[Federal Register Volume 64, Number 33 (Friday, February 19, 1999)]
[Notices]
[Pages 8424-8426]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-4117]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41041; File No. SR-NYSE-98-45]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Approving Proposed Rule Change by the New York Stock Exchange,
Inc. Relating to Amendments to Rule 80A
February 11, 1999.
I. Introduction
On December 8, 1998, 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 amend its Rule 80A relating to
limitations on program trading.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on December 23, 1998.\3\ Three comment letters were received
on the proposal.\4\ This order approves the NYSE proposal.
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\3\ Securities Exchange Act Release No. 40797 (December 23,
1998), 63 FR 71176.
\4\ The comment letters have been placed in Public File SR-NYSE-
98-45, which is available for inspection in the Commission's Public
Reference Room. See Letters from T. Eric Kilcolin, President and
Chief Executive Officer, Chicago Mercantile Exchange (``CME''),
dated January 11, 1999 (``CME Letter''); Pikku Thakkar, Senior
Counsel, Neuberger Berman, LLC (``Neuberger'') dated January 15,
1999 (``Neuberger Letter''); and Paul A. Merolla, Vice President,
Associate General Counsel, Goldman, Sachs & Co., Christine A.
Sakach, Director and Senior Counsel, Merrill Lynch & Co., Robin
Roger, Principal and Counsel, Morgan Stanley & Co. Incorporated, and
Andrew Constan, Managing Director, Salomon Smith Barney Inc.
(collectively, ``Broker-Dealers''), dated January 20, 1999
(``Broker-Dealer Letter'').
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II. Description of the Proposal
The NYSE proposes to eliminate the ``sidecar'' provisions contained
in Rule 80A. As discussed below, current Rule 80A(a) provides that,
under the sidecar, program trading orders in stocks in the Standard &
Poor's (``S&P'') 500 Stock Price Index are temporarily diverted into
separate electronic files for a five-minute period if the primary S&P
500 futures contract declines by 12 points form its previous close. If
the sidecar is triggered, current Rule 80A(b) also imposes limitations
on the entry of certain types of stop orders or stop limit orders. Both
of these provisions would be eliminated under the Exchange's proposal.
The NYSE also proposes to revise the trigger levels for the
``collar'' provisions of Rule 80A. Currently, NYSE Rule 80A(c) provides
for limitations on index arbitrage trading in any component of the S&P
500 Stock Price Index whenever the Dow Jones Industrial Average \5\
(``DJIA'') moves up or down 50 points form its previous close. If the
market advances by 50 points or more, all index arbitrage orders to buy
must be stabilizing (buy minus); similarly, if the market declines, all
index arbitrage orders to sell must be stabilizing (sell plus). The
stabilizing requirements are removed if the DJIA moves back to or
within 25 points of the previous day's close. The NYSE proposes to
replace the current 50-point and 25-point triggers with thresholds set
at a ``two-percent value'' and a ``one-percent value'' of the DJIA.
These percent values would be translated into specific point levels at
the beginning of each calendar quarter based on an average for the DJIA
over the preceding month.
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\5\ ``Dow Jones Industrial Average'' is a service mark of Dow
Jones & Company, Inc.
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The NYSE is also proposing to delete the provisions, contained in
current Rule 80A(d), relating to purchases and sales of a ``basket''
(as that term is defined in Rule 800(b)(iii)), because the basket
product is no longer traded on the Exchange.
Finally, the Exchange is proposing to clarify its definition of
index arbitrage in Supplementary Material .40 to Rule 80A to include
some forms of ``basis trading.''\6\
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\6\ A description of the types of basis trading included in
Supplementary Material .40 is provided in infra note 24.
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III. Summary of Comments
As previously stated, the Commission received three comment letters
on the Exchange's proposal. Two of the commenters, the CME and the
Broker-Dealers, were generally supportive of the proposal, while one
commenter, Neuberger, opposed parts of the proposal.
