[Federal Register Volume 69, Number 46 (Tuesday, March 9, 2004)]
[Notices]
[Pages 11057-11058]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5211]



[[Page 11057]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49356]


Order Pursuant to Section 11A of the Securities Exchange Act of 
1934 and Rule 11Aa3-2(f) Thereunder Extending a De Minimis Exemption 
for Transactions in Certain Exchange-Traded Funds From the Trade-
Through Provisions of the Intermarket Trading System

March 3, 2004.
    This order extends, for an additional nine-month period, a de 
minimis exemption to the provisions of the Intermarket Trading System 
Plan (``ITS Plan''),\1\ a national market system plan,\2\ governing 
intermarket trade-throughs. The de minimis exemption was originally 
issued by the Commission on August 28, 2002 \3\ and extended on May 30, 
2003.\4\
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    \1\ The self-regulatory organizations (``SROs'') participating 
in the ITS Plan include the American Stock Exchange LLC, the Boston 
Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., the 
Chicago Stock Exchange, Inc., the National Stock Exchange, Inc. 
(formerly the Cincinnati Stock Exchange, Inc.), the National 
Association of Securities Dealers, Inc. (``NASD''), the New York 
Stock Exchange, Inc., the Pacific Exchange, Inc., and the 
Philadelphia Stock Exchange, Inc. (collectively, the 
``participants''). See Securities Exchange Act Release No. 19456 
(January 27, 1983), 48 FR 4938 (February 3, 1983).
    \2\ Securities Exchange Act of 1934 (``Act'') Rule 11Aa3-2(d), 
17 CFR 240.11Aa3-2(d), promulgated under section 11A, 15 U.S.C. 78k-
1, of the Act requires each self-regulatory organization (``SRO'') 
to comply with, and enforce compliance by its members and their 
associated persons with, the terms of any effective national market 
system plan of which it is a sponsor or participant. Rule 11Aa3-
2(f), 17 CFR 240.11Aa3-2(f), under the Act authorizes the Commission 
to exempt, either unconditionally or on specified terms and 
conditions, any SRO, member of an SRO, or specified security from 
the requirement of the rule 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.
    \3\ See Securities Exchange Act Release No. 46428 (August 28, 
2002), 67 FR 56607 (September 4, 2002) (the ``August 2002 Order''). 
The August 2002 Order granted relief through June 4, 2003.
    \4\ See Securities Exchange Act Release No. 47950 (May 30, 
2003), 68 FR 33748 (June 5, 2003) (the ``May 2003 Order''). The May 
2003 Order granted relief through March 4, 2004.
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    The ITS Plan system is an order routing network designed to 
facilitate intermarket trading in exchange-listed securities among 
participating SROs based on current quotation information emanating 
from their markets. Quotations in exchange-listed securities are 
collected and disseminated by the Consolidated Quote System (``CQS''), 
which is governed by a national market system plan that the Commission 
has approved pursuant to Rule 11Aa3-2 under the Act.\5\ Under the ITS 
Plan, a member of a participating SRO may access the best bid or offer 
displayed in CQS by another Participant by sending an order (a 
``commitment to trade'') through ITS to that Participant. Exchange 
members participate in ITS through facilities provided by their 
respective exchanges. NASD members participate in ITS through a 
facility of the Nasdaq Stock Market (``Nasdaq'') known as the Computer 
Assisted Execution System (``CAES''). Market makers and electronic 
communications networks (``ECNs'') that are members of the NASD and 
seek to display their quotes in exchange-listed securities through 
Nasdaq must register with the NASD as ITS/CAES Market Makers.\6\
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    \5\ 17 CFR 240.11Aa3-2.
    \6\ See Securities Exchange Act Release No. 42536 (March 16, 
2000), 65 FR 15401 (March 22, 2000). Market Makers and ECNs are 
required to provide their best-priced quotations and customer limit 
orders in certain exchange-listed and Nasdaq securities to an SRO 
for public display under Commission Rule 11Ac1-1 and Regulation ATS. 
17 CFR 240.11Ac1-1 and 242.301(b)(3).
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    The May 2003 Order granted a de minimis exemption from compliance 
with section 8(d)(i) of the ITS Plan with respect to three specific 
exchange-traded funds (``ETFs''), the Nasdaq-100 Index ETF (``QQQ''), 
the Dow Jones Industrial Average ETF (``DIA''), and the Standard & 
Poor's 500 Index ETF (``SPY'').\7\ Section 8(d)(i) of the ITS Plan 
provides that participants should not purchase or sell any security 
that trades on the ITS Plan system at a price that is worse than the 
price at which that security is otherwise being offered on the ITS Plan 
system.\8\ By its terms, the May 2003 Order exempts from the trade-
through provisions of the ITS Plan any transactions in the three ETFs 
that are effected at prices at or within three cents away from the best 
