 104.
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    The Commission carefully considered the concerns expressed by 
Archipelago and AICM in their letters opposing the proposal. Although 
the proposed rule change places restrictions on specialists, the 
Commission finds that the restrictions are reasonable. First, NYSE's 
proposal only applies to the bids and offers of individual specialists 
on the floor of the Exchange. The Commission notes that the NYSE has 
amended the proposal so that it no longer applies to affiliates of 
individual specialists. Therefore, the proposal is limited to the firms 
that benefit from the privilege of acting as specialists on the NYSE. 
Second, the proposal is not inconsistent with Rule 19c-1 because it 
does not impose restrictions on the routing of customer orders. Third, 
it is not inconsistent with the OHR because it does not impose 
restrictions on a specialist's responsibility to display customer 
orders. Specialists will continue to have an obligation under the OHR 
to display a customer limit order that betters their quote.\22\ Fourth, 
exchanges have historically maintained a minimum increment for quoting 
and trading listed securities on the exchange in order to ensure fair 
and orderly trading, including capacity limitations of exchange 
computer systems.\23\ Fifth, as discussed above, exchanges need to have 
the ability to set standards for specialists' performance. This 
proposal with allow specialists to meet their obligations by ensuring 
that if a specialist places a superior priced bid or offer on an ECN or 
other market center, the specialist can trade at his or her best bid or 
offer with contra-side marketable orders received on the Exchange.
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    \22\ See supra note 11 at 48316; see also NYSE Rule 79A.
    \23\ Currently, the exchanges have adopted a minimum price 
variation of a penny. See Securities Exchange Act Release No. 42914 
(June 8, 2000).
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    For these reasons, the Commission finds that the proposal is 
consistent with the Act, including sections 6(b)(5), 6(b)(8) and 11(b), 
in that it does not impose any burden on competition that is not 
necessary or appropriate in furtherance of the Act.

V. Conclusion

    It is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NYSE-97-18), as amended, is 
approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-10232 Filed 4-24-01; 8:45 am]
BILLING CODE 8010-01-M