The CME ``applaud[ed] the efforts of the NYSE to liberalize the
provisions of Rule [80A]'' because it ``has long regarded Rule 80A as
an artificial constraint to the interplay of U.S. equity markets.'' \7\
The CME cited studies that it asserted would refute the efficacy of the
rule.\8\ While the CME stated that ``further expansion of the trigger
or the elimination of the collar altogether is a worthy objective[,]''
it also ``understand[s] that progress is often realized in graduated
steps rather than in leaps.'' \9\
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\7\ CME Letter at 1, supra note 4.
\8\ See Harris, L., Sofianos, G., and Shapiro J. 1994, ``Program
Trading and Intraday Volatility'' The Review of Financial Studies
Vol. 7, No. 4, Winter 1994; and Overdahl, J., and McMillan, H. 1998,
``Another Day, Another Collar: An Evaluation of the Effects of NYSE
Rule 80A on Trading Costs and Intermarket Arbitrage,'' Journal of
Business Vol. 71, No. 1, 1998.
\9\ CME Letter at 2, supra note 4.
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The Broker-Dealers also generally supported the NYSE's proposals to
eliminate the sidecar procedures and to widen the thresholds for the
restrictions on index arbitrage imposed by Rule 80A's collar
provisions. Nevertheless, the Broker-Dealers stated that they agree
with members of The President's Working Group on Financial Markets
(``Working Group''),\10\ that the index arbitrage collar provisions do
not appear to be appropriate and may hamper legitimate intermarket
trading activities and result in market inefficiencies. Like the CME,
the Broker-Dealers believe that the Commission should approve the
Exchange's current revisions to Rule
[[Page 8425]]
80A only as an interim step and that the Commission should urge the
NYSE to move expeditiously toward ultimate rescission of Rule 80A.\11\
In addition, the Broker-Dealers were critical of the Exchange's
proposed revision to its definition of index arbitrage for purposes of
Rule 80A. In particular, the Broker-Dealers were concerned that the
reference to ``basis trading'' in the revised definition of index
arbitrage could be interpreted to apply to activities that are not
typically associated with index arbitrage and not reasonably implied by
the language of Rule 80A.\12\
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\10\ The Working Group consists of the Under Secretary of
Finance of the Department of the Treasury and the Chairmen of the
Commission, the Commodity Futures Trading Commission, and the Board
of Governors of the Federal Reserve System. The Working Group's
concerns over NYSE Rule 80A are discussed below.
\11\ Broker-Dealer Letter at 1-3, supra note 4.
\12\ Id. at 1-4.
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Neuberger, on the other hand, believes that, if adopted, the
proposed expansion of the collar thresholds ``is certain to
substantially increase the daily volume of index arbitrage activity and
will simultaneously translate into a substantially higher level of
daily volatility upon the NYSE.'' \13\ In addition, Neuberger ``feel[s]
that this proposal is not in the best interests of the investing
public, particularly the small investor.'' \14\
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\13\ Neuberger Letter at 1, supra note 4.
\14\ Id.
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IV. Discussion
After careful review of the Exchange's proposed amendment to Rule
80A and the comments, the Commission is approving the changes as
proposed. The Commission believes that the proposed rule changes are
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities exchange
and, in particular, the requirements of Section 6(b).\15\ Specifically,
the Commission believes that the proposals are consistent with Section
6(b)(5) requirements that the rules of an exchange be designed 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, to prevent fraudulent and manipulative acts, and, in
general, to protect investors and the public interest.\16\
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\15\ 15 U.S.C. 78f(b).
\16\ 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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Elimination of Sidecar Provisions
As discussed above, the sidecar provisions of current NYSE Rule
80A(a) temporarily divert program trading orders and impose limitations
on the entry of stop orders if the primary S&P 500 futures contract
declines by 12 points from its previous close if this price decline
occurs prior to 3:25 p.m. (Eastern). Specifically, when the 12-point
trigger is reached in the S&P 500 futures, for the next five minutes,
market orders involving program trading in each of the stocks
underlying the S&P 500 futures entered into the Exchange's automated
order-routing facilities are routed to a separate file for each such
stock. Buy and sell orders are then paired in the file to determine the
extent of the order imbalance, if any. After five minutes, the program
trading order imbalances, if any, are reported to the stocks'
specialists. The program orders then become eligible for execution.