bid and offer quoted in the CQS for a period of nine months, which ends 
on March 4, 2004.
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    \7\ The Commission limited the de minimis exemption to these 
three securities because they share certain characteristics that may 
make immediate execution of their shares highly desirable to certain 
investors. In particular, trading in the three ETFs is highly liquid 
and market participants may value an immediate execution at a 
displayed price more than the opportunity to obtain a slightly 
better price.
    \8\ Each ITS participant has adopted a trade-through rule 
substantially similar to the rule of the ITS Plan. See ITS Plan, 
section 8(d)(ii); See, e.g., NYSE Rule 15A, NASD Rule 5262.
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    The three cent de minimis exemption allows ITS participants and 
their members to execute transactions, through automated execution or 
otherwise, without attempting to access the quotes of other 
participants when the expected price improvement would not be 
significant. In providing the three cent de minimis exemption, the 
Commission believed that, on balance, exempting the specified 
transactions from the ITS trade-through provisions would provide 
investors increased liquidity and expand the choice of execution 
venues, while limiting the possibility that investors would receive 
significantly inferior prices.\9\
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    \9\ See August 2002 Order, supra note 3. The Commission's Office 
of Economic Analysis conducted an analysis of trading in the QQQs in 
2002, comparing trading on a day before the de minimis exemption was 
implemented, a day after the exemption was implemented before 
Island, an ECN, stopped displaying its orders to anyone, even its 
subscribers (going ``dark''), and a day after the exemption was 
implemented when Island was ``dark.'' The analysis showed that the 
percent of trades executed outside the NBBO did not increase, and 
that less than 1% of total trades were executed more than three 
cents away from the NBBO, after the de minimis exemption was 
implemented. A copy of the analysis is available in File No. S7-10-
04.
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    In May 2003, the Commission extended the three cent de minimis 
exemption for an additional nine-months, in order to assess trading 
data associated with the de minimis exemption and to consider whether 
to adopt the de minimis exemption on a permanent basis, to adopt some 
other alternative solution, or to allow the exemption to expire. As a 
result of its review of trading data associated with the de minimis 
exemption, the Commission has proposed, as part of its market structure 
initiatives, Regulation NMS under the Act, which would include a new 
rule relating to trade-throughs.\10\ Over the next several months, the 
Commission intends to consider proposed Regulation NMS, together with 
any comments received, and determine whether to adopt the proposed 
trade-through rule or an alternative.
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    \10\ On February 24, 2004, the Commission proposed Regulation 
NMS for public comment. Securities Exchange Act Release No. 49325 
(February 26, 2004). In part, proposed Rule 611 of Regulation NMS 
would require certain identified market centers to establish, 
maintain, and enforce policies and procedures reasonably designed to 
prevent trade-throughs. Extension of the de minimis pilot in no way 
prejudges or determines what actions the Commission may take with 
respect to any rule proposal.
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    In view of the foregoing, the Commission believes that an extension 
of the de minimis exemption for an additional nine-month period 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. 
Depending on the action the Commission takes on proposed Regulation NMS 
prior to December 4, 2004, the Commission may determine to modify, 
withdraw, or

[[Page 11058]]

extend the de minimis exemption. The Commission emphasizes, as it did 
in the May 2003 Order and in the August 2002 Order, that the de minimis 
exemption does not relieve brokers and dealers of their best execution 
obligations under the federal securities laws and SRO rules.
    Accordingly, it is ordered, pursuant to section 11A of the Act and 
Rule 11Aa3-2(f) thereunder,\11\ that participants of the ITS Plan and 
their members are hereby exempt from section 8(d) of the ITS Plan 
during the period covered by this Order with respect to transactions in 
QQQs, DIAs, and SPYs that are executed at a price that is no more than 
three cents lower than the highest bid displayed in CQS and no more 
than three cents higher than the lowest offer displayed in CQS. This 
Order extends the de minimis exemption from March 4, 2004 through 
December 4, 2004.
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    \11\ 17 CFR 240.11Aa3-2(f).

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-5211 Filed 3-8-04; 8:45 am]
BILLING CODE 8010-01-P