[Federal Register Volume 69, Number 236 (Thursday, December 9, 2004)]
[Notices]
[Pages 71445-71446]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3569]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50795]


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

December 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\ and on March 3, 2004.\5\
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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 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.
    \5\ See Securities Exchange Act Release No. 49356 (March 3, 
2004), 69 FR 11057 (March 9, 2004) (the ``March 2004 Order''). The 
March 2004 Order granted relief through December 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.\6\ 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.\7\
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    \6\ 17 CFR 240.11Aa3-2.
    \7\ 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 March 2004 Order continued the 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'').\8\ 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.\9\ By its terms, the March 2004 Order continued the 
exemption 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 December 4, 2004.
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    \8\ 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.
    \9\ 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.\10\

[[Page 71446]]

    In March 2004 and in May 2003, the Commission extended the three 
cent de minimis exemption for additional nine-month periods, 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.\11\ 
Because the Commission has not yet taken action with respect to 
proposed Regulation NMS, the Commission believes it is appropriate to 
extend the de minimis exemption.
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    \10\ 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 national best bid and offer 
(``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.
    \11\ On February 24, 2004, the Commission proposed Regulation 
NMS for public comment. Securities Exchange Act Release No. 49325 
(February 26, 2004), 69 FR 11126 (March 9, 2004). On May 20, 2004, 
the Commission published a supplemental request for comment and 
extended the period for comment on proposed Regulation NMS. 
Securities Exchange Act Release No. 49749 (May 20, 2004), 69 FR 
30142 (May 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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    This extension of the de minimis exemption, however, applies only 
to the DIA and the SPY, and not the QQQ. On December 1, 2004, trading 
of the QQQ transferred from the American Stock Exchange to Nasdaq, and 
trades in the QQQ ceased to be subject to the trade-through provisions 
of the ITS Plan. Accordingly, an exemption for the QQQ is no longer 
necessary.
    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 September 4, 
2005, the Commission may determine to modify, withdraw, or extend the 
de minimis exemption. The Commission emphasizes, as it did in the March 
2004 Order, the May 2003 Order and 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,\12\ 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 
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 December 4, 2004 through 
September 4, 2005.
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    \12\ 17 CFR 240.11Aa3-2(f).

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-3569 Filed 12-8-04; 8:45 am]
BILLING CODE 8010-01-P