Trading in a stock will halt, however, if there appears that there is
not sufficient trading interest on the Exchange to allow for an orderly
execution of a transaction in the stock.
The sidecar provisions of current NYSE Rule 80A(b) also prohibit
members or member organizations from entering certain types of stop
orders or stop limit orders for the remainder of the trading day if the
12-point trigger in the S&P 500 futures is reached prior to 3:25 p.m. A
member or member organization may, however, enter a stop order or stop
limit order of 2,099 shares or less for the account of an individual
investor pursuant to instructions received directly from that investor.
The Exchange proposes to eliminate these sidecar provisions in
their entirety. The Exchange represents that experience has shown that
program trading orders have not been entered in significant numbers
while a sidecar is in effect and that these restrictions, therefore, do
not appear to be necessary. The Exchange believes that the collars
contained in NYSE Rule 80A, along with the Exchange's trading halt
policy and circuit breakers contained in NYSE Rule 80B, obviate the
need for a sidecar. The NYSE's proposal to eliminate the sidecar
provisions was supported by the CME \17\ and the Broker-Dealers,\18\
and no objection to this aspect of the rule proposal was addressed by
Neuberger.\19\ In addition, the Commission staff's trading analysis of
October 27, 1997 indicated that the triggering of the sidecar
provisions had no discernible effect on that day's market decline.\20\
Accordingly, the Commission believes that the Exchange's determinations
regarding the elimination of the sidecar provisions are reasonable and
appropriate in the public interest.
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\17\ CME Letter at 1, supra note 4.
\18\ Broker-Dealer Letter at 1, supra note 4.
\19\ Neuberger Letter, supra note 4.
\20\ See Division of Market Regulation, Trading Analysis of
October 27 and 28, 1997 (September 1998), at 35 n. 102.
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B. Widening of the Collar Trigger Levels
The Exchange also proposes to widen the trigger levels for the
collar restrictions on index arbitrage program trading imposed by NYSE
Rule 80A(c). Currently, the collar restrictions apply to index
arbitrage trading in any component of the S&P 500 Stock Price Index
whenever the DJIA is up or down 50 points from its previous close. If
the market advances by 50 points or more, all index arbitrage orders to
buy must be stabilizing (buy minus); similarly, if the market declines,
all index arbitrage orders to sell must be stabilizing (sell plus). The
stabilizing requirements are removed if the DJIA moves back to or
within 25 points of the previous day's close.
In its proposal, the NYSE acknowledges that the stock market has
risen dramatically since the 50-point and 25-point triggers for Rule
80A(c) were adopted in 1990. The Exchange, therefore, proposes to
replace the current 50-point and 25-point triggers with thresholds set
at a ``two-percent value'' and a ``one-percent value'' of the DJIA.
These percent values would be translated into specific point levels at
the beginning of each calendar quarter based on a average for the DJIA
over the preceding month. Resetting the NYSE Rule 80A triggers on a
quarterly basis to retain alignments with the 2% and 1% thresholds of
the DJIA would be consistent with the procedures currently used by the
securities markets to reset the point triggers for the 10%, 20%, and
30% cross-market circuit breaker trading halts.
The Commission believes that the Exchange's proposal to widen the
current thresholds for NYSE Rule 80A is reasonable and appropriate in
the public interest. The shift to 2% and 1% thresholds for the collars
represents a significant improvement over the current 50-point and 25-
point triggers. The new percentage thresholds for Rule 80A should
result in a substantial reduction in the frequency of the application
of the rule's restrictions on index arbitrage trading, which have been
implemented on virtually a daily basis over the past few months. For
example, the 50-point collar provisions were triggered a total of 366
times in 1998; if the proposed 2% threshold had been in place, the
collar provisions would have been triggered only 42 times during the
year.
The Commission is sensitive to the issue raised in the Neuberger
comment letter that some small investors may be concerned that the
NYSE's proposal to
[[Page 8426]]
widen the collars to 2% and 1% could result in increased program
trading that may contribute to higher levels of market volatility.\21\
Nevertheless, the Commission questions whether Rule 80As current
restrictions on certain types of intermarket program trading strategies
are an appropriate means to address overall volatility. Indeed, the
Commission notes that last year the Working Group suggested that Rule
80A had become outdated and recommended that the NYSE at least
significantly increase Rule 80A's trigger levels.\22\
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\21\ Neuberger Letter at 1, supra note 4.
\22\ This position was reflected in a joint letter issued by the
Working Group to Richard Grasso, NYSE Chairman and Chief Executive
Officer, dated May 7, 1998 (``Working Group Joint Letter''), as well
as in the Working Group Staff Report on Circuit Breakers, issued on
August 18, 1998 (``Working Group Staff Report''), at 21.
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Although the Commission is approving the Exchange's current
proposal, it continues to question whether the restrictions on index
arbitrage that are retained in the revised Rule 80A are appropriate.
The markets have changed significantly over the past decade. For
example, the NYSE has substantially increased its system capacity so
that it can handle five times the trading volumes experienced in
October 1987. Moreover, the variety of derivative products has grown,
as has the array of derivative-related equity trading strategies. It
may make little sense to single out index arbitrage, which ensures that
markets are aligned economically, from all other types of program
trading. Indeed, the restrictions on index arbitrage may tend to
disconnect the securities and futures markets and impose unnecessary
costs on market participants.\23\
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\23\ See Working Group Staff Report at 21.
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Accordingly, although the Commission believes that the Exchange's
proposal meets the statutory standards for approval and that it
represents an improvement over the previous set of trading restrictions
contained in Rule 80A, the Commission recommends that the Exchange
periodically evaluate the continuing need for Rule 80A's restrictions
on index arbitrage.
C. The Rule's Definition of Index Arbitrage
In its proposal, the Exchange defines index arbitrage in
Supplementary Material .40 to Rule 80A to include some forms of ``basis
trading.'' \24\ As discussed above, the Broker-Dealers were critical of
the proposed revision to the definition of index arbitrage. In
particular, the Broker-Dealers indicated that the inclusion of basis
trading in the revised definition of index arbitrage would be
inappropriate and could apply to activities that are not typically
associated with index arbitrage and not reasonably implied by the
language of Rule 80A.\25\
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\24\ The proposed Supplementary Material .40 states that, for
purposes of Rule 80A, ``index arbitrage'' means a trading strategy
in which pricing is based on discrepancies between a ``basket'' or
group of stocks and the derivative index product (i.e., a basis
trade) involving the purchase or sale of a basket or group of stocks
in conjunction with the purchase or sale, or intended purchase or
sale, of one or more derivative index products in an attempt to
profit by the price difference between the basket or group of stocks
and the derivative index products. The inclusion of some forms of
basis trading for the application of the index arbitrage limitations
of Rule 80A was reflected in the NYSE Information Memorandum 92-23
(August 28, 1992) (``1992 Memo'').
\25\ Broker-Dealer Letter at 1-2, supra note 4.
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The Commission agrees with the Broker-Dealers that care needs to be
exercised by the NYSE in its interpretation of the proposed definition
of index arbitrage so that the collar restrictions are not applied to
activities that are not typically associated with index arbitrage and
not reasonably implied by the language of Rule 80A. The Commission also
agrees with the Broker-Dealers that a basis trade would be subject to
Rule 80A only if the trade otherwise satisfies all of the conditions of
the definition of index arbitrage contained in Supplementary Material
.40.\26\
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\26\ Id. at 3.
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The Commission understands that the NYSE regulatory staff has been
diligent in working with program trading firms over the past few years
to clarify which types of intermarket trading strategies are subject to
the collar provisions of Rule 80A and the Commission urges the Exchange
to continue these efforts. In the long term, the Commission believes
that the best resolution of the definitional issues raised by the
Broker-Dealer would be to have the Exchange reassess the overall
rationale for Rule 80A's restrictions on selected intermarket trading
stragies.
V. Conclusion
For the foregoing reasons, the Commission finds that the amendments
to NYSE Rule 80A are consistent with the requirements of the Act and
the rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-NYSE-98-45) is approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\27\
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\27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-4117 Filed 2-18-99; 8:45 am]
BILLING CODE 8010-01-M
